Author Topic: Using futures to leverage investment returns  (Read 16937 times)

zb3

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Using futures to leverage investment returns
« on: September 14, 2014, 05:01:35 PM »
Hi everyone,

I am curious if anyone uses futures to leverage investment returns?  I think I have thought of a way to get an extra 3 to 5% return a year using this method, but would welcome input from people incase I am missing something.

Leveraged investing may not be the best for everyone but research has suggested that x2 leverage delivers the strongest return over the long term.  I am young with a relatively high level of disposable income (thanks to this website for the savings tips) so figure it would be appropriate to leverage.

Anyway how this method would work:

For those who don't know anything about futures, they are essentially a contract to buy or sell something in the future at a set price.  Stock futures are cash settled.  All you need in your account is money to cover the margin of the gain or loss, and since you don't own anything you don't borrow money or incur interest charges.  I plan on using the S&P500 Emini for my strategy so I will just quickly explain how it works before listing out my strategy.  The Emini S&P 500 gives exposure to stock with a value of 50 times the index, i.e. the S&P 500 is at 2000 at the moment so 1 contract = 100k exposure.  The margin required to hold one contract overnight is around 6k.  If the S&P500 goes up 1 point you make $50, if it goes down 1 point you lose $50.  As markets generally trend upwards if you go long (i.e. buy) some of these contracts at a reasonably low level of leverage, you are set to gain $$.  The cost of one contract to buy and sell is around $ 16, they have a 3 month expiry so to get a years exposure it would cost around $64 (hardly more than the management fee you'd pay to a low cost index fund).

Suppose I have 100k:

I could buy 100k worth of VOO (vanguard S&p 500 index) and see a return of on average 10% a year not accounting for inflation

Or I could:

Put 30k into an account and buy one ES contract (S&P 500 Emini contract) which would give me exposure to 100k worth of S&P 500.  The average return on this would be around 8% as holding the contract doesn't entitle you to dividends as you don't actually own any stock.  Note that 30k is far more than required to hold one contract and the market would need to drop 600 points before getting stopped out.

Put 20k into a conservative mutual fund which allows access to funds within one week (we have one in NZ which has averaged 14% return since inception in March 2010 with very low volatility but lets assume its average return is 8%). This is a further 20k which can be accessed very quickly to top up margin. 

The remaining 50k into a low cost index fund like VOO for an average return of 10% a year.

The total return on this 100k would be as follows:

8k on ES ( as exposure to 100k)
1,600 on mutual fund
5,000 on VOO

Total 14,600 or 14.6% return a year.  Note this is not a dangerous level of leverage - its only 1.7.

Anyway I would appreciate some feedback from more knowledgeable members on this strategy.  Note this money is not money that I will need in the near future - it will be invested for at least 10 years.




innerscorecard

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Re: Using futures to leverage investment returns
« Reply #1 on: September 14, 2014, 07:31:02 PM »
An expected return is only a range of outcomes, not the outcome that will happen. Stocks have higher expected returns than other asset classes because they have a high range of outcomes, including negative ones. Leverage will only increase this variance.

I think the use of leverage is one case where buying the market is actually more dangerous than buying individual stocks that you might have the fortune of actually understanding.

foobar

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Re: Using futures to leverage investment returns
« Reply #2 on: September 14, 2014, 08:39:12 PM »
Back test your strategy using the past 15 to 20 years of results rather than making simplifying assumptions. For example how would you have down over 2008-2009 when you potentially would have lost your futures stake twice (once in 2008 and then in the follow up crash in 2009)? If it was easy to beat the market by 1% using a strategy like this, there would be 8 zillion mutual funds doing it. Leverage looks awesome in up markets. But those every 6 or 7 year bear markets  can really affect your returns.

zb3

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Re: Using futures to leverage investment returns
« Reply #3 on: September 14, 2014, 08:54:46 PM »
Back test your strategy using the past 15 to 20 years of results rather than making simplifying assumptions. For example how would you have down over 2008-2009 when you potentially would have lost your futures stake twice (once in 2008 and then in the follow up crash in 2009)? If it was easy to beat the market by 1% using a strategy like this, there would be 8 zillion mutual funds doing it. Leverage looks awesome in up markets. But those every 6 or 7 year bear markets  can really affect your returns.

Here is a link to an interesting article that has backtested the strategy in the context of leveraged ETFs (which have fees of around 1% so its better doing it yourself using futures) in various markets, the article concludes that x2 leverage is optimal.  http://ddnum.com/articles/leveragedETFs.php

I have looked at the 2008 crash and assuming you invested at the Oct 2007 high of 1576, at the march 2009 low of 666 you would have lost 910 x 50 = $45,500.  You would of course be very unlikely if that were to happen.  But so long as you don't out leverage yourself you will never be caught out - hence x2 leverage is best.

hodedofome

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Re: Using futures to leverage investment returns
« Reply #4 on: September 15, 2014, 08:54:16 AM »
Back test your strategy using the past 15 to 20 years of results rather than making simplifying assumptions. For example how would you have down over 2008-2009 when you potentially would have lost your futures stake twice (once in 2008 and then in the follow up crash in 2009)? If it was easy to beat the market by 1% using a strategy like this, there would be 8 zillion mutual funds doing it. Leverage looks awesome in up markets. But those every 6 or 7 year bear markets  can really affect your returns.

Actually there are funds that do this, look up Enhanced Index Funds. They use futures to buy the index and then plop a bond strategy on top of that.  Essentially a 50/50 stock/bond portfolio leveraged up 2x.

