Lifecycle Investing - Leveraging when young

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ChrisBenn
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Re: Lifecycle Investing - Leveraging when young

Post by ChrisBenn » Tue Jan 14, 2020 8:54 pm

Appreciate the discourse!

I do think that human capital bears more in common with a bond than cash - wasn't trying to argue that specifically; just wanted to explore some of the areas where it seems to diverge from pure bond behaviour - since how it's modeled would have significant impacts on actual implementations of any strategies.

I have (finally) ordered the book as the notions here (so far) seem very appealing to me from a theoretical framework perspective. I definitely want a more in depth understanding of what actual implementation looks like (especially with different risk aversion factors).

Thanks again for starting this thread.

langlands
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Re: Lifecycle Investing - Leveraging when young

Post by langlands » Tue Jan 14, 2020 9:31 pm

Maybe I'm misunderstanding, but it seems like there is some conflation of the bond like characteristics of human capital and the asset class commonly called "bonds." While they share the interest rate risk, human capital has characteristics unique to each person. If you work in finance, your human capital is correlated to the financial sector of the stock market. I'd say for most people, human capital is more correlated with stocks than bonds actually.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Tue Jan 14, 2020 9:47 pm

langlands wrote:
Tue Jan 14, 2020 9:31 pm
I'd say for most people, human capital is more correlated with stocks than bonds actually.
That was not the conclusion of the research by John Heaton and Deborah Lucas in "Portfolio Choice in the Presence of Background Risk". They studied wages from 1979 to 1990 and found that the average person has a slight negative correlation between the salary increases and the stock market. However, there is substantial heterogeneity in the population: 33% of the population had a correlation below -0.15, 32% had one between -0.15 and 0.15 and the rest had a correlation above 0.15. Work by Vladyslav Kyrychenko goes deeper by sector: finance, insurance and real estate had a correlation of 0.21. Manufacturing had 0.17. Public administration 0.04 and wholesale/retail -0.07.

Either way, IMO, there's little to be gained from trying to study or speculate what others' human capital is correlated or not correlated to. What matters is your own. Moshe Milevsky (author of "Are you a stock or a bond?", a reasonably good read) has also delved into this field and has gone on to suggest that tenured Prof. leverage 280%, while mechanical engineers leverage 125%. I'm electrical but assume Mech.E is a reasonably close fit to me. I've conservatively set my correlation at 0.2.

Uncorrelated
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Re: Lifecycle Investing - Leveraging when young

Post by Uncorrelated » Wed Jan 15, 2020 4:03 am

ChrisBenn wrote:
Tue Jan 14, 2020 6:13 pm
UberGrub wrote:
Tue Jan 14, 2020 4:54 pm
Lee_WSP wrote:
Tue Jan 14, 2020 4:11 pm
(...)
Interesting reasoning. So the leverage must get you to greater than 100% equities as opposed to leverage the entire portfolio?
Im not sure what you’re saying. The point of lifecycle investing is to over invest in stocks (past 100% exposure to equities) because you’re so invested in “bonds” via your human capital.
So huge caveat in that I haven't read the book - only inferred things about it from this thread and discussion ...

... but, is it (lifecycle investing) really about only equity exposure specifically, or is narrative mostly focused on that because that's what you can get efficient leverage on at the individual investor level?

Wouldn't the standard MPT / leverage best risk adjusted return / etc. mantra still apply; one would just leverage it past the same volatility as straight equities (i guess, ideally, to the same volatility as your target equity exposure under lifecycle).

Now how feasible at the individual investor level this is is another issue, and I fully concede that logistics may make this a non-starter - but from the lifecycle investing POV this wouldn't be wrong, would it? If ones "end state" portfolio was a 50/50 portfolio @ 2 mil then once one had 1 mil of psdlx they would actually start divesting of it for a non-leveraged 50/50 portfolio as gains accumulated, right? Or did something in the book limit this only to equities?
Lifecycle investing is based on merton's portfolio problem. In particular, lifecycle investing solves merton's portfolio problem in special case where the universe only consists of two different assets: a risk-free rate yielding savings account and stocks. If you consider multiple different assets, the situation becomes more complicated. However, I have a tool that is able to solve merton's portfolio problem for arbitrary combinations of assets (for example see this post).

I disagree with Pelusa's implementation that lifecycle investing targets a constant equity exposure. Rather, lifecycle investing says you should invest in the portfolio with the highest utility with a given (fixed) risk tolerance. In the specific case where where you can only invest in the risk free rate and savings account and your lifetime wealth is bond-like, this corresponds to holding a constant percentage of your lifetime wealth in stocks.

