Author Topic: Cash and Calls: talk me out of it  (Read 3176 times)

ChpBstrd

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Cash and Calls: talk me out of it
« on: November 06, 2019, 09:06:04 PM »
Suppose one's portfolio currently consists entirely of 2,000 shares of SPY, worth $307.18 per share (value: $614,360). One is looking to de-risk the portfolio without exiting the market.

One can buy a call option giving one the right to buy SPY for $305 anytime before 1/21/22 for the price of $31.47/share. There are 807 days, or about 2.21 years till expiration. If the price of SPY is below $305 on 1/21/22, the option one paid $31.47/share for expires worthless. If it is above $305, the value on that date will be the price minus $305. One's maximum risk is the amount paid for the option, which is 31.47 / 307.18 = 10.24%. The maximum upside is unlimited, but will realistically be the performance of the S&P 500 over the next 2.21 years minus 10.24%. In the event of a correction, one's maximum loss hits a floor of 10.24%. In practical terms, this means if a severe recession/correction/bear occurs, one's retirement date is only set back by a year or two, rather than several years. 

To control 2,000 shares of SPY, one would need to buy 20 contracts at a total cost of $62,940. The remaining $614,360 in the portfolio could sit in a money market account or bond fund earning a couple of percent to entirely replace the dividends one is missing out on.

Alternate allocation 1:
   10.24% - 20 contracts SPY 1/21/22 305 call - $62,940
   89.76% - short term cash / debt instruments - $551,420

If the market DID crash, this hypothetical investor could rotate the $551k plus interest back into stocks, having lost only most of the value from the $62,940k option allocation instead of, say 20-50% of the entire portfolio.
If the market DID NOT crash, this hypothetical investor could exercise their options to buy SPY in 2 years at a slightly lower price than is available today. Thus, by owning the options, they avoid the risk of the market running away without them, and having to buy at a much higher price later.

In other words, this alternative portfolio would enable the investor to sit out market risk for the next 2.21 years, while enjoying unlimited upside, no risk of the market running away without them, and with almost 90% of their cash available to pounce on any stock selloff. The relative cost of this protection is about 10.24% / 2.21 = 4.63% per year underperformance of the S&P 500.

This seems like not a bad deal compared to, say, a bond tent which could still lose much more than 10.24% and can be expected to underperform the S&P by a similar amount.

Kicker: To increase leverage, one could buy call options to control 150% of the number of shares one formerly owned. Then one's maximum downside would be 15.36% and the maximum upside 50% greater. You'd still be about 85% in cash.

Alternative allocation 2:
   15.36% - 30 contracts SPY 1/21/22 305 call - $94,410
   84.63% - short term cash / debt instruments - $519,950


Talk me out of it.

YoungAndNotFree

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Re: Cash and Calls: talk me out of it
« Reply #1 on: November 07, 2019, 04:21:09 AM »
Iím also interested in the answers. But I believe the experts would factor in what stage are you, are you accumulating? Are you do in monthly contributions? Will you stop during this 2 years time frame? And in the event of a crash, the DCA of the monthly contribution should lower you average cost.

Oh well I just through in ideas for the experts to say...

reeshau

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Re: Cash and Calls: talk me out of it
« Reply #2 on: November 07, 2019, 04:33:12 AM »
Why are you trying to set this up as all-or-nothing on a single date?  You can talk about this strategy or not, but you have maximized the risk here, minimizing the ability to hedge.  If you had been betting on Jan 22, 2019 you would have been in trouble--not for any broad market issue, but because Q4 last year was so bad, and the market hadn't recovered fully through January.  The market is up 13.5% since then.  Would be a shame to miss that.

YoungInvestor

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Re: Cash and Calls: talk me out of it
« Reply #3 on: November 07, 2019, 06:03:46 AM »
Broadly speaking LEAPS can achieve what you describe(and more if the 85%-90% is making a return).

I would think that buying a put that limits losses to 10% would be more straightforward, but you do you. In fact, a Man 2021 put@307 costs roughly 22$.

ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #4 on: November 07, 2019, 07:20:42 AM »
Why are you trying to set this up as all-or-nothing on a single date?  You can talk about this strategy or not, but you have maximized the risk here, minimizing the ability to hedge.  If you had been betting on Jan 22, 2019 you would have been in trouble--not for any broad market issue, but because Q4 last year was so bad, and the market hadn't recovered fully through January.  The market is up 13.5% since then.  Would be a shame to miss that.

All or nothing is for simplicity of discussion. Options are complex enough without adding the complexity of DCAing into a position or spreading out across maturity dates, but of course this is an available choice and probably what Iíd realistically do.

Being positioned this way in Q4 of 2018 would have had an excellent outcome. Oneís portfolio would be down a few percent while an all-stock portfolio was hit 20%. Depending on oneís IPS, one could be required to buy back into stocks if they fell x%. That would have also been a great move. Otherwise- for example if the IPS said buy if stocks fall 25% but they only fell 20% - youíd at least still own the long-duration calls which would appreciate during the recovery and give you the opportunity to buy at the strike price later.

ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #5 on: November 07, 2019, 07:28:33 AM »
Broadly speaking LEAPS can achieve what you describe(and more if the 85%-90% is making a return).

I would think that buying a put that limits losses to 10% would be more straightforward, but you do you. In fact, a Man 2021 put@307 costs roughly 22$.

The protective put and long call + cash strategies have the same risk profile. Much of my portfolio is currently in protective puts. The calls and cash strategy allows one to increase leverage during a correction because one is holding the bulk of assets in cash instead of stock.
« Last Edit: November 07, 2019, 08:31:12 AM by ChpBstrd »

Buffalo Chip

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Re: Cash and Calls: talk me out of it
« Reply #6 on: November 07, 2019, 12:39:34 PM »
Is this meant to address SoRR? If so it seems to me like a short term solution to a longer term problem.  If you take a look at the stuff at ERN, I seem to recall that SoRR is typically a 5-10 year problem assuming a relatively high allocation to equities. The strategy detailed above would cover a little over 2 years.


jrbrokerr

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Re: Cash and Calls: talk me out of it
« Reply #7 on: November 07, 2019, 12:57:20 PM »
what if SPY jigsaws higher/ lower but on expiration date sits at 305 ??? you would have lost 10% of your account



ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #8 on: November 07, 2019, 03:13:34 PM »
Is this meant to address SoRR? If so it seems to me like a short term solution to a longer term problem.  If you take a look at the stuff at ERN, I seem to recall that SoRR is typically a 5-10 year problem assuming a relatively high allocation to equities. The strategy detailed above would cover a little over 2 years.