But I agree with you that everything like this should be back tested, and questions should be asked if you are being compensated properly for the additional risk. Leveraged strategies carry their own risk, and it could be deadly if you don't manage your risk.

beltim

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Re: Using futures to leverage investment returns
« Reply #5 on: September 15, 2014, 09:02:48 AM »
I recommend reading the book Lifecycle Investing by Ian Ayres and Barry Nalebuff.  They come to a similar conclusion that 2x leverage during one's working years enhances returns, and they do back-testing to show outperformance over history in a variety of developed markets (but not, I think, emerging markets).  Well worth a read.

aj_yooper

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Re: Using futures to leverage investment returns
« Reply #6 on: September 15, 2014, 12:56:50 PM »
Beltim, thanks for the reference.

foobar

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Re: Using futures to leverage investment returns
« Reply #7 on: September 15, 2014, 01:37:47 PM »
Back test your strategy using the past 15 to 20 years of results rather than making simplifying assumptions. For example how would you have down over 2008-2009 when you potentially would have lost your futures stake twice (once in 2008 and then in the follow up crash in 2009)? If it was easy to beat the market by 1% using a strategy like this, there would be 8 zillion mutual funds doing it. Leverage looks awesome in up markets. But those every 6 or 7 year bear markets  can really affect your returns.

Actually there are funds that do this, look up Enhanced Index Funds. They use futures to buy the index and then plop a bond strategy on top of that.  Essentially a 50/50 stock/bond portfolio leveraged up 2x.

But I agree with you that everything like this should be back tested, and questions should be asked if you are being compensated properly for the additional risk. Leveraged strategies carry their own risk, and it could be deadly if you don't manage your risk.

Enhanced Index funds are a generic term for ETFs with active management. There are definitely leveraged ETFs and mutual funds out there. SSO is one of the ones with the longest track record that I am aware of.  10k investing in 2006 has about the same performance as just buying into the S&P 500.  If you look at mutual funds, RYNAX is a leveraged mutual fund which I think has 150% leverage.  They started in 1993. You would have 55k versus 65k just investing in the index some 20 years later. The ER kills any gains you get by adding leverage.

If your a market timer (i.e. you upping your stock allocation  in Jan, Feb and March of 2009 from 50% to 90%), then these are great tools.  But I haven't seen much evidence that they work well for buy and holders. Leveraged Bond funds have worked out well but I wonder how much of that is a result of a pretty much continuous bond bull market for the past 30 years.

PeachFuzzInVA

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Re: Using futures to leverage investment returns
« Reply #8 on: September 15, 2014, 02:33:19 PM »
If you're looking to leverage your portfolio a bit, why not sell covered calls on what you already own? If the buyer actually exercises the call, you're selling your stock at a price you've already determined you're comfortable with. If the buyer declines to exercise the call, you've earned a few extra dollars to reinvest. It seems to address what you're trying to accomplish minus a lot of the risk.
« Last Edit: September 15, 2014, 03:23:58 PM by Nic »

foobar

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Re: Using futures to leverage investment returns
« Reply #9 on: September 15, 2014, 03:05:13 PM »
If you're looking to leverage your portfolio a bit, why not sell covered calls on what you already own? If the buyer actually excersises the call, you're selling your stock at a price you've already determined you're comfortable with. If the buyer declines to excersise the call, you've earned a few extra dollars to reinvest. It seems to address what you're trying to accomplish minus a lot of the risk.

With covered calls, you get all the risk and only half the reward:). Ok it is really all of the risk of stocks- the income you get from selling calls. You might have been happy to sell a stock at 100 but when news comes out that makes the stock worth 200, getting paid an extra 2 bucks doesn't seem like a great win. See something like
http://performance.morningstar.com/funds/etf/total-returns.action?t=PBP&region=usa&culture=en-US . You downside in 2008 was better than the index, but you gave back all those gains in 2013. And to make it even worse, you are generating ordinary income instead of capital gains. Historically writing covered calls makes more money in about 70% of the years (either bear markets to in a small enough trading range). The problem is in the 30% of the time you lose out big and those loses are about enough to even out the return.

PeachFuzzInVA

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Re: Using futures to leverage investment returns
« Reply #10 on: September 15, 2014, 03:23:10 PM »
If you're looking to leverage your portfolio a bit, why not sell covered calls on what you already own? If the buyer actually excersises the call, you're selling your stock at a price you've already determined you're comfortable with. If the buyer declines to excersise the call, you've earned a few extra dollars to reinvest. It seems to address what you're trying to accomplish minus a lot of the risk.

With covered calls, you get all the risk and only half the reward:). Ok it is really all of the risk of stocks- the income you get from selling calls. You might have been happy to sell a stock at 100 but when news comes out that makes the stock worth 200, getting paid an extra 2 bucks doesn't seem like a great win. See something like
http://performance.morningstar.com/funds/etf/total-returns.action?t=PBP&region=usa&culture=en-US . You downside in 2008 was better than the index, but you gave back all those gains in 2013. And to make it even worse, you are generating ordinary income instead of capital gains. Historically writing covered calls makes more money in about 70% of the years (either bear markets to in a small enough trading range). The problem is in the 30% of the time you lose out big and those loses are about enough to even out the return.

What sort of time frame are you looking at? I've only done it a handful of times, but have always kept the expiration date within a few months. I wouldn't advocate selling anything with an expiration say, a year out. Even still, if you sell it at a strike price you're comfortable selling the stock at, you shouldn't be too worried about lost returns beyond that price considering your shares are likely to have been called way beforehand and you've already reinvested the money and you were likely to have sold it had it reached the strike price anyway had you not sold the option.

edit: Dear God my spelling is horrible today
edit again: I'm not advocating this as a permanent income strategy like some talking heads do, but as a less risky strategy for someone interested in leveraging their portfolio.
« Last Edit: September 15, 2014, 03:40:33 PM by Nic »

Northerly

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Re: Using futures to leverage investment returns
« Reply #11 on: September 15, 2014, 03:29:19 PM »
x2 leverage delivers the strongest return over the long term. 

At what confidence interval, I wonder. I've dicked around back-testing leveraged futures, and holy fuck does timing matter. So between having to get the timing nuts-on, and knowing that you'll suffer sickening losses during volatility thanks to leveraged decay, it seems that this is more a speculation strategy than an investment strategy.

Believe me, I really wanted leveraged futures to be my ticket, but the supporting evidence is not there. Here's a fun website though: http://www.tradingfutures.biz/

zb3

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Re: Using futures to leverage investment returns
« Reply #12 on: September 15, 2014, 03:50:04 PM »
If you're looking to leverage your portfolio a bit, why not sell covered calls on what you already own? If the buyer actually exercises the call, you're selling your stock at a price you've already determined you're comfortable with. If the buyer declines to exercise the call, you've earned a few extra dollars to reinvest. It seems to address what you're trying to accomplish minus a lot of the risk.