On the salary issue, there are some academic papers that claim your salary becomes very equity-like in the last ~10 years of your life due to forced retirement risk (age discrimination, higher chance of being fired when there is a recession). Before that, your salary is very much like bonds.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Jan 15, 2020 8:56 am

Uncorrelated wrote:
Wed Jan 15, 2020 4:03 am
I disagree with Pelusa's implementation that lifecycle investing targets a constant equity exposure. Rather, lifecycle investing says you should invest in the portfolio with the highest utility with a given (fixed) risk tolerance. In the specific case where where you can only invest in the risk free rate and savings account and your lifetime wealth is bond-like, this corresponds to holding a constant percentage of your lifetime wealth in stocks.
?? My implementation targets a constant percentage of lifetime wealth. In fact, an argument early on in the thread was whether I should target a constant dollar value or % but I decided to stick with the latter.

If I say that I’m trying to hit X dollar amount in equity today, it is only because it represents Y% of my lifetime wealth today. It’s easier to think of leverage exposure in terms of a dollar exposure for me personally.

Lee_WSP
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Re: Lifecycle Investing - Leveraging when young

Post by Lee_WSP » Wed Jan 15, 2020 9:22 am

Are our salaries more like a junk bond or more like a corporate bond?

Uncorrelated
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Re: Lifecycle Investing - Leveraging when young

Post by Uncorrelated » Wed Jan 15, 2020 10:12 am

305pelusa wrote:
Wed Jan 15, 2020 8:56 am
If I say that I’m trying to hit X dollar amount in equity today, it is only because it represents Y% of my lifetime wealth today. It’s easier to think of leverage exposure in terms of a dollar exposure for me personally.
I think that's pretty confusing.

UberGrub
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Re: Lifecycle Investing - Leveraging when young

Post by UberGrub » Wed Jan 15, 2020 10:28 am

Uncorrelated wrote:
Wed Jan 15, 2020 10:12 am
305pelusa wrote:
Wed Jan 15, 2020 8:56 am
If I say that I’m trying to hit X dollar amount in equity today, it is only because it represents Y% of my lifetime wealth today. It’s easier to think of leverage exposure in terms of a dollar exposure for me personally.
I think that's pretty confusing.
Why is it confusing? I do the same thing. Add my current savings to the PV of future savings. Take 40% of that. And I try to buy enough exposure via options to get that nominal exposure.

I’m not even sure how else you could do it.

Lee_WSP
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Re: Lifecycle Investing - Leveraging when young

Post by Lee_WSP » Wed Jan 15, 2020 10:50 am

UberGrub wrote:
Wed Jan 15, 2020 10:28 am
Uncorrelated wrote:
Wed Jan 15, 2020 10:12 am
305pelusa wrote:
Wed Jan 15, 2020 8:56 am
If I say that I’m trying to hit X dollar amount in equity today, it is only because it represents Y% of my lifetime wealth today. It’s easier to think of leverage exposure in terms of a dollar exposure for me personally.
I think that's pretty confusing.
Why is it confusing? I do the same thing. Add my current savings to the PV of future savings. Take 40% of that. And I try to buy enough exposure via options to get that nominal exposure.

I’m not even sure how else you could do it.
While I think it makes perfect sense, it does assume that the salary portion is more or less going to happen. But I suppose historically aside from short bouts of unemployment, that’s more or less how we live our lives.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Jan 15, 2020 11:03 am

Lee_WSP wrote:
Wed Jan 15, 2020 10:50 am
UberGrub wrote:
Wed Jan 15, 2020 10:28 am
Uncorrelated wrote:
Wed Jan 15, 2020 10:12 am
305pelusa wrote:
Wed Jan 15, 2020 8:56 am
If I say that I’m trying to hit X dollar amount in equity today, it is only because it represents Y% of my lifetime wealth today. It’s easier to think of leverage exposure in terms of a dollar exposure for me personally.
I think that's pretty confusing.
Why is it confusing? I do the same thing. Add my current savings to the PV of future savings. Take 40% of that. And I try to buy enough exposure via options to get that nominal exposure.

