Author Topic: Cash and Calls: talk me out of it  (Read 7819 times)

Car Jack

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Re: Cash and Calls: talk me out of it
« Reply #50 on: November 18, 2019, 08:27:23 AM »
Just start buying BND.  This is boring and what everyone is doing, but it works.  Buy BND until you're happy with the risk you hold.  The end.

index

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Re: Cash and Calls: talk me out of it
« Reply #51 on: November 18, 2019, 10:34:55 AM »
Just start buying BND.  This is boring and what everyone is doing, but it works.  Buy BND until you're happy with the risk you hold.  The end.

Buying bonds is a completely different risk profile. Go 50/50 bonds and equity. Recession happens and stocks go down 30%. You are down 15%. Next year the market returns 15% you are up 7.5%. With the option strategy, the market is down 30% you lose 4%. The market is up 15% you are up 11%...

MoneyQuirk

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Re: Cash and Calls: talk me out of it
« Reply #52 on: December 01, 2019, 11:48:25 PM »
It's not a terrible idea.

Personally, I wouldn't.

Not only are you losing (by default) 4.95% per year, but you're also missing out on 2% of dividends. So you're losing 6.95% based off of how you would be doing on the HOPE that your estimation is correct.

One of the most educational points I heard about calls/puts versus long/shorts is that in long/shorts you only have to be correct about the underlying thesis. VTI will go up over time. TSLA will go down over time (unless it can become consistently profitable, which it hasn't shown its ability to do yet). However, when you add in another variable, time, all of a sudden it becomes a very different animal. Not only do you have to be right with your underlying thesis (which usually isn't too hard), but you have to pick the right time.

"The market can remain irrational longer than you can remain solvent."

I would stick with being long in index funds.

yoda34

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Re: Cash and Calls: talk me out of it
« Reply #53 on: December 11, 2019, 12:47:05 PM »
It's really interesting and I've played around with very similar things. A couple of things that I've thought about:

- A %5 OTM put+stock and a ATM call+cash end up costing about the same and have virtually the same risk profile

- Since 1999 the S&P Total Return has lost more than 5% 4 times

- Trailing the S&P TR by ~5% a year will (as you know) cause drastic under performance compared to the benchmark (even avoiding the 2008 type years)

- However, while under-performing it will also avoid major SORR risk in case of big drops (as others have pointed out sideways markets are problematic)

- If you want to use leverage the call+cash option can get you the equivalent exposure without paying brokerage margin rates that you would pay in a put+stock model

- The biggest difference in my mind is having to invest the cash in an equivalent to get the dividend that you would get in a put+stock combo and having to invest in another bond fund. For example BND dropped about 13% in 2008 (I think doing that from memory) along with the market. Basically you're exposing your cash to another market risk (it might be small - I agree, but it's there) so your hedge really isn't as capped as you might think. So in the cash+call option, not only are you trailing the market by 5% you also have another market risk to consider in the fund where your cash is invested

For the record I have a SPX put hedge on my S&P portfolio

markbike528CBX

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Re: Cash and Calls: talk me out of it
« Reply #54 on: December 11, 2019, 02:32:22 PM »
I sell puts on stocks I want, at some reasonable price (close, or in-the-money). 

My initial impetus for this was to cover my trading fees.  Now that fees have gone low or away, I guess I'm just doing it for fun.

VXUS Jan 17 '20 $52 put, hold till expired/exercised. Repeat as necessary.

ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #55 on: December 11, 2019, 06:59:19 PM »
It's really interesting and I've played around with very similar things. A couple of things that I've thought about:

- A %5 OTM put+stock and a ATM call+cash end up costing about the same and have virtually the same risk profile

- Since 1999 the S&P Total Return has lost more than 5% 4 times

- Trailing the S&P TR by ~5% a year will (as you know) cause drastic under performance compared to the benchmark (even avoiding the 2008 type years)

- However, while under-performing it will also avoid major SORR risk in case of big drops (as others have pointed out sideways markets are problematic)

- If you want to use leverage the call+cash option can get you the equivalent exposure without paying brokerage margin rates that you would pay in a put+stock model

- The biggest difference in my mind is having to invest the cash in an equivalent to get the dividend that you would get in a put+stock combo and having to invest in another bond fund. For example BND dropped about 13% in 2008 (I think doing that from memory) along with the market. Basically you're exposing your cash to another market risk (it might be small - I agree, but it's there) so your hedge really isn't as capped as you might think. So in the cash+call option, not only are you trailing the market by 5% you also have another market risk to consider in the fund where your cash is invested

For the record I have a SPX put hedge on my S&P portfolio

Lots of good observations here. I’ll add a couple of my thoughts:

-I bet this algorithm would perform well in historical backtests; one goes to a hedged position for 2-3y after a yield curve inversion, and stays long the rest of the time. The only ways to underperform would be if the relationship between yield curve inversion and recessions broke down.