Thanks I will have a look into them.

zb3

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Re: Using futures to leverage investment returns
« Reply #13 on: September 15, 2014, 03:54:19 PM »
x2 leverage delivers the strongest return over the long term. 

At what confidence interval, I wonder. I've dicked around back-testing leveraged futures, and holy fuck does timing matter. So between having to get the timing nuts-on, and knowing that you'll suffer sickening losses during volatility thanks to leveraged decay, it seems that this is more a speculation strategy than an investment strategy.

Believe me, I really wanted leveraged futures to be my ticket, but the supporting evidence is not there. Here's a fun website though: http://www.tradingfutures.biz/

That was an interesting link, he had the exact same idea as I have, pity he got greedy.  Timing matters to same extent - i.e. if you enter just before a crash you will be down for at least 5 years but over 20 years plus it seems to be a solid strategy if you can stomach the volatility

foobar

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Re: Using futures to leverage investment returns
« Reply #14 on: September 15, 2014, 04:00:45 PM »

What sort of time frame are you looking at? I've only done it a handful of times, but have always kept the expiration date within a few months. I wouldn't advocate selling anything with an expiration say, a year out. Even still, if you sell it at a strike price you're comfortable selling the stock at, you shouldn't be too worried about lost returns beyond that price considering your shares are likely to have been called way beforehand and you've already reinvested the money and you were likely to have sold it had it reached the strike price anyway had you not sold the option.

edit: Dear God my spelling is horrible today
edit again: I'm not advocating this as a permanent income strategy like some talking heads do, but as a less risky strategy for someone interested in leveraging their portfolio.

The price I was happy with 3 months ago (or even 1 day ago) may or may not reflect what I am happy with now. This is easiest to see in stocks where 1 earning or deal announcement can add 30%+ to a companies net worth. Yep when the stock is called away, you get to reinvest but there is not a ton of incentive for the option holder to do that early. There is a reason why volume tends to spike on option expiration dates.

This strategy reduces your risk of loss at the cost of potentially reducing your gains. It isn't horrible but it isn't something that is going to add 2%/yr to your returns from all the numbers i have seen

hodedofome

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Re: Using futures to leverage investment returns
« Reply #15 on: September 15, 2014, 07:20:28 PM »
Enhanced Index funds are a generic term for ETFs with active management. There are definitely leveraged ETFs and mutual funds out there. SSO is one of the ones with the longest track record that I am aware of.  10k investing in 2006 has about the same performance as just buying into the S&P 500.  If you look at mutual funds, RYNAX is a leveraged mutual fund which I think has 150% leverage.  They started in 1993. You would have 55k versus 65k just investing in the index some 20 years later. The ER kills any gains you get by adding leverage.

If your a market timer (i.e. you upping your stock allocation  in Jan, Feb and March of 2009 from 50% to 90%), then these are great tools.  But I haven't seen much evidence that they work well for buy and holders. Leveraged Bond funds have worked out well but I wonder how much of that is a result of a pretty much continuous bond bull market for the past 30 years.

Here's what I was talking about. They take an index strategy and layer on what I believe is their Total Return Bond fund https://investments.pimco.com/Products/pages/305.aspx

hodedofome

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Re: Using futures to leverage investment returns
« Reply #16 on: September 15, 2014, 07:34:54 PM »
x2 leverage delivers the strongest return over the long term. 

At what confidence interval, I wonder. I've dicked around back-testing leveraged futures, and holy fuck does timing matter. So between having to get the timing nuts-on, and knowing that you'll suffer sickening losses during volatility thanks to leveraged decay, it seems that this is more a speculation strategy than an investment strategy.

Believe me, I really wanted leveraged futures to be my ticket, but the supporting evidence is not there. Here's a fun website though: http://www.tradingfutures.biz/

The entire Commodity Trading Advisor/Managed Futures industry is based on market 'timing.' Essentially most of the funds are trend following in nature, using an objective trigger like a moving average or Donchian channels or something along those lines for entries and exits. Risk per trade is pre-defined and is much more robust, diverse and sophisticated than the overly simple strategy from that website. They will typically trade at least 40-50, sometimes 100+ worldwide, diverse, uncorrelated markets and go long the markets that are rising and short the markets that are falling. They would never risk more than 1% per trade and usually limit the number of correlated markets they will hold at one time. Also, account minimum sizes are usually $1-5 million+, simply because anything less is too risky on a per-trade basis. This guy starting out trading futures with $100k, and adding contracts on a regular basis, was far too leveraged. A good managed futures strategy can be as risky or as risk-less as you desire.

Here's an example https://drive.google.com/file/d/0BzyyTlvGE-T2UGFSMkpsa2lkY1E/edit?usp=sharing
« Last Edit: September 15, 2014, 07:44:03 PM by hodedofome »

larmando

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Re: Using futures to leverage investment returns
« Reply #17 on: September 15, 2014, 07:46:06 PM »
Short answer: this is a bad idea, and I wouldn't do it. If it was easy&safe everybody would do it, but it's not.

Long answer: http://www.bogleheads.org/forum/viewtopic.php?f=10&t=5934
(someone tried exactly that, and lost everything, plus finished with 210K in debt. it's not the only outcome, but it's *a possible outcome*, not sure whether you are comfortable with that possibility)

Equities have some risk, but if they drop in price you still (a) receive some dividend and (b) can wait for a recovery as long as you know for sure you won't need the cash. They're like a non-mortgaged rental property that lost half its value and on which you had to cut the rent, possibly. Not the best thing in the world, but also not the worst problem to have.