I’m not even sure how else you could do it.
While I think it makes perfect sense, it does assume that the salary portion is more or less going to happen. But I suppose historically aside from short bouts of unemployment, that’s more or less how we live our lives.
Well idk about you but my future savings contributions WILL occur one way or another, whereas I’m fired or not. I simply don’t have enough today to retire regardless of my AA chosen. So I know I MUST accumulate somehow. So I know I can count on future accumulation. I simply will be destitute otherwise

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hdas
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Re: Lifecycle Investing - Leveraging when young

Post by hdas » Wed Jan 15, 2020 11:27 am

305pelusa wrote:
Fri Mar 01, 2019 12:11 am
Hello,
I recently came across the research from Prof. Ayres and Nalebuff about lifecycle investing and time diversification. The cliffnotes is that if one thinks about every future year as a potential bet, then it's in your best interest to spread out your bets as uniformly as possible across all those years. This means investing, to the best of your ability, the same dollar amount in stocks every year throughout your life. Since people accumulate money as they age, the implication is to use leverage when young to get closer to that target. That increases short term risk but, paradoxically, lowers long term risk. There are some rules set (such as not borrowing on credit, keeping leverage at 2:1 max, taking into account the nature of your income, etc) but that's the general idea.

The paper is here:

https://poseidon01.ssrn.com/delivery.ph ... 23&EXT=pdf

I decided to buy their book. I think their logic is sound and the results are extremely compelling. t was cool to read about MarketTimer since that's the thread that first got me thinking about it.

I found few threads opened in the past on the subject but they're a few years old so I wanted to start a new one to see if anyone is implementing the strategy, hear about other people's thoughts, recommendations for other forums where people implement similar strategies in the case that this forum is not appropriate for the topic, etc. I am basically right on the fence at the moment on whether to use the strategy or not.

Thank you

UPDATE: I am following this strategy and will update every 3 months.

May 2019
Stock Exposure = 235k
Debt = 92k
Equity in the exposure = 143k
Leverage = 1.64

Aug 2019
Stock Exposure = 251k
Debt = 101k
Equity in the exposure = 150k
Leverage = 1.68

Nov 2019
Stock Exposure = 412k
Effective Debt = 233k
Equity in the exposure = 179k
Leverage = 2.29
Pelusa,
I think you are doing it the right way. The only meta problem, or potential problem is that this approach constrains your flexibility to start new ventures or take some risks as entrepreneur. If you think your life will be only one of an employee with predictable cash flows, fine. But if one day you decide to get of the treadmill and take some risks and create something, you'll have to adjust your portfolio and hopefully you don't have to make the adjustments at an inconvenient time.

Cheers :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

Lee_WSP
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Re: Lifecycle Investing - Leveraging when young

Post by Lee_WSP » Wed Jan 15, 2020 11:34 am

305pelusa wrote:
Wed Jan 15, 2020 11:03 am
Lee_WSP wrote:
Wed Jan 15, 2020 10:50 am
UberGrub wrote:
Wed Jan 15, 2020 10:28 am
Uncorrelated wrote:
Wed Jan 15, 2020 10:12 am
305pelusa wrote:
Wed Jan 15, 2020 8:56 am
If I say that I’m trying to hit X dollar amount in equity today, it is only because it represents Y% of my lifetime wealth today. It’s easier to think of leverage exposure in terms of a dollar exposure for me personally.
I think that's pretty confusing.
Why is it confusing? I do the same thing. Add my current savings to the PV of future savings. Take 40% of that. And I try to buy enough exposure via options to get that nominal exposure.

I’m not even sure how else you could do it.
While I think it makes perfect sense, it does assume that the salary portion is more or less going to happen. But I suppose historically aside from short bouts of unemployment, that’s more or less how we live our lives.
Well idk about you but my future savings contributions WILL occur one way or another, whereas I’m fired or not. I simply don’t have enough today to retire regardless of my AA chosen. So I know I MUST accumulate somehow. So I know I can count on future accumulation. I simply will be destitute otherwise
If my income dried up or fell precipitously, investment contributions would be the second to go after unnecessary expenses such as daycare & entertainment/dining/drinks/et al.

I really don't have a better "no income coming in" plan other than to pickup side gigs like Uber which will not even come close to replacing my current income. And also wouldn't be possible if the cause of missing work is due to a catastrophic physical ailment.

Which is why I don't interpret human capital as anywhere near a "safe" asset and is more akin to a corporate or even a high yield bond.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Jan 15, 2020 12:25 pm

Lee_WSP wrote:
Wed Jan 15, 2020 11:34 am

If my income dried up or fell precipitously, investment contributions would be the second to go after unnecessary expenses such as daycare & entertainment/dining/drinks/et al.
I’m glad you’re in a situation in life where you can afford to just not save more. I certainly am not. If my income fell precipitously, I would need to get my investment contributions back up ASAP. In the short term, they’ll stop but not for any extensive amount of time.

