Author Topic: Indexing with leverage  (Read 53074 times)

forummm

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Re: Indexing with leverage
« Reply #50 on: March 18, 2015, 11:37:55 AM »
For MMM-types, the Ayres-Nalebuff analysis would need some modification. They assume a 4% annual savings rate and a lifetime of work and minimal savings and conservative AA in retirement. Their idea is to more-evenly spread the amount invested across time--an intriguing concept. But for MMM-types, we're saving large amounts in our early years, and typically have a higher AA in equities for the duration of our lives, so the time-shifting is already being accomplished in large part by our aggressive savings rates. Given the dramatic narrowing of our earning/saving timeline, the A-N analysis indicating lower overall risk would seem to be totally inapplicable. All we'd need is 1 crash in our savings period to dramatically setback our FIRE plans.

For us, the calculation is a little different. If we have 2x leverage in 100% equities after 4 years of saving at a 75% savings rate, and a 50%+ market crash wipes out 100% of our assets, that's potentially a 50% increase of our time to FIRE (from 7 years to 11) and some serious psychological pain (perhaps even enough to keep some from investing again). If we're lucky and there is no crash and we have steady 10% returns, that would increase our net total annual returns to about 17% after the cost of leverage is included. So, to make the math easy, for a $100k after-tax income and $75k savings, a leveraged portfolio would have something like $451k vs $383k for a non-leveraged portfolio. So in this scenario you could be risking an extra 4 years of working if you're unlucky vs ~10 fewer months of working if you're lucky. That doesn't seem like a fantastic improvement to me. Especially if you add in the cost of anxiety over those years when you're so vulnerable to a temporary market crash. And remember that the people on the other side of your bets (which is what leverage requires if you use options or LEAPs or futures) are betting that you are wrong and they are right.

I guess you could partially leverage. Say, leave 80% unleveraged and do 2:1 leverage with 20%. You would risk losing that portion entirely, but that would only cost you a year or so of working in the above scenario. On the other hand, your gains from leverage would be pretty limited--a few months of working in the above scenario.

I certainly wouldn't buy on leverage with the overvalued markets we appear to have today. I would consider it perhaps if we had another 50%+ decline like in 2000-02 and 2008-09. But my guess is that it would be more difficult to get the leverage we'd want at the prices we can get it for now, which would eat away a lot of the potential gains--and thereby increase the risk. Remember, risk goes up as the price of the asset increases with respect to its underlying value.

It's important to think about your risk tolerance. I feel perfectly OK with being 100% stocks now because no matter what the market price might be (even a 99% drop), I still own X percent of thousands of great companies with huge revenue streams, and will continue to own them as markets return to rational pricing. And there's no way I would panic and sell them. I'm OK with working an extra year or two or working part time if there were such a crash (which would make me much wealthier in the long run anyway). I would be much more freaked out about a market crash if I knew I would lose everything (i.e. not owning those companies at all anymore). And I would be less wealthy in the future.

Despite Buffett's quote against leverage, Berkshire does participate in derivatives trading to some extent. They actually lost quite a bit of money doing it one year. Other years they have made money. If they can lose money at it, you can too. Buffett has said that they are decreasing their exposure to them.

forummm

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Re: Indexing with leverage
« Reply #51 on: March 18, 2015, 12:03:15 PM »
If you are using much leverage with volatile instruments then diversification is pretty much required. It's either that or you have to use market timing. Something has to protect the downside.

FWIW here's a 50/50 portfolio of 3X S&P 500 and 3X Long-Term Treasuries since inception (rebalanced annually). Too bad they don't go back BEFORE 2009. https://drive.google.com/file/d/0BzyyTlvGE-T2RUI4RndUU3JqZWc/view?usp=sharing
So the vulnerability here is if interest rates increase and the market goes down? That could wipe you out, right? Also the high costs and lack of long term tracking to the index. The 3X S&P doesn't seem to actually return 3x the S&P quite a bit. Sometimes it is WAY off. e.g. https://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1329512400000&chddm=98532&chls=IntervalBasedLine&cmpto=INDEXSP:.INX&cmptdms=0&q=NYSEARCA:FAS&ntsp=0&ei=vbwJVcmvEoO38QafpIDABA

And here's a long/short futures strategy of the permanent portfolio. S&P 500, Gold, US 30-yr Bonds and US Dollar futures. Buy if the price is above the 50/200 day moving average (golden cross), sell short if the price is below the 50/200 day moving average (death cross). 1996-2015. There are no stops. Starts with $1 million in equity. https://drive.google.com/file/d/0BzyyTlvGE-T2YlhPblhsdy10aXc/view?usp=sharing
What are the vulnerabilities here? Is the data available for more than 20 years?