When the call gets close to maturity, one would just sell it and buy another call with a more distant maturity. In this way the strategy could be maintained indefinitely. There would be a net debit with each such trade, because one would be buying more time in exchange. If the stock went up, profits from the sale of the old call would partly offset the higher cost of the new call.

The tricky part would be if the market was in a meltdown near the expiration date of the old call. Increased volatility would raise the price of the new call one is buying by more than the price of the old call one is selling, while a falling stock price would have a larger opposite effect. Whether the cost of the roll would go up or down depends on many factors. A choice could be made to either continue the strategy or jump back into stocks, after having avoided most of the crash. Regardless of the choice made, the portfolio would have lost less than 10% of its value amid a much larger correction. This can only be good from a SORR perspective, even if after suffering minimal losses during phase 1 of the crash we flip back to 100% stocks with another 25% downside to go over the next 4-5 years.

TL;DR - the strategy can be continued indefinitely and should protect against multi-year SORR events such as 1929-33 because it mitigates losses.

Buffalo Chip

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Re: Cash and Calls: talk me out of it
« Reply #9 on: November 07, 2019, 06:01:42 PM »
Is this meant to address SoRR? If so it seems to me like a short term solution to a longer term problem.  If you take a look at the stuff at ERN, I seem to recall that SoRR is typically a 5-10 year problem assuming a relatively high allocation to equities. The strategy detailed above would cover a little over 2 years.

When the call gets close to maturity, one would just sell it and buy another call with a more distant maturity. In this way the strategy could be maintained indefinitely. There would be a net debit with each such trade, because one would be buying more time in exchange. If the stock went up, profits from the sale of the old call would partly offset the higher cost of the new call.

The tricky part would be if the market was in a meltdown near the expiration date of the old call. Increased volatility would raise the price of the new call one is buying by more than the price of the old call one is selling, while a falling stock price would have a larger opposite effect. Whether the cost of the roll would go up or down depends on many factors. A choice could be made to either continue the strategy or jump back into stocks, after having avoided most of the crash. Regardless of the choice made, the portfolio would have lost less than 10% of its value amid a much larger correction. This can only be good from a SORR perspective, even if after suffering minimal losses during phase 1 of the crash we flip back to 100% stocks with another 25% downside to go over the next 4-5 years.

TL;DR - the strategy can be continued indefinitely and should protect against multi-year SORR events such as 1929-33 because it mitigates losses.
Looks to me like worst case scenario is that the market does what itís doing and goes sideways to about the strike price. Loss on the option of about 4.8% annualized less what you would get in a bank account for the remainder. Best I could find on a quick search was 2.05%. Sooo what are we talking? Around 2.8% max downside? Unlimited upside?  Maybe something to think about. Depends on what trying to achieve.

One thing that I didnít agree with though is the assumption of a bond tent as an alternative. More than likely Iíd be in cash. So I donít see quite the downside potential there.

ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #10 on: November 07, 2019, 06:25:01 PM »
Is this meant to address SoRR? If so it seems to me like a short term solution to a longer term problem.  If you take a look at the stuff at ERN, I seem to recall that SoRR is typically a 5-10 year problem assuming a relatively high allocation to equities. The strategy detailed above would cover a little over 2 years.

When the call gets close to maturity, one would just sell it and buy another call with a more distant maturity. In this way the strategy could be maintained indefinitely. There would be a net debit with each such trade, because one would be buying more time in exchange. If the stock went up, profits from the sale of the old call would partly offset the higher cost of the new call.

The tricky part would be if the market was in a meltdown near the expiration date of the old call. Increased volatility would raise the price of the new call one is buying by more than the price of the old call one is selling, while a falling stock price would have a larger opposite effect. Whether the cost of the roll would go up or down depends on many factors. A choice could be made to either continue the strategy or jump back into stocks, after having avoided most of the crash. Regardless of the choice made, the portfolio would have lost less than 10% of its value amid a much larger correction. This can only be good from a SORR perspective, even if after suffering minimal losses during phase 1 of the crash we flip back to 100% stocks with another 25% downside to go over the next 4-5 years.

TL;DR - the strategy can be continued indefinitely and should protect against multi-year SORR events such as 1929-33 because it mitigates losses.
Looks to me like worst case scenario is that the market does what itís doing and goes sideways to about the strike price. Loss on the option of about 4.8% annualized less what you would get in a bank account for the remainder. Best I could find on a quick search was 2.05%. Sooo what are we talking? Around 2.8% max downside? Unlimited upside?  Maybe something to think about. Depends on what trying to achieve.

One thing that I didnít agree with though is the assumption of a bond tent as an alternative. More than likely Iíd be in cash. So I donít see quite the downside potential there.

Yep, a sideways market would suck because one would lose a few percent instead of breaking even. This kind of gets into the nature of regret. In years the stock market goes up 20%, should a person with a conservative AA regret not being 100% stocks, or using margin to be leveraged long stocks, or betting their entire net worth plus a credit card cash advance on futures contracts? In a year when the S&P goes up 25%, having a 60/40 AA instead of all stocks might "cost" an investor 10%. So even reasonable AAs have the potential for double-digit underperformance.

I think hindsight should have no influence on AA, because it tells us so little about the future. It doesn't tell one that they made a bad decision. I'm similarly suspicious of rationales given on this site for a high equities AA based on previous performance. We've all seen the turkey chart, right?




Roland of Gilead

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Re: Cash and Calls: talk me out of it
« Reply #11 on: November 07, 2019, 06:34:43 PM »
Perhaps better would be to sell the $305's for $63,000 and not pay tax on that $63,000 until 2022 (because, rules)

Then apply for your states version of medicaid, snap, and maybe free internet for 2020 and 2021 because your income is just the dividends on $600,000 which is around $12,000....below poverty level.

Market goes sideways, you look like a genius.  Market tanks, you have $63,000 more than everyone else.  Market skyrockets...well, can't win em all.