-I cannot execute a hedging strategy for part of my portfolio- the part that is locked up in my employer’s 401k plan. In the 401k, I am only allowed to use the “long stock” risk profile. In my brokerage account I can choose any risk profile. So I’m only talking about changing the brokerage accounts here. However, I wonder if SORR would be improved by diversifying risk profiles. If my 401k must be nthe “long stock” profile, should my brokerage accounts also be “long stock” or would it be more reasonable to diversify into the “protective put / long call” profile? If diversification by asset classes is beneficial, wouldn’t diversification by risk profile also be beneficial? After all, what’s the difference between stocks and bonds, other than their risk profiles?

-One could also get cheap leverage with a long stock, long put, and long call combination.

-At today’s 1.75% yield on the S&P, it should be possible to find low volatility fixed income to replace that dividend. Even TIP yields 1.8%.

-Puts are usually more expensive than calls, given their distance OTM or ITM. This is skew, and it's a factor in favor of this switching from a protective put to a calls and cash strategy.



« Last Edit: December 11, 2019, 07:41:04 PM by ChpBstrd »

jim555

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Re: Cash and Calls: talk me out of it
« Reply #56 on: December 11, 2019, 11:19:21 PM »
If you buy puts and are long stock it is identical to owning calls from a risk reward perspective.

yoda34

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Re: Cash and Calls: talk me out of it
« Reply #57 on: March 18, 2020, 10:05:16 AM »
Hey CB,

Curious if you went forward with this? If so might have been an amazingly well timed move.

bacchi

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Re: Cash and Calls: talk me out of it
« Reply #58 on: March 18, 2020, 10:30:42 AM »
I set up a 1/21 and 1/22 CD+bull call position. Most of my spending for those years is guaranteed.

It may not work for 2023 because of the low interest rates but I'd like to continue for at least a few more years to avoid SORR.

ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #59 on: March 18, 2020, 11:05:50 AM »
Hey CB,

Curious if you went forward with this? If so might have been an amazingly well timed move.

No, I chickened out.

I ended up sticking with my collars and protective puts for much of my portfolio, left about 150k in equity unhedged, and moved my 401k to about a 30/70 allocation. I lacked the confidence to make a more maverick move like cash & calls with a more complicated payout algorithm, especially after my hedges were such a drag in 2019 (recency bias - perhaps why I posted the idea to get feedback anyway). So instead I went with a more traditionally conservative allocation.

I also reduced my unhedged exposure in the last few days, as my initially glib impressions of the crisis gave way to "oh shit, this might be a depression and will last several years."

Overall, my NW is down ~13% from it's February peak, and I have hit the floor on most of my collar positions, so losses will slow from here while much upside remains. Some of my collar positions have a higher value now than when I entered them a year ago, due to higher-than-2008 volatility! Perhaps with cash & calls I would have lost half that amount, but I'm happy enough with my portfolio management decisions.

Now comes the terrifying and tantalizing game of going risk-on again. Some of my hedges expire in June!

The next shoes to drop will be financial institution stresses/failures, defaults by Italy, Greece, or maybe others, and unemployment shooting up over 10% by EOY. Volatility is now so high (VIX>75!), it is now too expensive to hedge using options. My next move will hopefully be to lock in the kinds of returns on equities and bonds that would allow me to confidently retire on a 5% WR or worse. REITs, utilities, and bonds can be had with FCF/price and interest rates in the 7-10% range now, but they all have much further to fall.

The dream would be to jump into the panic at its worst and buy yields/interest that would cover my base expenses. By preserving capital, I now have that possibility! Then if/when volatility calms down get back into S&P exposure with long calls. 

I have learned that asking internet peeps to evaluate ideas often results in the reflection of my own fears. We all read the same news and experience the same market returns. It is a bit like talking to oneself, because we all have the same biases. I've also learned that if one can outperform a bear market, it makes one feel smart/confident, and that can lead to mistakes of hubris.

yoda34

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Re: Cash and Calls: talk me out of it
« Reply #60 on: March 18, 2020, 08:50:23 PM »
That's too bad that you didn't pull the trigger on the cash+calls. I've hit the floor on my collars as well - but i was a little more aggressive in setting mine up so I'm only down ~3% right now - they have done their job.

Like you I have an issue in that the entirety of my hedge will expire in June this year and I'll have a decision to make on my re-entry.

Quote
My next move will hopefully be to lock in the kinds of returns on equities and bonds that would allow me to confidently retire on a 5% WR or worse. REITs, utilities, and bonds can be had with FCF/price and interest rates in the 7-10% range now, but they all have much further to fall.

The dream would be to jump into the panic at its worst and buy yields/interest that would cover my base expenses. By preserving capital, I now have that possibility! Then if/when volatility calms down get back into S&P exposure with long calls. 

You've always had very well thought out thesis on investing and markets in general. I would love to chat more with you about your plan for the above. Because of my puts I'm in the same position of possibly being able jump in at the right time and ride off into the sunset. Any details you can share on how you're thinking of locking in returns for a 5% WR?