DrF

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Re: Indexing with leverage
« Reply #52 on: March 18, 2015, 12:07:15 PM »
50/50 Ulpix/vlbtx does better than 100% SPY from 2005-2012.

$100 starting with $75,000 added each year.

25/75 Ulpix/vlbtx does better than both. IRRs of 7.06, 6.12, 3.01.

Over any time period, and during whatever part of saving/retirement you are in, adding leveraged ETFs seem to provide better returns with less volatility.

Run your own analysis. I've linked mine.

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Re: Indexing with leverage
« Reply #53 on: March 18, 2015, 12:09:23 PM »
If you are using much leverage with volatile instruments then diversification is pretty much required. It's either that or you have to use market timing. Something has to protect the downside.

FWIW here's a 50/50 portfolio of 3X S&P 500 and 3X Long-Term Treasuries since inception (rebalanced annually). Too bad they don't go back BEFORE 2009. https://drive.google.com/file/d/0BzyyTlvGE-T2RUI4RndUU3JqZWc/view?usp=sharing
So the vulnerability here is if interest rates increase and the market goes down? That could wipe you out, right? Also the high costs and lack of long term tracking to the index. The 3X S&P doesn't seem to actually return 3x the S&P quite a bit. Sometimes it is WAY off. e.g. https://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1329512400000&chddm=98532&chls=IntervalBasedLine&cmpto=INDEXSP:.INX&cmptdms=0&q=NYSEARCA:FAS&ntsp=0&ei=vbwJVcmvEoO38QafpIDABA

And here's a long/short futures strategy of the permanent portfolio. S&P 500, Gold, US 30-yr Bonds and US Dollar futures. Buy if the price is above the 50/200 day moving average (golden cross), sell short if the price is below the 50/200 day moving average (death cross). 1996-2015. There are no stops. Starts with $1 million in equity. https://drive.google.com/file/d/0BzyyTlvGE-T2YlhPblhsdy10aXc/view?usp=sharing
What are the vulnerabilities here? Is the data available for more than 20 years?

You're using the wrong 3x fund. You need UPRO. FAS is 3x the Financial services (BAC, C, WF).

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Re: Indexing with leverage
« Reply #54 on: March 18, 2015, 12:39:16 PM »
50/50 Ulpix/vlbtx does better than 100% SPY from 2005-2012.

$100 starting with $75,000 added each year.

25/75 Ulpix/vlbtx does better than both. IRRs of 7.06, 6.12, 3.01.

Over any time period, and during whatever part of saving/retirement you are in, adding leveraged ETFs seem to provide better returns with less volatility.

Run your own analysis. I've linked mine.

Same scenario, but from 1998-2005.

IRR of 3.2, 1.2, and -0.58%.

2 of the worst market corrections in the past 30 years and leveraged portfolios do better in every case.

During the accumulation or retirement phase, I'd rather be slightly leveraged than not.

Edit: on all of the above I mean VBLTX not VLBTX
« Last Edit: March 18, 2015, 12:45:30 PM by DrFunk »

arebelspy

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Re: Indexing with leverage
« Reply #55 on: March 18, 2015, 02:03:17 PM »

you keep talking about decay, decay is just price weakness that you can take advantage of when you rebalance (quarterly, semi-annual, annual - your preference).

at 10% AA for 3x or 20% AA for 2x, decay doesn't matter.

I think you don't understand what decay is.  You ought to read up a lot more before you implement your strategy.

Good luck, df.

Very glib thing to say. I do understand what decay is, and again it doesn't matter when you keep your AA low.

It affects your overall portfolio less, but it affects that portion. Leveraged ETFs are for short term hedging, not long term holding. Decay will ruin the returns for that portion of your portfolio.
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dragoncar

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Re: Indexing with leverage
« Reply #56 on: March 18, 2015, 02:15:57 PM »
You guys are great.  Still too busy to write intelligently on this topic, but I'll leave this here.  Not sure if any of you are on the PP forum, but similar points have been made regarding real life decay, diversification, etc.