Buffalo Chip

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Re: Cash and Calls: talk me out of it
« Reply #12 on: November 08, 2019, 10:07:49 AM »

Yep, a sideways market would suck because one would lose a few percent instead of breaking even. This kind of gets into the nature of regret. In years the stock market goes up 20%, should a person with a conservative AA regret not being 100% stocks, or using margin to be leveraged long stocks, or betting their entire net worth plus a credit card cash advance on futures contracts? In a year when the S&P goes up 25%, having a 60/40 AA instead of all stocks might "cost" an investor 10%. So even reasonable AAs have the potential for double-digit underperformance.

I think hindsight should have no influence on AA, because it tells us so little about the future. It doesn't tell one that they made a bad decision. I'm similarly suspicious of rationales given on this site for a high equities AA based on previous performance. We've all seen the turkey chart, right?



That chart is outstanding and encapsulates my aversion to the ďjust put it all in the ABC stock index fundĒ strategy that is so popular amongst the FI community.

Ultimately the AA should drive the strategy. Easy to say, and very hard to do. Because you canít turn your brain off to what you see around you. Yeah, I realize that a certain part of my portfolio should be in corporate debt. Yeah, I realize that itís done fairly well in the past and has been a counterweight to equities. And yet I wonít force myself to invest in an asset class where BBB yields are south of 3.5%. I can get north of 2% in an FDIC insured bank account. AA be damned, Iím not tossing money into that.

bacchi

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Re: Cash and Calls: talk me out of it
« Reply #13 on: November 08, 2019, 10:42:23 AM »
This is exactly what equity indexed annuities do. Well, they cap your gain.

Create a debit spread.

Buy a CD/bond/whatever with most of the money.
Buy an ATM call with an expiration >365 days (for LTCG tax purposes).
Sell an OTM call @ +10% with the same expiration date.

If the market skyrockets, you gain a maximum of 10% - the spread + cash interest.
If the market gains 1-10%, the OTM calls expire worthless and you gain on the ATM calls. Even a small gain would cover the spread and make you profitable.
If the market drops, you lose the spread.

Worst case is you have the same amount of money as you start with - inflation. Hopefully the interest rate on the bond covers that.
« Last Edit: November 08, 2019, 10:44:23 AM by bacchi »

bwall

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Re: Cash and Calls: talk me out of it
« Reply #14 on: November 08, 2019, 01:37:36 PM »
As will all options strategy, it's a matter of timing. In general, it's a good idea. I think the greatest risk is what previous posters have mention; sideways movement for the next 2+ years, which I do see to be a reasonable possibility.

The biggest potential market mover in the next two years will be the 2020 election. I have no idea how the market will react to which candidate. In 2016, I thought the market would tank with a Trump presidency. It did--for about 45 minutes, and then roared up 30% (or so) and has been flat ever since. So, I guess I was both right and wrong. Which doesn't really build much confidence.

bacchi

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Re: Cash and Calls: talk me out of it
« Reply #15 on: November 08, 2019, 01:46:32 PM »
Real world example

SPY@308.6
Estimated 2% return from fixed income: $30860/(1.02^2) = $29661
Money for debit spread: 30860 - 29661 = $1200

12/21 314 Call @ -$2710
12/21 340 Call @ +$1500

Cost: $1210

Maximum loss is inflation on cash position
Maximum gain is 10.4% over 2 years

The shitty yield on fixed income really hinders this play though it's comparable to what a current fixed index annuity yields, without the fees.

https://www.schwab.com/public/schwab/investing/accounts_products/investment/annuities/fixed_indexed_annuities/fia_rates.html

ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #16 on: November 08, 2019, 07:40:55 PM »
Create a debit spread.

Buy a CD/bond/whatever with most of the money.
Buy an ATM call with an expiration >365 days (for LTCG tax purposes).
Sell an OTM call @ +10% with the same expiration date.

I thought about it, but here's why I'm not going a route like this. There are 2 big risks: (1) the risk of losing money on a long position if stock prices go down, and (2) the risk of losing the ability to own shares if stock prices go up while one is out of the market.

This strategy doesn't address the risk that the stock market jumps higher and by the time one eventually buys back in one can't afford as many shares as one originally sold. With the spread, if stocks pop up 40% during the next 2 years, maybe juiced by buybacks, QE, more tax cuts, an infrastructure bill, or a falling savings rate, then the short call would be called at just a 10% profit. One would not "lose" money technically but would end up without the ability to purchase 30% of the shares one could have formerly purchased.

Not among the big risks is the chance of losing a couple percent. That's a small risk, and a small price to pay to potentially dodge either a SORR bullet or the risk of being on the defensive while the market goes on offense. 

ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #17 on: November 08, 2019, 08:17:55 PM »
As will all options strategy, it's a matter of timing. In general, it's a good idea. I think the greatest risk is what previous posters have mention; sideways movement for the next 2+ years, which I do see to be a reasonable possibility.

The biggest potential market mover in the next two years will be the 2020 election. I have no idea how the market will react to which candidate. In 2016, I thought the market would tank with a Trump presidency. It did--for about 45 minutes, and then roared up 30% (or so) and has been flat ever since. So, I guess I was both right and wrong. Which doesn't really build much confidence.

I'm not very concerned about the election or the impeachment. It's more the fact that the unemployment rate is so low business expansion is being impacted, we've had a yield curve inversion which has a 7/7 record for predicting recessions an average of 19 months out, and corporate leverage and credit quality are a time bomb. I'm counting on Trump to "win" the trade war by caving to the Chinese position just in time to pump the stock market prior to the election - most obvious political play ever.

A sideways market would be unfortunate, as that is essentially the thing this strategy bets against, but a plain ole long stock position is also a bet - against a downturn. So the alternative also involves risk. The difference is I'll still retire soon after losing the option's entire value, but going long and losing 30-50% would delay my retirement several years. For example, to recover from an 8% loss, I'd have to save/earn 8.7%. To recover from a 40% loss, I'd have to save/earn 66%. In the grand scheme of things, the risk of time decay seems like small potatoes.

bacchi

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Re: Cash and Calls: talk me out of it
« Reply #18 on: November 08, 2019, 08:55:12 PM »
Create a debit spread.

Buy a CD/bond/whatever with most of the money.
Buy an ATM call with an expiration >365 days (for LTCG tax purposes).
Sell an OTM call @ +10% with the same expiration date.

(2) the risk of losing the ability to own shares if stock prices go up while one is out of the market.

This strategy doesn't address the risk that the stock market jumps higher and by the time one eventually buys back in one can't afford as many shares as one originally sold.

Right, a fixed index annuity isn't going to make anyone rich. It's going to preserve the principal while maybe making a small gain. It's going to protect against SORR.