As for leveraged equity, you're just a big drop and a margin call you can't make away from losing *everything*, and being back at 0 to negative net worth. It's actually *worse* than a very mortgaged property, as the margin call may be for an arbitrary amount and very sudden, while a mortgage has at least very regular and expected payments (although that doesn't help if you cash flow has been obliterated, and you can still be foreclosed on).


hodedofome

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Re: Using futures to leverage investment returns
« Reply #18 on: September 15, 2014, 08:17:16 PM »
Totally agree that this is probably a really bad idea. Just leveraging 1 asset (US stocks) is making a giant macro bet on the future of the US economy. It's not diversified enough and it's a risky enough asset class WITHOUT leverage. Now leveraging up a 'balanced,' 'low-volatility' portfolio like the permanent portfolio...not as horrible...

However, without having read all 1400 posts from that Bogleheads thread...here's a little tip that'll save people a bunch of headaches in the future. If you are just dead set on going with a particular strategy to outperform the indexes, apply the Buffett/Graham value mindset and BUY INTO THE DRAWDOWN. What I mean by that, is to view strategies the same way Graham viewed stocks, buy when they are cheap. Deciding to leverage up a stock index in the 5th year of a bull market (2007) is more retarded than Taylor Swift. The time to do that, is AT LEAST after a 10-20% pullback. Most people do the opposite and, after a big bull run like we've had, look back and think about all the money they could have made if they had just done 'X.' However, the intelligent person will wait until the next bear market, and only then buy into the strategy.

zb3

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Re: Using futures to leverage investment returns
« Reply #19 on: September 15, 2014, 08:55:00 PM »
Both good points Larmando and Hodedofome.   The thing that attracts me to futures is you do not have to pay any interest - the only cost of leveraging a futures contract for a year is the $60 odd you have to pay to roll over the quarterly contracts.  At the same time, one futures contract does equate to 100k of S&P which is a huge investment in itself.

You have both scared me off this strategy for now, I think I will spend awhile researching and thinking and when the market next goes on sale I will be ready with a futures contract or two.

Perhaps for now I will just leverage by 1.2 or so using a margin loan through interactive brokers.  I saw they charged 1.59% interest on USD which is incredibly low, does anyone know if that applies only to US residents or anyone investing with USD?  Interest rates over in NZ are crazy high and it would be awesome to take advantage of the low US rates.

zb3

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Re: Using futures to leverage investment returns
« Reply #20 on: September 15, 2014, 09:29:55 PM »
x2 leverage delivers the strongest return over the long term. 

At what confidence interval, I wonder. I've dicked around back-testing leveraged futures, and holy fuck does timing matter. So between having to get the timing nuts-on, and knowing that you'll suffer sickening losses during volatility thanks to leveraged decay, it seems that this is more a speculation strategy than an investment strategy.

Believe me, I really wanted leveraged futures to be my ticket, but the supporting evidence is not there. Here's a fun website though: http://www.tradingfutures.biz/

Also I'm not sure you are right about volatility decay in a strategy such as mine.  There is definitely volatility decay with leveraged ETFs as they replicate 1 day returns, not returns for an extended period.  Ie essentially they 'loan'/leverage and repay all in the same day - i.e. buy the future at open and sell at close, whereas with holding a future long term you aren't repaying it the same day.  Let me illustrate with an example:

Lets assume for simplicity the S&P 500 is at 100, and an investor is investing in a x2 Leveraged ETF (thus has x2 exposure):

Day 1:  Market up 10% - the ETF investor goes from 200 to $220, repays the $100 borrowed and retains $120.
Day 2:  Now as the investor has $120, in order to get x2 leverage he needs to borrow 120, thus investing 240.  Prices go down 10%, the investor loses $24, repays the 120 'loan' and only retains 96 dollars.

A non leveraged investor would have lost 1 dollar - i.e. from 100 to 110 to 99.  Yet the guy with the leveraged ETF has lost 4 dollars - more than double the non leveraged investor.

The point is that with leverage ETFS you are maintaining a leverage of x 2 EVERYDAY, thus you get volatility decay.  This isn't the same with the futures strategy above:

Now lets assume he starts with x2 leverage but doesn't repay the 'loan' i.e. doesn't sell the future at the end of each day:

Day 1: Market up 10% - S&P goes to 110, leveraged investor goes from 200 to 220
Day 2:  Market down 10% - S&P goes to 99, leveraged investor goes to 198.

Leverage has not decayed his returns he has simply made or lost double the unleveraged investor - as you would expect.  Ie at day 2 he has lost 2 dollars compared to the non leveraged investor who has lost 1 dollar.  Following this strategy you are not always using x2 leverage, sure he starts out with x 2 leverage (as has exposure to 200 when only owns 100), but as futures are marked to market daily, at day two he has 120 dollars in his account but is only exposed to 220 S&P.



« Last Edit: September 15, 2014, 09:41:29 PM by zb3 »

larmando

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Re: Using futures to leverage investment returns
« Reply #21 on: September 17, 2014, 07:35:43 PM »
Day 1: Market up 10% - S&P goes to 110, leveraged investor goes from 200 to 220
Day 2:  Market down 10% - S&P goes to 99, leveraged investor goes to 198.

Leverage has not decayed his returns he has simply made or lost double the unleveraged investor - as you would expect.  Ie at day 2 he has lost 2 dollars compared to the non leveraged investor who has lost 1 dollar.  Following this strategy you are not always using x2 leverage, sure he starts out with x 2 leverage (as has exposure to 200 when only owns 100), but as futures are marked to market daily, at day two he has 120 dollars in his account but is only exposed to 220 S&P.

Yes. Now make the same account for the market losing 10%, then another 20%, then another 30%....: can you maintain the right margin in your account not to lose your exposure? If you read the thread I posted the person starts at X2, and ends up at more than X10, while trying to keep his position over. Then fails to do so. If you have enough money at the beginning to support X10, but only buy X2 this might work, with the caveat that you have a lot of money sitting idle "just in case", which of course eats your return, plus in the meantime you lost dividends. If you just have the X2 (or X4 to be "safe") you better be able to conjure up a lot of money very fast. Also you're buying price, not the right to a cash flow depending on the business conditions. Is it worth it? Well, if you *know* the market will do what it did 2009 to now, yes. If it's 2007, 2000, or so, absolutely not.



zb3

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Re: Using futures to leverage investment returns
« Reply #22 on: September 17, 2014, 08:27:14 PM »
I have nearly read half of that thread.  One of the best threads I have ever read tbh.  Cheers for the link.