Quote
If you found an investment that for the past 40 years had:

-A CAGR of 20.10%
-Standard deviation of 16.6%

....would you be interested?  Of course, you should probably know the main risk of this investment is in counterparty solvency which would be difficult to quantify.  Also, systemic risk could be an issue--also difficult to quantify.  Let's say that the risks appear to be minimal, but within the realm of possibility.
http://gyroscopicinvesting.com/forum/variable-portfolio-discussion/20-annual-returns-over-40-years-interested/

arebelspy

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Re: Indexing with leverage
« Reply #57 on: March 18, 2015, 02:18:58 PM »
Great link DC. DF, lots of good links on that first page alone. :)
I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
If you want to know more about me, this Business Insider profile tells the story pretty well.
I (rarely) blog at AdventuringAlong.com. Check out the Now page to see what I'm up to currently.

hodedofome

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Re: Indexing with leverage
« Reply #58 on: March 18, 2015, 02:29:37 PM »
If you are using much leverage with volatile instruments then diversification is pretty much required. It's either that or you have to use market timing. Something has to protect the downside.

FWIW here's a 50/50 portfolio of 3X S&P 500 and 3X Long-Term Treasuries since inception (rebalanced annually). Too bad they don't go back BEFORE 2009. https://drive.google.com/file/d/0BzyyTlvGE-T2RUI4RndUU3JqZWc/view?usp=sharing
So the vulnerability here is if interest rates increase and the market goes down? That could wipe you out, right? Also the high costs and lack of long term tracking to the index. The 3X S&P doesn't seem to actually return 3x the S&P quite a bit. Sometimes it is WAY off. e.g. https://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1329512400000&chddm=98532&chls=IntervalBasedLine&cmpto=INDEXSP:.INX&cmptdms=0&q=NYSEARCA:FAS&ntsp=0&ei=vbwJVcmvEoO38QafpIDABA
 

ULPIX (2x S&P 500) and GVPIX (2x 30 yr Treasuries) were around in 2008 but not the 3X ETFs. Performance of a 50/50 ULPIX/GVPIX and SPY/TLT (unleveraged 50/50) and SPY only since 2003 is here: https://www.portfoliovisualizer.com/backtest-portfolio?s=y&allocation2_1=50&allocation1_1=50&annualOperation=0&initialAmount=10000&allocation4_2=50&symbol4=TLT&symbol1=ULPIX&endYear=2014&symbol3=SPY&symbol2=GVPIX&annualAdjustment=0&showYield=true&startYear=1985&rebalanceType=1&annualPercentage=0.0&allocation3_2=50&allocation3_3=100

Because treasury bonds did great in 2008, it cushioned the blow to stocks. However, if there was a period (like the 1970s) where both stocks and bonds went down you'd be in a pickle. It is worth noting that ULPIX by itself since 2000 is still below the unleveraged SPY. However, if you bought at the bottom of a bear market then you've seen some good gains.

And here's a long/short futures strategy of the permanent portfolio. S&P 500, Gold, US 30-yr Bonds and US Dollar futures. Buy if the price is above the 50/200 day moving average (golden cross), sell short if the price is below the 50/200 day moving average (death cross). 1996-2015. There are no stops. Starts with $1 million in equity. https://drive.google.com/file/d/0BzyyTlvGE-T2YlhPblhsdy10aXc/view?usp=sharing
What are the vulnerabilities here? Is the data available for more than 20 years?

There's data available but not for the trial version of TradingBlox :) I'm too cheap to spend $3-4k on the paid version along with thousands of $$ on CSI data going back to the 1970s.

Richard Donchian back in 1949 started the first diversified managed futures fund using simple trend following rules across multiple asset classes. Guys were using trend following on single markets (corn guys stuck to corn, stock guys stuck with stocks, etc etc). But Donchian was the first to do it with multiple asset classes in a single strategy. In the 1970s a lot of new futures markets began to be developed (interest rates, various commodities, currencies, stock indexes). They were incredibly inefficient because they were so new. Combined with currencies being able to be freely floated and no longer tied to the price of gold, and rampant inflation, strong trends developed and very simple trend following strategies were able to make a crap ton of money. Ed Seykota was probably the first to put simple trend following strategies into a computer system in the 1970s and over 12 years was able to take a customer's account from $5,000 to $15,000,000 AFTER fees and AFTER the customer was taking money out on a regular basis. That's roughly 100% a year returns.

Strong trends continued through the 1980s but by the 1990s a lot of people were catching on. The trader effect happens when too many people pursue the same strategy. Returns began to be pretty volatile and there were multi-year stretches where diversified trend following systems had a difficult time. These are systems that are intellectually very simple. A high school kid is smart enough to figure it out. But it's emotionally very difficult to trade because you have to endure a lot of small losses and long stretches of underperformance. Most people give up during the hard times so that's why it tends to bounce back after a while. In other words, it's about the same as value investing these days.