The strategy might be to roll out what you'd need in 1-3 years. If you expect to spend $50k in 2021, you could create a spread for Dec 2020. If you make 4%, great. If the market tumbles, you know you're set for 2021. Do the same for 12/21 and you're set for 2022.

I'm not sure how to handle longer than 3 years out. LEAPs don't go out any further as far as I know.


eta: I misread ChpBstrd's comment.
« Last Edit: November 08, 2019, 09:08:50 PM by bacchi »

bwall

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Re: Cash and Calls: talk me out of it
« Reply #19 on: November 09, 2019, 07:13:20 AM »
As will all options strategy, it's a matter of timing. In general, it's a good idea. I think the greatest risk is what previous posters have mention; sideways movement for the next 2+ years, which I do see to be a reasonable possibility.

The biggest potential market mover in the next two years will be the 2020 election. I have no idea how the market will react to which candidate. In 2016, I thought the market would tank with a Trump presidency. It did--for about 45 minutes, and then roared up 30% (or so) and has been flat ever since. So, I guess I was both right and wrong. Which doesn't really build much confidence.

I'm not very concerned about the election or the impeachment. It's more the fact that the unemployment rate is so low business expansion is being impacted, we've had a yield curve inversion which has a 7/7 record for predicting recessions an average of 19 months out, and corporate leverage and credit quality are a time bomb. I'm counting on Trump to "win" the trade war by caving to the Chinese position just in time to pump the stock market prior to the election - most obvious political play ever.

A sideways market would be unfortunate, as that is essentially the thing this strategy bets against, but a plain ole long stock position is also a bet - against a downturn. So the alternative also involves risk. The difference is I'll still retire soon after losing the option's entire value, but going long and losing 30-50% would delay my retirement several years. For example, to recover from an 8% loss, I'd have to save/earn 8.7%. To recover from a 40% loss, I'd have to save/earn 66%. In the grand scheme of things, the risk of time decay seems like small potatoes.

I do agree with most of your above analysis.

I think that there is very little chance of a 30% or greater drop in the stock market. This would mean a DOW closing at 19,386 (from Friday's close). At the end of 2018 there was a drop (from lower highs) that didn't even get close to 20,000.

I also think that yield curve inversion is a tired horse. It's true that all recessions have been preceded by inversions, but it's also true that inversions have occurred but did not lead to recessions.

Past recessions have been ridiculously hard to predict.

YMMV.

Buffalo Chip

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Re: Cash and Calls: talk me out of it
« Reply #20 on: November 09, 2019, 07:45:16 AM »


A sideways market would be unfortunate, as that is essentially the thing this strategy bets against, but a plain ole long stock position is also a bet - against a downturn. So the alternative also involves risk. The difference is I'll still retire soon after losing the option's entire value, but going long and losing 30-50% would delay my retirement several years. For example, to recover from an 8% loss, I'd have to save/earn 8.7%. To recover from a 40% loss, I'd have to save/earn 66%. In the grand scheme of things, the risk of time decay seems like small potatoes.

My crystal ball is as fuzzy as the next guys, but the more I hear talk of coming doom, the less I find it credible. How many of us saw the last truck bearing down on us in 2008? If we take the position that central banks can continue to keep economies limping along, then sideways makes a lot of sense.  Do we really think that there is a lot of room on the upside? And if central banks are going to jump in as soon as economies so much as catch a sniffle, is there really so much risk on the downside?  Long term I doubt the central banks can keep the pins in the air, but that may well be looooong term.   

Roland of Gilead

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Re: Cash and Calls: talk me out of it
« Reply #21 on: November 09, 2019, 11:20:45 AM »


A sideways market would be unfortunate, as that is essentially the thing this strategy bets against, but a plain ole long stock position is also a bet - against a downturn. So the alternative also involves risk. The difference is I'll still retire soon after losing the option's entire value, but going long and losing 30-50% would delay my retirement several years. For example, to recover from an 8% loss, I'd have to save/earn 8.7%. To recover from a 40% loss, I'd have to save/earn 66%. In the grand scheme of things, the risk of time decay seems like small potatoes.

My crystal ball is as fuzzy as the next guys, but the more I hear talk of coming doom, the less I find it credible. How many of us saw the last truck bearing down on us in 2008? If we take the position that central banks can continue to keep economies limping along, then sideways makes a lot of sense.  Do we really think that there is a lot of room on the upside? And if central banks are going to jump in as soon as economies so much as catch a sniffle, is there really so much risk on the downside?  Long term I doubt the central banks can keep the pins in the air, but that may well be looooong term.   

I didn't think there was much room to the upside when the S&P was 2700, and now it is near 3100, which is what, a 14.8% gain?

It could go to 4000 before dropping, nobody really knows.

Buffalo Chip

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Re: Cash and Calls: talk me out of it
« Reply #22 on: November 09, 2019, 12:36:59 PM »

I didn't think there was much room to the upside when the S&P was 2700, and now it is near 3100, which is what, a 14.8% gain?

It could go to 4000 before dropping, nobody really knows.

No we really donít know. But we do know that PE ratios for US stocks* are high compared to the rest of the world. So if we think there is room for growth in equities, why would we pick a market where the prices are high over other outside the US markets where there is arguably more room for upside growth?

*(yeah, yeah I know I sound like a broken record on PE ratios. Maybe Iíll give it up for Lent.)

Gremlin

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Re: Cash and Calls: talk me out of it
« Reply #23 on: November 10, 2019, 03:21:45 PM »
I'd always look at this sort of thing post-tax.

If you're currently holding SPY, then to sell down you trigger a capital gains event.  If you (hopefully) exercise your option, you trigger another capital gains event.

Capital gains tax is different for different jurisdictions.  I'm in Australia and this strategy would trigger a much bigger tax liability for me than others that might play out.  If you want to play with options, have you thought about retaining the shares and buying a put instead?  Maybe the tax situation would be more favourable in that scenario?

YMMV.

Roland of Gilead

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Re: Cash and Calls: talk me out of it
« Reply #24 on: November 10, 2019, 04:01:51 PM »
A lot of us in the USA have 401K....I have a 401K with the equivalent of 3000 shares of SPY (Vanguard S&P index actually) and it would not trigger anything to buy or sell it or write calls on it.

frugal_c

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Re: Cash and Calls: talk me out of it
« Reply #25 on: November 10, 2019, 05:37:21 PM »
I am just worried abouta flat to slow growth market.   If the market ii a flat in 2 years you are down 10%. If it's up 10% you're flat.  If it's up 15% you are only up 5%.  I don't know, that differential can really add up over time.

ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #26 on: November 11, 2019, 08:50:44 AM »
I am just worried abouta flat to slow growth market.   If the market ii a flat in 2 years you are down 10%. If it's up 10% you're flat.  If it's up 15% you are only up 5%.  I don't know, that differential can really add up over time.

The S&P500 has had price returns - excluding dividends - between 0% and 10% fourteen times in the last 90 years, or about 15.5% of the time*. In that scenario, a one-year call option's expected performance would be between -10% and 0% respectively**.

Returns below 10%, when this portfolio would outperform the S&P, occurred 19 times since 1928, or about 21% of the time. Some of those years are >20% down, such as 2008, 2002, 1974, 1937, and 1931, and so have a greater impact on portfolio survivability than their frequency alone might suggest. So historically, this portfolio would have offered better odds of dodging a sequence-of-returns-risk bullet than landing in the "regret zone" when the S&P's price goes up 0% to 10%.

*https://www.macrotrends.net/2526/sp-500-historical-annual-returns

**Option prices do not move dollar-for-dollar with the underlying if they still have time value remaining. Other factors such as volatility, interest rates, etc. have an impact. The 1:1 estimate is close though, and reflects the value if a one-year option is compared directly to a one-year holding period. For a 2.2 year option like I'm talking about, time decay would occur more slowly and volatility is very low right now (VIX ~12), so I would expect a better return in the first year.

frugal_c

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Re: Cash and Calls: talk me out of it
« Reply #27 on: November 11, 2019, 12:09:57 PM »
Any positive return will cause you to trail is the thing.   With larger returns you just may not notice it as much.  It's really only when returns get up past 30% that the call cost starts to be less significant.

It's not a crazy thing to do. I just wonder what the total return would have been for the past 100 years.  With stocks we have the numbers but this is a bit more theory. Would it still lead to 6%+ returns over the full length of market cycles?  You trail during the bull but then make it up during the bear but how does it average out?  It seems it would depend on how volatile prices are.

I'm still more in the prove it camp. I don't think I can disprove the strategy but I would need more evidence before I could take the plunge. 

By the way, read Taleb. He has suggested a similar strategy to what you suggest. He invest 95% bonds and 5% a mix of calls and puts that are way out of the money if I remember correctly.
« Last Edit: November 11, 2019, 12:15:53 PM by frugal_c »

jrbrokerr

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Re: Cash and Calls: talk me out of it
« Reply #28 on: November 11, 2019, 03:04:38 PM »
Imagine it is late January 2018, SPY sitting at all time highs just like these days.... you execute this strategy.... almost 2 years later the SPY is
barely up almost 7% since those highs, how does this strategy is working out ??'

SPY also went down 20% since those highs, would you have bpught in ?? how much drawdown % do you consider acceptable for going back into the market ???


ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #29 on: November 11, 2019, 04:03:09 PM »
Imagine it is late January 2018, SPY sitting at all time highs just like these days.... you execute this strategy.... almost 2 years later the SPY is
barely up almost 7% since those highs, how does this strategy is working out ??'

SPY also went down 20% since those highs, would you have bpught in ?? how much drawdown % do you consider acceptable for going back into the market ???

You are right that the buy-in moment must be defined. I think the main benefit of the strategy hinges on swapping back into stocks during a big-enough downturn. Set this number too low and you aren't really buying much protection. Set it too high and you won't be protected very frequently - maybe once in a lifetime.

My IPS says 20% is the magic number to switch to a 100% long position for the equity portion of my portfolio. These corrections happen every few years on average. This worked out beautifully for my protective put positions in Dec. 2018, and a calls and cash approach would work the same. Of course had it been a 19% correction instead of 20% the correction would have come and gone without triggering my de-hedging rule. Had it been a 30% correction, I'd have 10% downside to go from that point, but still come out ahead of those with all-stocks portfolios.

Systems101

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Re: Cash and Calls: talk me out of it
« Reply #30 on: November 11, 2019, 05:19:20 PM »

The problem with this trade is you have to be rather lucky. 

In general, Theta will win and will be a drag on your portfolio.  Anything else is market timing (and then you have to make sure Vega [implied volatility] doesn't catch up with you and cause you to lose money over time anyway...)

Since you are asking very specifically to hedge SoRR, it *might* be okay... The rest of this doesn't quite apply to the specific "I do this once to hedge within exactly the next N years where I can buy a LEAP today"... but you also said:

All or nothing is for simplicity of discussion. Options are complex enough without adding the complexity of DCAing into a position or spreading out across maturity dates, but of course this is an available choice and probably what Iíd realistically do.

So what if you do this regularly and DCA it?  Theta wins, you lose.

An opposite trade to what you are proposing is: Take a long position in the stocks in the S&P 500 index and a short position in an S&P 500 (SPX) call option.  That's who's likely selling to you.
The neutral trade is: Hold the S&P 500.

If you started trading against each other on June 30, 1986 to June 30, 2019:
The S&P 500 is up 11.72X, max drawdown 52.5%
The opposite trade is up 15.65X, max drawdown 35.8%
A trade of buying a 5% out of the money put (similar risk profile to buying long calls) is up 9.36X, max drawdown 38.9%

Now, this is not exactly the trade you are proposing, but this would imply you significantly losing to the S&P 500 if you are consistently buying calls, and with higher drawdown than if you were selling the calls...  Decaying Theta eventually wins.

The opposite trade is represented by CBOE Index BXM.  The out of the money put trade is represented by CBOE Index PPUT.  You can see a number of indexes the Chicago Board Options Exchange has here for options strategies: http://www.cboe.com/products/strategy-benchmark-indexes

The performance numbers above are trivially generated from their historical data: http://www.cboe.com/micro/buywrite/monthendpricehistory.xls



ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #31 on: November 11, 2019, 09:44:50 PM »

The problem with this trade is you have to be rather lucky. 

In general, Theta will win and will be a drag on your portfolio.  Anything else is market timing (and then you have to make sure Vega [implied volatility] doesn't catch up with you and cause you to lose money over time anyway...)