Maybe that means I become a physical trainer, I severely cut my expenses, or whatever else.

That’s why I can count on them. I will have far bigger problems if I couldn’t.
Lee_WSP wrote:
Wed Jan 15, 2020 11:34 am

I really don't have a better "no income coming in" plan other than to pickup side gigs like Uber which will not even come close to replacing my current income. And also wouldn't be possible if the cause of missing work is due to a catastrophic physical ailment.
You should seriously buy disability insurance.
Lee_WSP wrote:
Wed Jan 15, 2020 11:34 am

Which is why I don't interpret human capital as anywhere near a "safe" asset and is more akin to a corporate or even a high yield bond.
That’s fine. Everyone will be different. I think of my future contributions as a high credit rating corporate bond.

If I thought it was a high yield or junk bond, with a reasonably high chance of going bankrupt and losing everything (I.e no chance to earn any more money for the rest of my life) I would invest far more conservatively than most BHs and annuitize ASAP

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Jan 15, 2020 12:35 pm

hdas wrote:
Wed Jan 15, 2020 11:27 am
305pelusa wrote:
Fri Mar 01, 2019 12:11 am
Hello,
I recently came across the research from Prof. Ayres and Nalebuff about lifecycle investing and time diversification. The cliffnotes is that if one thinks about every future year as a potential bet, then it's in your best interest to spread out your bets as uniformly as possible across all those years. This means investing, to the best of your ability, the same dollar amount in stocks every year throughout your life. Since people accumulate money as they age, the implication is to use leverage when young to get closer to that target. That increases short term risk but, paradoxically, lowers long term risk. There are some rules set (such as not borrowing on credit, keeping leverage at 2:1 max, taking into account the nature of your income, etc) but that's the general idea.

The paper is here:

https://poseidon01.ssrn.com/delivery.ph ... 23&EXT=pdf

I decided to buy their book. I think their logic is sound and the results are extremely compelling. t was cool to read about MarketTimer since that's the thread that first got me thinking about it.

I found few threads opened in the past on the subject but they're a few years old so I wanted to start a new one to see if anyone is implementing the strategy, hear about other people's thoughts, recommendations for other forums where people implement similar strategies in the case that this forum is not appropriate for the topic, etc. I am basically right on the fence at the moment on whether to use the strategy or not.

Thank you

UPDATE: I am following this strategy and will update every 3 months.

May 2019
Stock Exposure = 235k
Debt = 92k
Equity in the exposure = 143k
Leverage = 1.64

Aug 2019
Stock Exposure = 251k
Debt = 101k
Equity in the exposure = 150k
Leverage = 1.68

Nov 2019
Stock Exposure = 412k
Effective Debt = 233k
Equity in the exposure = 179k
Leverage = 2.29
Pelusa,
I think you are doing it the right way. The only meta problem, or potential problem is that this approach constrains your flexibility to start new ventures or take some risks as entrepreneur. If you think your life will be only one of an employee with predictable cash flows, fine. But if one day you decide to get of the treadmill and take some risks and create something, you'll have to adjust your portfolio and hopefully you don't have to make the adjustments at an inconvenient time.

Cheers :greedy
A fair point. Thankfully, we live in an age where business ventures can actually be rather inexpensive due to technology. You just gotta put in your time. I started a company with a friend on 2019 on the side and have already began to turn a profit.

That said, if I wanted to start a truly capital-intensive venture and that happened to be right on a market downturn, my options would be more limited. Not severely so (since I still probably would look for funding) but certainly worse than if I hadn’t leveraged. You’ll have to balance your own personal likelihood of this happening (and coinciding with a downturn) against the benefits of temporal diversification.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sat Jan 18, 2020 4:06 pm

If you're looking for simple, straight-forward leverage:

The Dec 2022 option contracts are now open for business. Little volume thus far but the strike price of 230 seems to have a couple of contracts going. At this strike price, you'd get approximately 3:1 leverage. Delta is solidly 1.00, so you're not paying for almost any downside protection. It has a decent amount of time value, unlikely to get exercised too early. If purchased in tax-advantaged, I estimate a borrowing cost of 3.65% (4.1% if you have a 15% LTCG tax).