You won't see managed futures funds having performance anywhere near the system I just posted. For one, they take out outrageous fees (2% and 20%), and their customers are typically large pension funds and institutional investors. They don't want a lot of volatility, and they definitely don't want 50% drawdowns, so managed futures funds typically strive for consistent 5-15% returns with under 20% drawdowns. This system I showed is pretty balls to the wall and you won't get too many investors sticking around your fund with this kind of volatility. Bill Dunn at Dunn Capital has remained fairly true to his original system he started in the 1970s and his fund has done about 18%/yr after fees since then, however his max drawdown has been somewhere in the 60% range. He trades a lot more markets than the one shown here.

What are the risks to a system like this? The main risk to diversified trend following systems is a lack of trends and/or all markets becoming correlated. It thrives on diverse markets that are uncorrelated to each other. During a crisis all correlations tend to move to 1. The only saving grace to a system like this during a crisis is hopefully there's a strong trend intact. If the dollar, S&P 500 and treasury bonds all crashed together, the correlation would be 1 but hopefully the system would have you short anyways so you'd be making money. However, if everything was down 20% one day, and up 20% the next week and back and forth, the system would tell you to go short, then long, then back to short, constantly getting whipsawed along the way. This would result in a lot of losses and could add up.

Here's a 100 year backtest of a simple trend following system (after 2 and 20 fees) but it uses a lot of markets instead of a few: https://www.efficient.com/pdfs/A_Century_of_Evidence_on_Trend-Following_Investing.pdf

DrF

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Re: Indexing with leverage
« Reply #59 on: March 18, 2015, 02:37:27 PM »
Great link DC. DF, lots of good links on that first page alone. :)

You still seem to think I don't know what decay is. So, I'll tell you again... it doesn't matter. Here is a graph of 25/75 SSO/TLT for 2011, which was a very volatile year. Please tell me where the decay is? If you properly set your AA, you barely ever have to rebalance.

hodedofome

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Re: Indexing with leverage
« Reply #60 on: March 18, 2015, 02:40:02 PM »
You guys are great.  Still too busy to write intelligently on this topic, but I'll leave this here.  Not sure if any of you are on the PP forum, but similar points have been made regarding real life decay, diversification, etc.


Quote
If you found an investment that for the past 40 years had:

-A CAGR of 20.10%
-Standard deviation of 16.6%

....would you be interested?  Of course, you should probably know the main risk of this investment is in counterparty solvency which would be difficult to quantify.  Also, systemic risk could be an issue--also difficult to quantify.  Let's say that the risks appear to be minimal, but within the realm of possibility.
http://gyroscopicinvesting.com/forum/variable-portfolio-discussion/20-annual-returns-over-40-years-interested/

Here's my 3X Permanent Portfolio since I started live tracking it on ETFReplay.com in 2013. https://drive.google.com/file/d/0BzyyTlvGE-T2WEd4aldlUzFLN0U/view?usp=sharing

arebelspy

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Re: Indexing with leverage
« Reply #61 on: March 18, 2015, 02:42:26 PM »
I have that impression because you're saying things that make it seem as if you don't understand. Rebalancing, for example, is irrelevant. Yet you throw out sentences like
If you properly set your AA, you barely ever have to rebalance.

...okay?

Whatever. Best of luck to you. :)

I'd caution anyone else interested in this to learn about decay and read the links on the first page of DC's link.

I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
If you want to know more about me, this Business Insider profile tells the story pretty well.
I (rarely) blog at AdventuringAlong.com. Check out the Now page to see what I'm up to currently.

arebelspy

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Re: Indexing with leverage
« Reply #62 on: March 18, 2015, 02:43:54 PM »
You guys are great.  Still too busy to write intelligently on this topic, but I'll leave this here.  Not sure if any of you are on the PP forum, but similar points have been made regarding real life decay, diversification, etc.