Since you are asking very specifically to hedge SoRR, it *might* be okay... The rest of this doesn't quite apply to the specific "I do this once to hedge within exactly the next N years where I can buy a LEAP today"... but you also said:

All or nothing is for simplicity of discussion. Options are complex enough without adding the complexity of DCAing into a position or spreading out across maturity dates, but of course this is an available choice and probably what Iíd realistically do.

So what if you do this regularly and DCA it?  Theta wins, you lose.

An opposite trade to what you are proposing is: Take a long position in the stocks in the S&P 500 index and a short position in an S&P 500 (SPX) call option.  That's who's likely selling to you.
The neutral trade is: Hold the S&P 500.

If you started trading against each other on June 30, 1986 to June 30, 2019:
The S&P 500 is up 11.72X, max drawdown 52.5%
The opposite trade is up 15.65X, max drawdown 35.8%
A trade of buying a 5% out of the money put (similar risk profile to buying long calls) is up 9.36X, max drawdown 38.9%

Now, this is not exactly the trade you are proposing, but this would imply you significantly losing to the S&P 500 if you are consistently buying calls, and with higher drawdown than if you were selling the calls...  Decaying Theta eventually wins.

The opposite trade is represented by CBOE Index BXM.  The out of the money put trade is represented by CBOE Index PPUT.  You can see a number of indexes the Chicago Board Options Exchange has here for options strategies: http://www.cboe.com/products/strategy-benchmark-indexes

The performance numbers above are trivially generated from their historical data: http://www.cboe.com/micro/buywrite/monthendpricehistory.xls

Thanks for the links and insights. It's a shame they don't have anything for the specific strategy I'm considering. $PPUT.X is close because a long call is like a protective put, and $PPUT.X doesn't trail the S&P by much, despite rolling monthly. I'm looking at much longer durations specifically to reduce long-term Theta. For example, for $SPX 3075 call options, I see a theta of -0.6719 for the contracts expiring in 30d and -0.2448 for the contracts expiring in 767 days. By operating on a longer timeframe, I'm probably cutting my theta in half, at the expense of a larger asset allocation to the options. How much of $PPUT.X's performance was hurt by theta? IDK.

Interestingly, $BXMD.X the 30-Delta covered call strategy, has since 1986 had a higher performance and lower standard deviation than the S&P 500. Since 1999, $CLL.X, the collar strategy, outperformed the S&P with less volatility. This is the strategy I'd be moving away from if I made the change - except of course with longer durations.

I don't think Theta always wins. If that were true these options would never pay out. I grabbed a spreadsheet of S&P 500 annual returns and wrote a formula that fills in the annual theta of the option (2.1 year option, assuming -4.5% of the underlying's value) if the price return is <0% and the return minus the annual theta if the price return is >0%. The call would win in some time frames and lose in others. E.g. from 2000 until 2018 it would have yielded a 5% average annual return instead of 4.37%. In other timeframes it lags maybe 1 - 1.5%. Even for a lotto ticket, there is a rational value to pay, and these markets are ruthlessly efficient.   

I would happily underperform the S&P 500 by a percent or two if it meant the elimination of SORR events like 2000-2003 or 2008. Since 1975, the options alone would have yielded 8% which is worse than the S&P but perhaps more survivable when considering withdraws from the portfolio.

vand

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Re: Cash and Calls: talk me out of it
« Reply #32 on: November 12, 2019, 03:07:42 AM »
Do It.
Nothing can possibly go wrong.

vand

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Re: Cash and Calls: talk me out of it
« Reply #33 on: November 12, 2019, 04:26:48 AM »
Whenever you introduce leverage or derivatives you move from going from an investors towards a speculator.

As an investor, you own the asset, which pays you for owning it. Time becomes your ally.

For speculators, time works against you. You are paying for the leverage you are employing, and you need the market to move advantageously to your position in order to profit.

This is why it is not a question of maths, but rather deeply becomes a psychological issue... time is the one resource that is just as limited and precious to us all. If you hold a speculative position that has gone against you, the opportunity cost of that is the time that an investment could have been working in your favour. You may view it as "2.21 years" in writing, but in living it it represents a significant few % of your remaining time on this Earth, and that is far more important in judging how you feel about it.

Portfolio risk is the price that we pay for expected returns. If all the clever bods at working for all the hedge fund in the world can't figure out how to "derisk" without also decreasing expected return, then I highly doubt it can be done without also introducting some other risk.  The markets are just too efficient for it to be that easy... if you are not comfortable with the amount of risk you are currently exposed to then imo the answer is just to increase your cash position to order to be able to take advantage of a bear market.
« Last Edit: November 12, 2019, 04:34:39 AM by vand »

MustacheAndaHalf

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Re: Cash and Calls: talk me out of it
« Reply #34 on: November 12, 2019, 09:43:25 AM »
The relative cost of this protection is about 10.24% / 2.21 = 4.63% per year underperformance of the S&P 500.
This seems like not a bad deal compared to, say, a bond tent which could still lose much more than 10.24% and can be expected to underperform the S&P by a similar amount.
Are you saving for retirement or protecting your nest egg during retirement?

Bond tents come in many time frames and levels of equities, but I would think they only make sense when you're protecting your retirement savings.

index

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Re: Cash and Calls: talk me out of it
« Reply #35 on: November 12, 2019, 04:10:33 PM »
You need to look at SPX and XSV options and not SPY options. With the spy options you are getting hit on the dividend, have unfavorable tax treatment, and they are settled to stock and not cash. It is a good strategy. Start playing around with the numbers of buying options 10% out of the money. i.e. The $335 Jan 2022 SPY options are $17.5, so you could buy two for every one $305 option. It becomes more advantageous after a greater than 20% gain. If you look at distributions of gains; the market doesn't typically grind higher in nice increments. It may go 18%, 13%, 17%, -20%. You look at this annualized and it is about 5.5%. Using this strategy allows you to take partial advantage of lumpy gains and avoid the losses. What you have laid out costs you about 6% per year in performance. If you lookback period was 1 year your sequence of returns in the above scenario are 12%, 7%, 11%, -6% and you end up at the same point.   

Park the rest of the money in something like MINT or NEAR and that 6% cost turns into 3.8%.

bacchi

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Re: Cash and Calls: talk me out of it
« Reply #36 on: November 12, 2019, 04:22:12 PM »
You need to look at SPX and XSV options and not SPY options. With the spy options you are getting hit on the dividend, have unfavorable tax treatment,

SPX fops are mark-to-market 1256 contracts. A >365 day SPY option falls under LTCG tax treatment.