Yes that is true that if the market drops your leverage will increase and vice versa.

My plan is to wait until the market drops 30% from its high, then I will buy 1 or 2 Emini contracts - this is dependent upon what capital I have at this point, as the capital I have and my cash flows will determine how many I buy.  At this stage I would buy enough to obtain a leverage of 1.6 to 1.7.  If the market goes up from that point then all the better for me.  If it drops further I would purchase 1 or 2 small cap future contracts like the Russell 2000.  Small caps recover faster in a recession.    Ie in March 2009 Russell 2000 reached its low of 342, by Dec 31 2009 it closed at 625 an 83% gain.   Comparatively, the S&P 500 only gained 66% from its low in March to Dec 31.

My overall goal is to have enough capital to withstand a 60% crash from the market's high and to never exceed x3 to 3.5 leverage.  Even if the market dropped more than 60% (very unlikely) I would use my cash-flow from employment to top up margin.

At the end of the day, if the market dropped more than this and I got wiped out, it would not be as bad as someone in their forties with 1mill odd equity exposure who would lose 700 odd thousand.

I like Market Timer's points about temporal diversification.

Everyday you are in the market you are essentially placing a wager that you will make money that day.  You can do this as the odds are in your favour, but to best exploit these odds you need to place the bet as many times as you can.  Basic probability suggests you will come out better off if your bet is always the same size in real terms, otherwise larger bets will dominate your payoff.

The problem young people face is the older they get the more equity exposure they have in real terms.  Ie for someone like me, I will have my greatest exposure to the equity market between the years of 45 to 55 (ie years 2035 to 2045).  If the market does historically badly in that 10-year period, then I will have far less to retire with.  Hence over time I am spreading my risk if I leverage while young.






 
« Last Edit: September 17, 2014, 08:30:42 PM by zb3 »

foobar

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Re: Using futures to leverage investment returns
« Reply #23 on: September 17, 2014, 10:06:53 PM »
I have nearly read half of that thread.  One of the best threads I have ever read tbh.  Cheers for the link.

Yes that is true that if the market drops your leverage will increase and vice versa.

My plan is to wait until the market drops 30% from its high, then I will buy 1 or 2 Emini contracts
 

This sounds fine as a strategy but you are likely to only see 30% drops every 10 or so years years.  I am not sure you can make enough money off that rate of event. If you get more aggressive (buy in when down 15%) you will have more opportunities but you will always run the risk that is is -15% going to -30%. When you look at 2008-2009, think about when you were buying in and selling and think about what being off by a week either way (buying too soon or selling too late) would have done to your returns.

zb3

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Re: Using futures to leverage investment returns
« Reply #24 on: September 17, 2014, 10:37:43 PM »
Yes it is probably better that I stage it some more and say implement 1.3 or so leverage after a 15% market downturn.  Even if I waited for a 30% downturn, there is still plenty of money to be made.  Ie in the 2008 crash if I waited for a 30% drop from its high, I would have got in the market at 1100, assuming I purchased 2 contracts and held them until now, I would have made 90k profit.  Of course I would have lost 43,400 before I even started to profit.  If i were to also to purchase 2 Russell 2000 futures contracts after 40% downturn and held them until now I would have made 120k odd.  I would have lost 48k on those before I started to make a profit too.  Overall 100k down before going up over 300k to finish with a profit of 210k on 4 futures contracts sounds pretty outstanding to me.

foobar

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Re: Using futures to leverage investment returns
« Reply #25 on: September 18, 2014, 12:31:33 PM »
Yes it is probably better that I stage it some more and say implement 1.3 or so leverage after a 15% market downturn.  Even if I waited for a 30% downturn, there is still plenty of money to be made.  Ie in the 2008 crash if I waited for a 30% drop from its high, I would have got in the market at 1100, assuming I purchased 2 contracts and held them until now, I would have made 90k profit.  Of course I would have lost 43,400 before I even started to profit.  If i were to also to purchase 2 Russell 2000 futures contracts after 40% downturn and held them until now I would have made 120k odd.  I would have lost 48k on those before I started to make a profit too.  Overall 100k down before going up over 300k to finish with a profit of 210k on 4 futures contracts sounds pretty outstanding to me.

How much money would it have taken to do this (contract cost and margin call requirements) and what would have been the return on just dumping that money in TSM at the various points (i.e. when the S&P 500 is down 30%, when you get your margin call,....). I am not super familiar with very long term ( you are talking 6 years) future contracts but I wouldn't be shocked to learn that from the bottom of a market to the top, you make a ton of money. You make a lot of money in stocks also.  The question is can you get out in time (i.e. how did you know to be fully invested in 2011 when the market pulled back 20% but not in 2008 when it pulled back 20% on the way to much steeper drop) and how much the cost of that leverage will eat into your returns.

To some extent I think market timing gets a bad name. Guessing what the market will do over the next 6 months is pretty much impossible. But guessing what the market will do after a 25% drop is a lot more biased (sure it can go down another 25% but the odds are against) one way so if you normally hold a conservative allocation (call it 50/50) being more aggressive (either with futures or just buying more stocks) during those cases makes sense but you need a plan both on when to get in and out. It is easy to look at the past an say you buy on March of 2008 and hold but along the way you had several 10%+ pull backs and figuring out if they are the next crash or just a dip is voodoo:)

zb3

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Re: Using futures to leverage investment returns
« Reply #26 on: September 18, 2014, 04:05:05 PM »
Futures contracts expire quarterly, to roll over each contract costs about 16 dollars, so 64 dollars for one years exposure per contract.  The margin to hold overnight is about 5k per contract - this is the initial margin.   You also have a maintenance margin which is the min your account can drop to before getting margin called - around 3k.  So I buy one Emini and post the initial margin of 5k, lets say the S&P drops 45 points, as one futures contract is 50 times the index, at the end of the day when the contract is marked to market, I would have lost 2250 so my account would be at 2750, below the 3k so I would need to top up my margin.