Quote
If you found an investment that for the past 40 years had:

-A CAGR of 20.10%
-Standard deviation of 16.6%

....would you be interested?  Of course, you should probably know the main risk of this investment is in counterparty solvency which would be difficult to quantify.  Also, systemic risk could be an issue--also difficult to quantify.  Let's say that the risks appear to be minimal, but within the realm of possibility.
http://gyroscopicinvesting.com/forum/variable-portfolio-discussion/20-annual-returns-over-40-years-interested/

Here's my 3X Permanent Portfolio since I started live tracking it on ETFReplay.com in 2013. https://drive.google.com/file/d/0BzyyTlvGE-T2WEd4aldlUzFLN0U/view?usp=sharing

Thanks. That's pretty telling.
I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
If you want to know more about me, this Business Insider profile tells the story pretty well.
I (rarely) blog at AdventuringAlong.com. Check out the Now page to see what I'm up to currently.

hodedofome

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Re: Indexing with leverage
« Reply #63 on: March 18, 2015, 02:45:02 PM »
DrFunk if you haven't looked into it yet, you may be interested in risk parity type strategies. Ray Dalio's All Weather portfolio is based on this. Essentially risk parity tells you to do roughly 25/75 stocks/bonds and then they leverage it up to be the same volatility as stocks. It ends up returning more than stocks but with the same volatility.

dragoncar

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Re: Indexing with leverage
« Reply #64 on: March 18, 2015, 02:48:12 PM »
Great link DC. DF, lots of good links on that first page alone. :)

You still seem to think I don't know what decay is. So, I'll tell you again... it doesn't matter. Here is a graph of 25/75 SSO/TLT for 2011, which was a very volatile year. Please tell me where the decay is? If you properly set your AA, you barely ever have to rebalance.

Yeah if you read through the thread, you see that decay hasn't been an issue and various explanations/excuses for why.  My best guess is simply that daily volatility hasn't been high enough.  If the underlying assets are trending up or down, decay isn't a big deal.  If they are sideways long term, with daily volatility, decay will eat you up.

hodedofome

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Re: Indexing with leverage
« Reply #65 on: March 18, 2015, 02:49:22 PM »

Here's my 3X Permanent Portfolio since I started live tracking it on ETFReplay.com in 2013. https://drive.google.com/file/d/0BzyyTlvGE-T2WEd4aldlUzFLN0U/view?usp=sharing

Thanks. That's pretty telling.

Yeah and before I started live tracking it, it performed splendidly. Funny how that always works out...

DrF

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Re: Indexing with leverage
« Reply #66 on: March 18, 2015, 02:50:18 PM »
I have that impression because you're saying things that make it seem as if you don't understand. Rebalancing, for example, is irrelevant. Yet you throw out sentences like
If you properly set your AA, you barely ever have to rebalance.

...okay?

Whatever. Best of luck to you. :)

I'd caution anyone else interested in this to learn about decay and read the links on the first page of DC's link.

No, you don't understand. Rebalancing may be the most relevant part of using leverage. You use rebalancing to capture price weakness in the 2x or 3x ETF. It doesn't have to be very often for it to be effective. You can see all about it in this thread -
http://forum.mrmoneymustache.com/investor-alley/triple-leverage-etf/msg437458/#msg437458

bacchi

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Re: Indexing with leverage
« Reply #67 on: March 18, 2015, 02:55:58 PM »
Note that IB will not issue a conventional "margin call".  If the computer detects you have a margin violation, it immediately begins liquidating positions to whatever extent necessary to bring you back into compliance.

IB will also change the margin requirements with little notice. What was once $4600 may become $6000 or more in a rout.

dragoncar

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Re: Indexing with leverage
« Reply #68 on: March 18, 2015, 03:03:25 PM »
I have that impression because you're saying things that make it seem as if you don't understand. Rebalancing, for example, is irrelevant. Yet you throw out sentences like
If you properly set your AA, you barely ever have to rebalance.

...okay?

Whatever. Best of luck to you. :)

I'd caution anyone else interested in this to learn about decay and read the links on the first page of DC's link.

No, you don't understand. Rebalancing may be the most relevant part of using leverage. You use rebalancing to capture price weakness in the 2x or 3x ETF. It doesn't have to be very often for it to be effective. You can see all about it in this thread -
http://forum.mrmoneymustache.com/investor-alley/triple-leverage-etf/msg437458/#msg437458

Consider the edge case where you rebalance daily.  Decay is no longer an issue (fees and expenses on the other hand...)  The reason is 3x funds have to (equivalently) buy on an up day and sell on a down day to maintain constant leverage.  Rebalancing your portfolio daily does the opposite- sell on an up day and buy on a down day

See http://www.investopedia.com/articles/exchangetradedfunds/07/leveraged-etf.asp

dragoncar

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Re: Indexing with leverage
« Reply #69 on: March 18, 2015, 03:08:08 PM »
Note that IB will not issue a conventional "margin call".  If the computer detects you have a margin violation, it immediately begins liquidating positions to whatever extent necessary to bring you back into compliance.