Anyway - I'm glad you're doing well.

ChpBstrd

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Re: Cash and Calls: talk me out of it
« Reply #61 on: March 19, 2020, 09:04:45 AM »
That's too bad that you didn't pull the trigger on the cash+calls. I've hit the floor on my collars as well - but i was a little more aggressive in setting mine up so I'm only down ~3% right now - they have done their job.

Like you I have an issue in that the entirety of my hedge will expire in June this year and I'll have a decision to make on my re-entry.

Quote
My next move will hopefully be to lock in the kinds of returns on equities and bonds that would allow me to confidently retire on a 5% WR or worse. REITs, utilities, and bonds can be had with FCF/price and interest rates in the 7-10% range now, but they all have much further to fall.

The dream would be to jump into the panic at its worst and buy yields/interest that would cover my base expenses. By preserving capital, I now have that possibility! Then if/when volatility calms down get back into S&P exposure with long calls. 

You've always had very well thought out thesis on investing and markets in general. I would love to chat more with you about your plan for the above. Because of my puts I'm in the same position of possibly being able jump in at the right time and ride off into the sunset. Any details you can share on how you're thinking of locking in returns for a 5% WR?

Anyway - I'm glad you're doing well.

Thanks @yoda34. To be clear, I am still down the value of my mortgage, but it could have been much worse, so I’m grateful. I’m glad to hear your collar was tighter! Almost tightened mine in Dec/Jan, but didn’t want to throw more cash at it. Having survived the initial phase of the correction, I find it hard to plot a course ahead for the following reasons:

1) Demographically, all of Western civilization plus the biggest Asian economies look a lot like Japan circa 1990, with a bulge of over-65 people who are all simultaneously entering a low-consumption phase of life. Lowering interest rates might not cause them to buy new cars, oversized houses, electronics, and fashion the way it did in the past. If anything, low rates cause them to hoard more money or sell more assets because their income has been cut.

2) Even 30% down, stocks are still historically overpriced. With a much-improved TTM PE ratio of 18, we still have 17% to fall before we hit the historical median PE of about 15. Bear in mind that most historical studies which validated the 4% rule had starting points much lower than today’s valuations (and all cohorts had a better demographic picture). We might still be in 3% or 2% SWR territory and not know it.

3) COVID-19 has not just slowed but halted large sectors of the economy. That is known. What is not known is how the defaults will start. Will it be corporate bonds, mortgages, or sovereign debt in Italy or Greece? Will a hedge fund collapse, or an investment bank, a bond trading desk, or will it be the regional banks who loaned to local restaurants, theaters, bars, and hotels? A financial crisis seems almost certain to emerge from this. If the infection curve doesn’t flatten, we’re looking at depression - no hyperbole. Even if everyone gave up and lifted restrictions, the death rate alone would shrink the economy.

4) So much of the modern economy is unsuited to disinflationary, high-unemployment conditions. Ford does not manufacture minimalistic cars like in the early 20th century; they sell the F-350 diesel crew cab 4x4 Harley Davidson Edition to office workers who want to project a macho image. Walgreens doesn’t mostly sell medications and necessities, their business is based on cosmetics, fake supplements, and “convenience snacks”. Look around Kroger or WalMart at all the gimmicky things that won’t sell in a depression, and imagine how small the store would need to be to efficiently sell just those things. So much of the economy is luxury, frivolities, and convenience goods. Consider the economies for phone apps, streaming services, advertising, hardware upgrades, and furnishings/decor in a world of 20+% unemployment where people are stretching to buy canned goods. Should I buy an index fund at such a turning point, or pick a portfolio of “necessity” stocks?

It could be that a PE closer to 8 or 10 would be the ideal re-entry point. Yet, the crisis could also be over as quickly as it started if classic public health measures start working in Western countries as they worked in China, or if the emergence of treatments reduces the urgency of social distancing (several pre-existing drugs on the market appear to be curing people.). I won’t catch the bottom, but at some point I’ll build a portfolio with a steady earnings stream.

If the 4% rule was validated on a typical PE ratio of 15, that’s a growing earnings stream of 1/15=6.7%. My screening process would set around 7% as a minimal expected free cash flow to equity  / price for stocks, and screen out non-necessity companies and markets with poor transparency. For bonds and preferreds with non-growing income streams, I’d need more like 8-10%. If nothing meets these criteria, I might bide my time selling puts at prices that would.

So bottom line is I have my work cut out. I need to screen for a large (>50) watchlist of stocks and bonds, calculate their new par level of earnings, establish my fair price, and evaluate running a put selling strategy until they get there. I’m looking hard at utilities like CNP, residential and healthcare REITs like EQR and OHI, and, for later in the game, software necessities stocks like CRM and MSFT. I’ll still hold my hedged index fund positions at least until expiration in case the swift rebound scenario happens (always place a side bet on yourself being wrong!). Some of my collars have a year or two remaining, so I can somewhat DCA into a new more-aggressive allocation.