Also, depending on your income planning (e.g., regarding ACA subsidies), it seems risky to let a mark-to-market contract affect your income on 12/31.

YoungInvestor

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Re: Cash and Calls: talk me out of it
« Reply #37 on: November 12, 2019, 08:14:44 PM »
Create a debit spread.

Buy a CD/bond/whatever with most of the money.
Buy an ATM call with an expiration >365 days (for LTCG tax purposes).
Sell an OTM call @ +10% with the same expiration date.

(2) the risk of losing the ability to own shares if stock prices go up while one is out of the market.

This strategy doesn't address the risk that the stock market jumps higher and by the time one eventually buys back in one can't afford as many shares as one originally sold.

Right, a fixed index annuity isn't going to make anyone rich. It's going to preserve the principal while maybe making a small gain. It's going to protect against SORR.

The strategy might be to roll out what you'd need in 1-3 years. If you expect to spend $50k in 2021, you could create a spread for Dec 2020. If you make 4%, great. If the market tumbles, you know you're set for 2021. Do the same for 12/21 and you're set for 2022.

I'm not sure how to handle longer than 3 years out. LEAPs don't go out any further as far as I know.


eta: I misread ChpBstrd's comment.

You can just roll your LEAPS every year so that you always hold a position between 2 and 3 years out.

Alex239

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Re: Cash and Calls: talk me out of it
« Reply #38 on: November 13, 2019, 09:34:35 PM »
have you ever been to https://www.reddit.com/r/wallstreetbets/

there is a YOLO for every Portfolio!

gertitorpe

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Re: Cash and Calls: talk me out of it
« Reply #39 on: November 15, 2019, 12:49:01 AM »
have you ever been to https://www.reddit.com/r/wallstreetbets/

there is a YOLO for every Portfolio!

Totally agree. If you want to loose your life savings, just to go wallstreetbets and follow literally any advice there. If you are working hard you could even go negative. They were offering infinite leverage recently too!

Jokes aside, if you already own your your SPY etfs and looking to play with options to compensate against downside why not consider writing those call options against your stocks? Then you can use the premium received to buy more on a downturn or start building your "safe" capital whatever you consider safe.

Statistically the outcome of betting options is something similar in the order of profitability below (for SPY I believe). It was a while ago when I ready an article in this topic:
- writing short term puts
- buying LEAP calls
the above two are around the return of the index

- buying short term calls -> this is around 0%
- buying short term puts -> this is deep in negative

What this is telling me is that you could write short or medium term calls against your stocks and with that harvest the money from the loosing side. It's up to your Personal Risk Tolerance how far the strike price is (what would be the acceptable price to be forced to sell your stocks). Also you can always buy back the SPY stocks on a pullback. What you risk is sell too low and see the prices never come back to your level

This is what I would do (because I enjoy investing) but the best outcome this is what you should actually choose: do nothing and never every touch your low cost ETF and spend your time on any other enjoyable activities instead of loosing money on the stock market while trying to be smart.

vand

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Re: Cash and Calls: talk me out of it
« Reply #40 on: November 15, 2019, 03:49:53 AM »
An except from a brilliant article which I think may be pertinent:

https://www.collaborativefund.com/blog/the-psychology-of-money/

"Say you want a new car. It costs $30,000. You have a few options: 1) Pay $30,000 for it. 2) Buy a used one for less than $30,000. 3) Or steal it.

In this case, 99% of people avoid the third option, because the consequences of stealing a car outweigh the upside. This is obvious.

But say you want to earn a 10% annual return over the next 50 years. Does this reward come free? Of course not. Why would the world give you something amazing for free? Like the car, thereís a price that has to be paid.

The price, in this case, is volatility and uncertainty. And like the car, you have a few options: You can pay it, accepting volatility and uncertainty. You can find an asset with less uncertainty and a lower payoff, the equivalent of a used car. Or you can attempt the equivalent of grand theft auto: Take the return while trying to avoid the volatility that comes along with it.

Many people in this case choose the third option. Like a car thief Ė though well-meaning and law-abiding Ė they form tricks and strategies to get the return without paying the price. Trades. Rotations. Hedges. Arbitrages. Leverage.

But the Money Gods do not look highly upon those who seek a reward without paying the price. Some car thieves will get away with it. Many more will be caught with their pants down. Same thing with money."

...


Every money reward has a price beyond the financial fee you can see and count. .. If you want success, figure out the price, then pay it.


seems to me that the OP is contemplating Grand Theft Auto.. an attempt to participate in the rewards without paying the price.

Roland of Gilead

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Re: Cash and Calls: talk me out of it
« Reply #41 on: November 15, 2019, 04:13:43 AM »
With that analogy though you are admitting that there ARE some people who will "get away with it".   They will get outsized returns without the volatility, just like some car thieves are never caught.

In one sense, it is just taking on more risk for more reward.

vand

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Re: Cash and Calls: talk me out of it
« Reply #42 on: November 15, 2019, 05:07:40 AM »
With that analogy though you are admitting that there ARE some people who will "get away with it".   They will get outsized returns without the volatility, just like some car thieves are never caught.

In one sense, it is just taking on more risk for more reward.

Yes, of course there different range of outcomes. Luck plays a huge role in outcomes. Career car thieves may get away with multiple hijacks, but the price they pay is the person they become.

Roland of Gilead

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Re: Cash and Calls: talk me out of it
« Reply #43 on: November 15, 2019, 05:20:45 AM »
One person starts working at age 20 at Enron, gets a bunch of stock options, then the company goes bust

Another person starts working at age 20 at Amazon, gets a bunch of stock options, retires at age 30

Life is kind of built on some luck.

index

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Re: Cash and Calls: talk me out of it
« Reply #44 on: November 15, 2019, 07:55:27 AM »
Not really the equivalent of grand theft auto. The strategy they are talking about is paying 4.5%/year to purchase the leverage. Essentially they are guaranteed to underperform the market by 4.5%, but in exchange are capping their loss at 4.5%. So it's not really some crazy money scheme. It is more akin to:

Quote
The price, in this case, is volatility and uncertainty. And like the car, you have a few options: You can pay it, accepting volatility and uncertainty. You can find an asset with less uncertainty and a lower payoff, the equivalent of a used car. Or you can attempt the equivalent of grand theft auto: Take the return while trying to avoid the volatility that comes along with it.