IB will also change the margin requirements with little notice. What was once $4600 may become $6000 or more in a rout.

Good point... Another reason to stay far far away from maintenance margin.  That said, if say 1.1x leverage forces a margin call, you might as well head down to the bomb shelter.  Don't get greedy and I think you'll be ok (you still might underperform the market though)

To elaborate on the above regarding daily leveraged rtf rebalancing, consider the decay example:

$100 in UPRO, $5 cash
Day 1 - SPY -1%, you have $97 in UPRO, $5 cash
Day 2 - SPY +1.01% you have $99.94 in UPRO, $5 cash.  Decay!

What if you rebalance instead?

$100 in UPRO, $5 cash.
Day 1 - SPY -1%, you have $97 UPRO, $5 cash
At end of day, you buy $3 UPRO. $100 UPRO, $2 cash
Day 2 - SPY +1.01% you have $103.03 UPRO, $2 cash
At end of day, you sell $3.03 UPRO.  $100 UPRO, $5.03 cash

Haven't though through where the .03 comes from.. Volatility capture?
« Last Edit: March 18, 2015, 03:16:50 PM by dragoncar »

DrF

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Re: Indexing with leverage
« Reply #70 on: March 18, 2015, 03:12:41 PM »
DrFunk if you haven't looked into it yet, you may be interested in risk parity type strategies. Ray Dalio's All Weather portfolio is based on this. Essentially risk parity tells you to do roughly 25/75 stocks/bonds and then they leverage it up to be the same volatility as stocks. It ends up returning more than stocks but with the same volatility.

That's pretty much the experiment that a guy over at bogleheads is doing.

http://www.bogleheads.org/forum/viewtopic.php?f=10&t=143037&sid=f356651715068725a3f10380f9587a9e&start=600

DrF

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Re: Indexing with leverage
« Reply #71 on: March 18, 2015, 03:21:56 PM »
The whole reason people buy index funds is to protect their investment. If the S&P500 goes down 30%, smart investors pour more money into the ETF. If you use leverage on a small portion of your portfolio, who cares if it goes down 50-90%? It is still based on an underlying index fund that historically is bound to go up. So, you rebalance from a mostly uncorrelated asset (treasuries) yearly, or percent, or bands. Rebalancing reduces volatility which in turn reduces decay. Decay is not an issue!

Who cares if you lose 25% of your portfolio over a couple of years, if it means gaining hundreds of % over the next 4. All because you rebalanced against one of the greatest bull markets in our lifetime 2008-2009!

This method works even better once you are retired and you want to protect your principle.

DrF

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Re: Indexing with leverage
« Reply #72 on: March 18, 2015, 03:24:00 PM »
Note that IB will not issue a conventional "margin call".  If the computer detects you have a margin violation, it immediately begins liquidating positions to whatever extent necessary to bring you back into compliance.

IB will also change the margin requirements with little notice. What was once $4600 may become $6000 or more in a rout.

Good point... Another reason to stay far far away from maintenance margin.  That said, if say 1.1x leverage forces a margin call, you might as well head down to the bomb shelter.  Don't get greedy and I think you'll be ok (you still might underperform the market though)

To elaborate on the above regarding daily leveraged rtf rebalancing, consider the decay example:

$100 in UPRO, $5 cash
Day 1 - SPY -1%, you have $97 in UPRO, $5 cash
Day 2 - SPY +1.01% you have $99.94 in UPRO, $5 cash.  Decay!

What if you rebalance instead?

$100 in UPRO, $5 cash.
Day 1 - SPY -1%, you have $97 UPRO, $5 cash
At end of day, you buy $3 UPRO. $100 UPRO, $2 cash
Day 2 - SPY +1.01% you have $103.03 UPRO, $2 cash
At end of day, you sell $3.03 UPRO.  $100 UPRO, $5.03 cash

Haven't though through where the .03 comes from.. Volatility capture?

Precisely!

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market timer

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Re: Indexing with leverage
« Reply #74 on: March 19, 2015, 01:20:13 AM »
Apparently we have a "market timer" on these forums, and based on previous posts (mentioning wife and kid), it sounds very likely it's the same person (or a large coincidence).

Sending him a PM linking to this thread.  Given how transparent/honest he was over at BH, I'd bet he'll chime in if it is him.
Yeah, that's me.