Yes it is useful to have a very conservative plan.  I aim to be able to survive a 60% drop from a high.  In Oct 2008 the S&P high was around 1550, if the market dropped 30% to 1085 I would enter at x2 leverage.  When the market dropped to its low of 666, thats a 39% drop from when I entered, (57% drop from the high).  By virtue of that drop, my x2 leverage would now be at 5.5 x leverage.  Ie I have 100k but exposed to 200k stock, 39% drop means I have 122k exposure but only 22k in my account - a 78% loss.

foobar

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Re: Using futures to leverage investment returns
« Reply #27 on: September 18, 2014, 08:52:24 PM »
Futures contracts expire quarterly, to roll over each contract costs about 16 dollars, so 64 dollars for one years exposure per contract.  The margin to hold overnight is about 5k per contract - this is the initial margin.   You also have a maintenance margin which is the min your account can drop to before getting margin called - around 3k.  So I buy one Emini and post the initial margin of 5k, lets say the S&P drops 45 points, as one futures contract is 50 times the index, at the end of the day when the contract is marked to market, I would have lost 2250 so my account would be at 2750, below the 3k so I would need to top up my margin.


Can you explain how you came up with your gain? You talk about buying 4 contracts when the market is off but I don't think you can do that (I thought there were 2 year year futures on the s&p 500 but I might be misremembering that). When you start having to buy and sell quarterly (or even yearly), tax drag and transaction costs add up in a hurry. You can't just multiple out what those 4 contracts would be worth at todays S&P values.  You also have to decide when you are not going to be leveraged. If you plan is to buy after 30% drops, after the market doubles do you get out or stay in? Do you have a plan to get out?  It is real easy to make your strategy look good by cherry picking time periods.

Doing thing like 1.5 leverage seem pretty doable (i.e. you should be able to make margin calls) but the problem tends to be that the transaction costs eat up most of the gains when you stay fully invested.

zb3

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Re: Using futures to leverage investment returns
« Reply #28 on: September 18, 2014, 10:24:57 PM »
Transaction costs on futures are low - 16 dollars to buy and sell one, as they expire quarterly, one years exposure will cost you 65 dollars. That is barely any more than you pay in passive index funds.  Currently one contract gives exposure of 100k.  On 100k of VOO you would pay 0.05% management fee or $50.  So not really much difference.

In regards to tax drag, I am from NZ and we have a different tax system.  Under our double tax agreement with the US, we effectively get taxed twice on dividends as we do not receive the benefits of imputation credits and are then subject to 15% withholding in the US and 15% in NZ.  But futures don't pay dividends.

We don't get taxed on capital gains in NZ but I am unsure how it works for foreign futures.  In regards to foreign shares, any investment above 50k  gets taxed at our marginal tax rate on a max of 5% of our total portfolio value every year, with no deduction for losses, but in the event of a loss we don't have to pay any tax.  We don't have any tax advantaged accounts or anything like that as you have in the US.

In regards to how gains are calculated, futures contracts are worth various multiples of the index, an S&P Emini has a multiple of 50, a russell 2000 contract has a multiple of 100.  So if the index moves 1 point you make 50 for an Emini and 100 for a russell.

As the market goes up you stay in the contracts, but by virtue of the market rising your leverage decreases.

Ie assume at the bottom of the market (s&P 666) I own 3 Emins and have 33k in my margin account (x3 leverage).  Lets assume the market rises from 700 to 2000 as in the last recession.  I make 1300 x 3(as 3 contracts) x 50 = 195k. 

My leverage = exposure/investment.

My exposure is now 3 x 2000 x 50 = 300k.
The amount I have invested (i.e. sitting in my margin account is 33k + 195k = 228k.
Leverage = 300k/228k = 1.31.

Of course has the amount in your margin account gets higher you may wish to take some out and put it elsewhere, i.e. in NZ we can currently get 4.5% from a savings account in a bank, so that could be a better option than leaving it rotting in the brokerage account.  Alternatively some could be taken out and invested into shares, but that would increase leverage.

« Last Edit: September 18, 2014, 11:02:46 PM by zb3 »

foobar

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Re: Using futures to leverage investment returns
« Reply #29 on: September 19, 2014, 07:19:02 AM »
I will not pretend to understand NZ tax laws. In the US you will get taxed on each transaction. That is a huge drag on performance when measured out over 5 years. And in the use LTGC are at lower rates than OI or the funky futures rate. That friction along the way eat up returns.


I feel we are talking across each other. Let me see if I can simplify it. If you had bought when the market was down 30% (~1000 in oct 2008), how much money would you have had to have invested by March 2009 when the market bottomed out? What would have been the return if you had just invested that money in TSM in October 08 versus buying the future contracts? Now in a lot of ways 2008 is a worst case for this system (normally you don't get another 30% drop after the first one) but when evaluating a system, don't cherry pick a situation that makes it look good (i.e. pretty much any time you buy stocks at a 10 year low, you will do well long term).  I expect you will have made more money than just buying TSM but I think the numbers will be very close ( in the 10-20%)

waltworks

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Re: Using futures to leverage investment returns
« Reply #30 on: September 19, 2014, 08:54:37 AM »
TANSTAAFL

-W

foobar

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Re: Using futures to leverage investment returns
« Reply #31 on: September 19, 2014, 03:14:17 PM »
TANSTAAFL

-W

No one thinks there is a free lunch in futures. The questions is the reward high enough to compensate for it.  My impression has always been no. You get the higher return in theory but over complete market cycles the drag is enough to suck up all that added return. If you start being selective about when to apply leverage, I expect you to make more money. The question is do those opportunities come about often enough (i.e. if you only leverage up when the market is down 40% and you deleverage within 3-4 years) can you make enough to make it worthwhile?  And if you leverage up more often (on any 10% dips), do you make more (there are a lot of -10% dips) or less money (some of those -10% are on the way to -50%).

waltworks

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Re: Using futures to leverage investment returns
« Reply #32 on: September 19, 2014, 03:53:23 PM »
Yes, if you have to work more to get more, that makes the lunch... not free.