One advantage of just buying the call is that it requires no margin of any kind. They are as easy to work with as a LETF. The borrowing cost does seem higher than LETFs. However, you avoid the daily reconstitution. And you still technically have some amount of downside protection, which is neat.

redstar
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Re: Lifecycle Investing - Leveraging when young

Post by redstar » Sat Jan 18, 2020 7:25 pm

305pelusa wrote:
Sat Jan 18, 2020 4:06 pm
If you're looking for simple, straight-forward leverage:

The Dec 2022 option contracts are now open for business. Little volume thus far but the strike price of 230 seems to have a couple of contracts going. At this strike price, you'd get approximately 3:1 leverage. Delta is solidly 1.00, so you're not paying for almost any downside protection. It has a decent amount of time value, unlikely to get exercised too early. If purchased in tax-advantaged, I estimate a borrowing cost of 3.65% (4.1% if you have a 15% LTCG tax).

One advantage of just buying the call is that it requires no margin of any kind. They are as easy to work with as a LETF. The borrowing cost does seem higher than LETFs. However, you avoid the daily reconstitution. And you still technically have some amount of downside protection, which is neat.
Do you have any thoughts on using XSP?

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sat Jan 18, 2020 8:16 pm

redstar wrote:
Sat Jan 18, 2020 7:25 pm
305pelusa wrote:
Sat Jan 18, 2020 4:06 pm
If you're looking for simple, straight-forward leverage:

The Dec 2022 option contracts are now open for business. Little volume thus far but the strike price of 230 seems to have a couple of contracts going. At this strike price, you'd get approximately 3:1 leverage. Delta is solidly 1.00, so you're not paying for almost any downside protection. It has a decent amount of time value, unlikely to get exercised too early. If purchased in tax-advantaged, I estimate a borrowing cost of 3.65% (4.1% if you have a 15% LTCG tax).

One advantage of just buying the call is that it requires no margin of any kind. They are as easy to work with as a LETF. The borrowing cost does seem higher than LETFs. However, you avoid the daily reconstitution. And you still technically have some amount of downside protection, which is neat.
Do you have any thoughts on using XSP?
I haven't looked into them. Perhaps I will in the future if I find some time.

ChrisBenn
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Re: Lifecycle Investing - Leveraging when young

Post by ChrisBenn » Sat Jan 18, 2020 8:29 pm

If you were using LEAP's for leverage in taxable I think you would not want XSP (or other index options), right? As long as you rolled after a year it would be 100 % LTCG (spy options) vs. 60% LTCG/40% LTCG (XSP / Index options). If you were rolling before a year the index options would be better.

In taxable I think you wouldn't want to do the synthetic long as well, right - as any gain on the put portion would be STCG (where the long would be LTCG) - the difference in those rates is going to trump the extra you are paying for downside protection (on average - i.e. assuming average rate of return), correct?

Basically buying calls on a security (not index) rolled one year and one day or later seems always optimal in taxable?

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sat Jan 18, 2020 8:55 pm

ChrisBenn wrote:
Sat Jan 18, 2020 8:29 pm
If you were using LEAP's for leverage in taxable I think you would not want XSP (or other index options), right? As long as you rolled after a year it would be 100 % LTCG (spy options) vs. 60% LTCG/40% LTCG (XSP / Index options). If you were rolling before a year the index options would be better.
That's my initial impression but in this world of leverage, borrowing, arbitrage, etc, I've learned not to take anything for granted until I see the numbers.
ChrisBenn wrote:
Sat Jan 18, 2020 8:29 pm
In taxable I think you wouldn't want to do the synthetic long as well, right - as any gain on the put portion would be STCG (where the long would be LTCG) - the difference in those rates is going to trump the extra you are paying for downside protection (on average - i.e. assuming average rate of return), correct?
It's not great that the put is STCG but it'll depend on your tax circumstances. Even accounting for taxes, my synthetic long in taxable will come out to about 1% less in borrowing costs than if I just bought a LEAP. Plus, I didn't have to liquidate holdings (paying taxes on those gains I had) to establish.

You can also sell the put on the SPX index and get more favorable tax treatment. That's not something I knew much about when I sold the put but after checking the numbers, it didn't help me that much either. So I didn't buy back my put, just left it there.
ChrisBenn wrote:
Sat Jan 18, 2020 8:29 pm
Basically buying calls on a security (not index) rolled one year and one day or later seems always optimal in taxable?
It depends a lot on your tax circumstances. In order of cheapest costs for me, they rank as:
1) Margin at IB
2) Synthetic long (with the put on SPY or SPX... they were similar for me)
3) Futures
4) Just a LEAP call

In order of how "easy" the position is:
1) Just a LEAP call (this is as B&H as it gets, uncallable and no margin)
2 & 3) Margin/Synthetic longs (once setup you can let them be but if the market moves, you might have to look into them)
4) Futures (you have to periodically refill your collateral cash or take out the cash to invest)

Just my 2 cents.

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