Leverage is a popular discussion topic around all-time stock market highs. I see some parallels between 2007 and today, and am not optimistic about future returns (given my poor timing, perhaps you could consider this as a contrary indicator).

For the record, I agree with the logic of Ayres and Nalebuff in their Lifecycle Investing book. One should try to smooth risk across time, which, under some reasonable assumptions, means using leverage when young, poor, and with a lifetime of earnings ahead of you. The example they use to open the book is a 3rd year Yale Law student, biglaw offer in hand, with $5K to invest. I see no problem with that person using 2x leverage to buy $10K of stocks. I also agree with Ayres and Nalebuff that my implementation was foolhardy, due to my concentration in bank stocks and using proceeds from credit card balance transfer promotions to invest. Mostly, though, I just had horrible timing. My life could have easily been ruined if not for a few lucky breaks. Unlike the Yale Law student, I started my leverage experiment and went heavily into debt before even having a job offer in hand.

While Ayres and Nalebuff confine their analysis to stocks, I believe one could improve on their recommendation by including other asset classes, particularly long term bonds. There is a recent Bogleheads thread on leveraging a balanced fund, which is closer to how I'd recommend using leverage today: https://bogleheads.org/forum/viewtopic.php?f=10&t=143037

As forummm notes above (reply #50), the lifecycle investing profile of a MMM-style FIRE investor is very different from what Ayres and Nalebuff had in mind. If your goal is to work 5-10 years and retire, using leverage in your early years in less important. A much more challenging problem is surviving for 50+ years on investment returns. For someone planning a typical career lasting 30-40 years, early leverage (offset by less risk later in life) can substantially improve risk and return over the entire lifecycle.

There are various ways to implement this strategy: options, futures, leveraged ETFs, etc. Currently, due to technical reasons involving optimal early exercise and low interest rates, I'd recommend avoiding LEAPS. Futures are my preferred investment vehicle, as they are extremely liquid and allow one to borrow essentially at the risk-free rate. However, they are large in size: one S&P eMini currently has exposure equivalent to 500 SPDRs, or $100K+. Leveraged ETFs are commonly disparaged due to volatility drag; however, with regular rebalancing, this is actually not a problem. More importantly, any leveraged strategy involves scenarios where low prices will force you to sell, and high prices compel you to buy. You can reset your exposure on a daily basis (like a leveraged ETF), a monthly basis (as recommended by Ayres and Nalebuff), or when your RegT is binding and your broker issues a margin call (as I did). If you choose to adopt this strategy, have contingency plans in place ahead of time and follow your plan. You don't want to be a deer in headlights, making decisions lacking sleep in the middle of night, as I was. One of the key lessons I learned is that bad decisions tend to beget more bad decisions. Try to make decisions with a sound mind.

innerscorecard

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Re: Indexing with leverage
« Reply #75 on: March 19, 2015, 01:30:00 AM »
Apparently we have a "market timer" on these forums, and based on previous posts (mentioning wife and kid), it sounds very likely it's the same person (or a large coincidence).

Sending him a PM linking to this thread.  Given how transparent/honest he was over at BH, I'd bet he'll chime in if it is him.
Yeah, that's me.

Leverage is a popular discussion topic around all-time stock market highs. I see some parallels between 2007 and today, and am not optimistic about future returns (given my poor timing, perhaps you could consider this as a contrary indicator).

For the record, I agree with the logic of Ayres and Nalebuff in their Lifecycle Investing book. One should try to smooth risk across time, which, under some reasonable assumptions, means using leverage when young, poor, and with a lifetime of earnings ahead of you. The example they use to open the book is a 3rd year Yale Law student, biglaw offer in hand, with $5K to invest. I see no problem with that person using 2x leverage to buy $10K of stocks. I also agree with Ayres and Nalebuff that my implementation was foolhardy, due to my concentration in bank stocks and using proceeds from credit card balance transfer promotions to invest. Mostly, though, I just had horrible timing. My life could have easily been ruined if not for a few lucky breaks. Unlike the Yale Law student, I started my leverage experiment and went heavily into debt before even having a job offer in hand.

While Ayres and Nalebuff confine their analysis to stocks, I believe one could improve on their recommendation by including other asset classes, particularly long term bonds. There is a recent Bogleheads thread on leveraging a balanced fund, which is closer to how I'd recommend using leverage today: https://bogleheads.org/forum/viewtopic.php?f=10&t=143037

As forummm notes above (reply #50), the lifecycle investing profile of a MMM-style FIRE investor is very different from what Ayres and Nalebuff had in mind. If your goal is to work 5-10 years and retire, using leverage in your early years in less important. A much more challenging problem is surviving for 50+ years on investment returns. For someone planning a typical career lasting 30-40 years, early leverage (offset by less risk later in life) can substantially improve risk and return over the entire lifecycle.