-W

hodedofome

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Re: Using futures to leverage investment returns
« Reply #33 on: September 19, 2014, 07:28:09 PM »
Recommend reading Following the Trend by Andreas Clenow. It deals with futures trading, position sizing and entry and exit strategy. Trend followers have been doing this on futures since at least the early 70s. A lot of your questions have already been answered in the books.

zb3

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Re: Using futures to leverage investment returns
« Reply #34 on: September 20, 2014, 12:53:44 AM »
I will not pretend to understand NZ tax laws. In the US you will get taxed on each transaction. That is a huge drag on performance when measured out over 5 years. And in the use LTGC are at lower rates than OI or the funky futures rate. That friction along the way eat up returns.


I feel we are talking across each other. Let me see if I can simplify it. If you had bought when the market was down 30% (~1000 in oct 2008), how much money would you have had to have invested by March 2009 when the market bottomed out? What would have been the return if you had just invested that money in TSM in October 08 versus buying the future contracts? Now in a lot of ways 2008 is a worst case for this system (normally you don't get another 30% drop after the first one) but when evaluating a system, don't cherry pick a situation that makes it look good (i.e. pretty much any time you buy stocks at a 10 year low, you will do well long term).  I expect you will have made more money than just buying TSM but I think the numbers will be very close ( in the 10-20%)

I'm not cherry picking a scenario that will give a favourable result.  The 2008-09 crash was one of the largest draw downs in history, hence why I picked it.  If this strategy can survive 08-09 its well placed to survive almost anything.

A 30% drop from the high in 07 (1555) would mean you start investing at 1088.  Assume after a 40% drop form that high you upped the leverage (933), and again at a 50% drop (777).  Suppose you had 80k to invest.

Scenario 1 (using futures):

Buy 2 contracts at 1088 = 108,800 exposure (remember 1 point in S&P) = $50 per future.  Leverage = 108800/80k = 1.36
Buy 1 more contract at 933.  Total exposure = 139,950.  Leverage = 139950/64500 = 2.17.  64500 figure arrived at by 933/1088 = .8575.  .8575 x 108800 = 93300.  108800 - 93300= 15500.  80k - 15500 = 64500.
Buy 1 more contract at 777.  Total exposure = 155,400.  Leverage = 155400/41100 = 3.78
At 666 total leverage would be 133200/18900 = 7.05.  Not Ideal but thats after a 58% drop in the S&P and at a low level of investment wouldn't be disastrous.

By the time S&P rose to 2000 you would have:  (2000 - 666) x 4 x 50 + 18900 = 285700 and leverage of 400k/285700 = 1.4

Note:  If you kept additional money in the bank and only topped up your margin account when needed you would have even more money.

Scenario 2 (no futures):

Invest the entire 80k at the bottom of the market at 666.  You would have 240k.  As you can see the futures strategy still wins.  Had you invested the 80k at a more realistic time, i.e. at 30% down like you did with futures, you would have a lot less.





zb3

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Re: Using futures to leverage investment returns
« Reply #35 on: September 20, 2014, 12:54:27 AM »
Recommend reading Following the Trend by Andreas Clenow. It deals with futures trading, position sizing and entry and exit strategy. Trend followers have been doing this on futures since at least the early 70s. A lot of your questions have already been answered in the books.

Thanks.  I found a pdf version on google and will read on my phone whenever I have a spare moment.

TomTX

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Re: Using futures to leverage investment returns
« Reply #36 on: September 20, 2014, 05:39:41 AM »
The biggest way individual investors lose out is by leaving cash on the sidelines waiting for a crash, and missing the runups while inflation nibbles away the cash.

MidWestLove

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Re: Using futures to leverage investment returns
« Reply #37 on: September 20, 2014, 06:45:33 AM »
let us be honest -for all purposes , it is gambling unless you want to do it professionally in which case it is work. there could a lot of expressed reasons to use leverage and risk management tools like options or futures, but in absolute majority of the case it is gambling for individual investor. and you are gambling against another investor (i.e. options) , at significant price disadvantage, plus transactions costs. Why would anyone want to do this is beyond me unless you own a futures brokerage and collect the transaction fees.

I am a little older than original poster and I have seen people really screw themselves up with options back in 90s , including co-workers that got into the rush and ended up losing their jobs, money, in some cases visa (H1B) because they pressure and stress of dealing with up and downs of such 'portfolios' was too much and was taken time from duties they were expected to do.

zb3

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Re: Using futures to leverage investment returns
« Reply #38 on: September 21, 2014, 05:42:34 PM »
The biggest way individual investors lose out is by leaving cash on the sidelines waiting for a crash, and missing the runups while inflation nibbles away the cash.

You don't have to do that.  Leave your money in shares just leverage when the stock market drops.  Or keep some money in bonds/ your mortgage and use that

zb3

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Re: Using futures to leverage investment returns
« Reply #39 on: September 21, 2014, 05:44:13 PM »
let us be honest -for all purposes , it is gambling unless you want to do it professionally in which case it is work. there could a lot of expressed reasons to use leverage and risk management tools like options or futures, but in absolute majority of the case it is gambling for individual investor. and you are gambling against another investor (i.e. options) , at significant price disadvantage, plus transactions costs. Why would anyone want to do this is beyond me unless you own a futures brokerage and collect the transaction fees.

I am a little older than original poster and I have seen people really screw themselves up with options back in 90s , including co-workers that got into the rush and ended up losing their jobs, money, in some cases visa (H1B) because they pressure and stress of dealing with up and downs of such 'portfolios' was too much and was taken time from duties they were expected to do.