It is a much better option for some people who are nearing retirement or risk averse than being 100% stocks. It is essentially the same strategy banks use when offering market linked CDs:

https://sp.jpmorgan.com/spweb/content/271732.pdf

The strategy is actually very popular in France.

ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #45 on: November 15, 2019, 12:14:52 PM »
Not really the equivalent of grand theft auto. The strategy they are talking about is paying 4.5%/year to purchase the leverage. Essentially they are guaranteed to underperform the market by 4.5%, but in exchange are capping their loss at 4.5%. So it's not really some crazy money scheme. It is more akin to:

Quote
The price, in this case, is volatility and uncertainty. And like the car, you have a few options: You can pay it, accepting volatility and uncertainty. You can find an asset with less uncertainty and a lower payoff, the equivalent of a used car. Or you can attempt the equivalent of grand theft auto: Take the return while trying to avoid the volatility that comes along with it.

It is a much better option for some people who are nearing retirement or risk averse than being 100% stocks. It is essentially the same strategy banks use when offering market linked CDs:

https://sp.jpmorgan.com/spweb/content/271732.pdf

The strategy is actually very popular in France.

@index yep, that was going to be my reply. @vand I am willing to pay a price for risk avoidance, as is anyone who buys insurance, owns bonds, holds cash, or foregoes eating junk food every day. With this strategy, the price is known and the downside protection is also known, so itís less a speculation than an asset allocation question. Yes, the market timers, technical analysts, sector rotators, leveraged investors, stock pickers, etc. are trying to get something for nothing, but what they donít realize is they too have entered a risk trade off, and on unfavorable terms.

@gertitorpe the covered call strategy has the exact opposite risk profile than Iím interested in. It has unlimited downside with limited upside, and the very real potential of owning fewer shares in a couple of years than one started with. It only seems safer because oneís starting position is getting a credit and it seems like if stocks go down one is no worse off and in fact a tiny bit better off than if one just owned long shares. The risk of stocks rising is ignored because we donít usually think of that as a bad thing. And thatís how one starts a covered call strategy with enough money to buy 1,000 shares and ends it with only enough money to buy 800.

vand

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Re: Cash and Calls: talk me out of it
« Reply #46 on: November 16, 2019, 12:00:48 AM »
What's the practical difference between cash+calls rather than just buying some puts to hedge off downside risk? Liquidating your entire position just seems drastic and with potential tax implications (though that might not apply here)

gertitorpe

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Re: Cash and Calls: talk me out of it
« Reply #47 on: November 16, 2019, 05:40:41 AM »
Not really the equivalent of grand theft auto. The strategy they are talking about is paying 4.5%/year to purchase the leverage. Essentially they are guaranteed to underperform the market by 4.5%, but in exchange are capping their loss at 4.5%. So it's not really some crazy money scheme. It is more akin to:

Quote
The price, in this case, is volatility and uncertainty. And like the car, you have a few options: You can pay it, accepting volatility and uncertainty. You can find an asset with less uncertainty and a lower payoff, the equivalent of a used car. Or you can attempt the equivalent of grand theft auto: Take the return while trying to avoid the volatility that comes along with it.

It is a much better option for some people who are nearing retirement or risk averse than being 100% stocks. It is essentially the same strategy banks use when offering market linked CDs:

https://sp.jpmorgan.com/spweb/content/271732.pdf

The strategy is actually very popular in France.

@index yep, that was going to be my reply. @vand I am willing to pay a price for risk avoidance, as is anyone who buys insurance, owns bonds, holds cash, or foregoes eating junk food every day. With this strategy, the price is known and the downside protection is also known, so itís less a speculation than an asset allocation question. Yes, the market timers, technical analysts, sector rotators, leveraged investors, stock pickers, etc. are trying to get something for nothing, but what they donít realize is they too have entered a risk trade off, and on unfavorable terms.

@gertitorpe the covered call strategy has the exact opposite risk profile than Iím interested in. It has unlimited downside with limited upside, and the very real potential of owning fewer shares in a couple of years than one started with. It only seems safer because oneís starting position is getting a credit and it seems like if stocks go down one is no worse off and in fact a tiny bit better off than if one just owned long shares. The risk of stocks rising is ignored because we donít usually think of that as a bad thing. And thatís how one starts a covered call strategy with enough money to buy 1,000 shares and ends it with only enough money to buy 800.

My personal opinion is that all the potential upside and potential downside talk, without the probabilities doesn't have much sense on its own. It's like someone trying to convince me that paying that 2 dollars for a lottery ticket is a good deal because I can only loose those 2 dollars but win millions.


What you overlook in your strategy is what happens if the price is unchanged or slightly changed at the end of those 2 years. Your option expires worthless, you end up with 90%of your original capital, and no dividend received. Option two with leverage would increase your potential loss to 15%. Any leverage will increase your risk.
Also, any for any gain you may realise, the price increase of spy in the period will need to exceed 10 or 15 percent.

Before deciding spend 30 minutes on google asking the question if buying or selling option is the better business. Of chores we are talking about probabilities. Some people actually do win the lottery :)

blue_green_sparks

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Re: Cash and Calls: talk me out of it
« Reply #48 on: November 16, 2019, 07:49:58 AM »
At first look the structured products (essentially index linked CDs) seem weak. Some track a conservative index and have high fees or they take too much via the rate cap to be attractive. I am going to construct some worksheets to test them and the Innovator ETFs against a range of index outcomes.

I still have 5 years or so till I wish to take my pensions and SS. It is simply not a good environment for conservative savers. I don't need huge returns, but I need returns. I can't complain too much. Almost all of my friends are condemned wage slaves till they drop. I am risk adverse but I have no choice and the market is booming. Go team !

ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #49 on: November 17, 2019, 08:14:34 PM »
What's the practical difference between cash+calls rather than just buying some puts to hedge off downside risk? Liquidating your entire position just seems drastic and with potential tax implications (though that might not apply here)

The risk profile is technically about the same; defined risk, unlimited upside. Vanguardís short duration bond fund currently yields slightly more than the dividend on the S&P 500 so earning more yield is a point in favor of the calls approach. More importantly, part of the strategy is to be poised to switch over to a 100% long stock portfolio if there is a significant correction. However, of course, options do not move dollar-for-dollar with the underlying, so in that correction It seems more straightforward to switch from short-term instruments to stock rather than relying on the appreciation of the put.

Taxes are not an issue for this portfolio.