I disagree that it is gambling.  More like a calculated risk with the odds in your favour.  But you make a good point regarding stress.  I'll try it out and see how I handle it, if I don't handle it well at least I tried it when the amount of money was relatively small

MidWestLove

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Re: Using futures to leverage investment returns
« Reply #40 on: September 21, 2014, 06:04:54 PM »
" disagree that it is gambling.  More like a calculated risk with the odds in your favour"

honestly, good luck (and I mean it). you are playing in a casino in which you have to pay for privilege of placing each bet (transaction fees and commissions). if you had valid reason to hedge specific, large risks (i.e. operating a cattle business, owning a refinery ,etc) I would understand desire to work with futures as a financial instrument. otherwise you are gambling, with a disadvantage. but luck may be in your favor and it is your money and your life to play with. have fun

zb3

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Re: Using futures to leverage investment returns
« Reply #41 on: September 21, 2014, 07:16:10 PM »
" disagree that it is gambling.  More like a calculated risk with the odds in your favour"

honestly, good luck (and I mean it). you are playing in a casino in which you have to pay for privilege of placing each bet (transaction fees and commissions). if you had valid reason to hedge specific, large risks (i.e. operating a cattle business, owning a refinery ,etc) I would understand desire to work with futures as a financial instrument. otherwise you are gambling, with a disadvantage. but luck may be in your favor and it is your money and your life to play with. have fun

You have a very wide definition of gambling.  You cannot seek to remove every risk from your life.  Everything has a risk.  What you fail to understand is that this strategy actually reduces risk by spreading equity exposure over time.  You sound like someone who jumps to conclusions before working through the numbers in your head.

bigchrisb

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Re: Using futures to leverage investment returns
« Reply #42 on: September 21, 2014, 07:31:38 PM »
I've been lurking on this thread for a while.  I'm someone who isn't shy about leverage (I spent most of the GFC highly leveraged, including a couple of margin calls, but came through it ok).

I suspect we are of similar outlooks - I was the kid playing monopoly who worked out the probability distribution of my opponents next roll, against the transaction costs of buying/selling houses / mortgaging properties.  I think of myself as very numerical and rational.

However, I had under-appreciated my own psychology being leveraged into the market while its in freefall, and in the receipt of margin calls.  I learned a lot about myself during those times, and to follow form that moderated my use of leverage a bit.

On paper, your plan looks like a good one.  From my own experience, I'd caution you to think twice about your psychological reaction to this much leverage, and if your behavior can match your theory, when the proverbial hits the fan. 

zb3

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Re: Using futures to leverage investment returns
« Reply #43 on: September 21, 2014, 07:51:55 PM »
Did your use of leverage result in a higher return than you would have achieved without leverage?

Yes I agree, the psychological aspect is the only part that worries me in my method.  Although I do not think I am the type to let emotions control my decision, I guess you never know how you will react in the face of huge losses.

I knew nothing of saving and investing until early feb, and had 30k in a bank deposit.  Since learning how to budget and invest, I now have 58k, and I am still at uni.  I never realised how easy it was to accumulate $ if you just save hard and invest well.  If a recession were to hit now I would not feel much if my stash were to drop to 10k, as I know that in the grand scheme of things this is nothing but a drop in the ocean of my net worth.  I just have to trust that my plan will work out and that when I start working full time next year, my cash flow will be able to cover any margin calls on my piddly portfolio.  Although if the recession were to not hit until a few years later, and at that point I had 200 odd thousand, I may not take huge losses so well, but I'll never know until I try. 
« Last Edit: September 21, 2014, 08:01:39 PM by zb3 »

bigchrisb

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Re: Using futures to leverage investment returns
« Reply #44 on: September 21, 2014, 09:20:02 PM »
Did your use of leverage result in a higher return than you would have achieved without leverage?

Depends on which period you pick!  There are periods in there where my returns were significantly reduced by leverage.

From start to end, leverage has been of benefit to me, to the tune of a couple of percent per year.  However, I would have been better off with slightly less leverage (I had some forced sales in there).  I was running between 50% and 75% loan to value  for the duration, where as using the same time period, a ratio of about 30% would have maximized (post tax real) returns.

zb3

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Re: Using futures to leverage investment returns
« Reply #45 on: September 21, 2014, 10:12:08 PM »
Did your use of leverage result in a higher return than you would have achieved without leverage?

Depends on which period you pick!  There are periods in there where my returns were significantly reduced by leverage.

From start to end, leverage has been of benefit to me, to the tune of a couple of percent per year.  However, I would have been better off with slightly less leverage (I had some forced sales in there).  I was running between 50% and 75% loan to value  for the duration, where as using the same time period, a ratio of about 30% would have maximized (post tax real) returns.

Thats odd, over the last 5 years x3 leverage would have been optimal, unless you're in one of those countries with crazy margin rates (like NZ).  The reason I'm so attracted to futures is they have a very low implied interest rate.  I'm not sure where you are from but you should check out interactive brokers.  They have some very low rates.

bigchrisb

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Re: Using futures to leverage investment returns
« Reply #46 on: September 21, 2014, 11:39:07 PM »
I'm Australian.

With the leverage I had, I had margin calls and forced sales at just the wrong times in late 2008, early 2009 and again in mid 2011. Less margin and I would have been buying, rather than selling at these points in time. 

I used a mix of OZ margin loans (high rate) and IB (both in AUD and USD).  IB was good until access to its margin loans was shut down by the AUS regulators (for access to individual investors).  That said, the low rates on USD debt worked out well, until the AUD crashed.  Between the interest rate savings and the forex losses I ended up losing about $10k on that experiment.

zb3

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Re: Using futures to leverage investment returns
« Reply #47 on: September 22, 2014, 12:22:26 AM »
Ouch I would never use high rate margin loans they kill any returns.  Margin loans over in NZ are around 8%.  I'm not sure that the brokers in Aus are like but the ones over here also charge 3% spread on foreign currency.  If only I knew about IB before opening my nz brokerage account.  At least that Aus restriction doesn't apply to futures contracts or to companies.  If I were you I would avoid Aus margin loans altogether and just use IB margin loans through a company or use futures contracts.

Given your experience in leveraged investing, are there any tips you could give to someone like me who is just starting to go down that road?  What have been your biggest regrets/what would you do differently?  Do you leverage more on individual stocks or indexes?  Cheers

bigchrisb

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Re: Using futures to leverage investment returns
« Reply #48 on: September 22, 2014, 12:34:00 AM »
If I were to give advice to my mid-20's self, I'd tell myself to have a go at leverage, but to go easy.  My mid 20's self would then ignore that, go hard, and learn the lessons I've learned! 

I'm increasingly of the view in personal finance that there is no need to swing for the fences when slow and steady doesn't actually take that long.