There are various ways to implement this strategy: options, futures, leveraged ETFs, etc. Currently, due to technical reasons involving optimal early exercise and low interest rates, I'd recommend avoiding LEAPS. Futures are my preferred investment vehicle, as they are extremely liquid and allow one to borrow essentially at the risk-free rate. However, they are large in size: one S&P eMini currently has exposure equivalent to 500 SPDRs, or $100K+. Leveraged ETFs are commonly disparaged due to volatility drag; however, with regular rebalancing, this is actually not a problem. More importantly, any leveraged strategy involves scenarios where low prices will force you to sell, and high prices compel you to buy. You can reset your exposure on a daily basis (like a leveraged ETF), a monthly basis (as recommended by Ayres and Nalebuff), or when your RegT is binding and your broker issues a margin call (as I did). If you choose to adopt this strategy, have contingency plans in place ahead of time and follow your plan. You don't want to be a deer in headlights, making decisions lacking sleep in the middle of night, as I was. One of the key lessons I learned is that bad decisions tend to beget more bad decisions. Try to make decisions with a sound mind.

Really appreciate hearing from you.

The example of the law student is particularly funny, as many law students even from great schools had their offers in hand that were revoked from them. Life is unpredictable, and so are the effects of leverage, especially when applied to dumb blind instruments such as index funds.

arebelspy

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Re: Indexing with leverage
« Reply #76 on: March 19, 2015, 08:50:39 AM »
Thanks for chiming in, market timer.  I found your story very compelling, and was glad to hear you're essentially FI now (or close), only a few years later, with a wife and kid.  Glad everything worked out so wonderfully.
I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
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Re: Indexing with leverage
« Reply #77 on: March 19, 2015, 09:04:07 AM »
Leverage is a popular discussion topic around all-time stock market highs. I see some parallels between 2007 and today, and am not optimistic about future returns (given my poor timing, perhaps you could consider this as a contrary indicator).

I've noticed a similar trend. Is it just me, or as the market climbs steadily higher, are there fewer of the "The market looks overpriced, should I wait to invest?" threads, and more of the "Should I use leverage to enhance my returns?" threads? I've only been investing since 2011, so this is a peculiarly thing to witness.

hodedofome

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Re: Indexing with leverage
« Reply #78 on: March 19, 2015, 10:21:37 AM »
There are also single stock futures available. These are like futures contracts but for individual stocks and ETFs. Margin requirements are 20% (instead of 50% like stocks and ETFs) and each contract is equal to 100 shares of stock. They have expiration dates on them so you'd have to sell the contract before expiration and buy another contract expiring sometime in the future. I believe there's a contract each quarter of the calendar year.

Also, margin on mutual funds at Interactive Brokers is 25% after 30 days. That gives you a lot more leeway as far as margin calls go than ETFs.

----------------------------------------------------------------------------------------------------------------------------------------------------

One thing I haven't mentioned but is worth mentioning in this thread. The thing to focus on the most is not how much money you can make, but how you can keep from losing it. Become a good risk manager first, then learn how to take on extra risk second. With leveraged strategies you have to pay very careful attention to what can happen if everything goes to crap. Go through all sorts of scenarios in your head and read up on market history so you at least know how it went to crap in the past. It won't be perfect because there will be something new in the future that hasn't happened in the past, but it'll get you pretty far.

When I look for an investment, the first thing I do is calculate how much I can lose. Once I've done that, then I estimate, to the best of my ability, what I can possibly make. Once I have that figured out, then I can see the risk/reward relationship and determine if it's worth pursuing or not. I personally look for at least 3% of gain for every 1% of loss. If it's less than that I pass. If it's more then I'll probably do it. If there's a possibility of losing all of my investment, then I really can't have a 1:3 risk/reward ratio because you can't divide by 0. So I'll pass on something like that.

If you can maintain a 1:3 risk/reward ratio on everything that you do, you can be right just 40% of the time and still have a positive expectancy over a long period of time. If the upside is another 3% on top of the market return, but you have the possibility of losing everything, that's a negatively skewed risk/reward. I would pass on an investment like that. Paul Tudor Jones says it like this:

I’d say that my investment philosophy is that I don’t take a lot of risk, I look for opportunities with tremendously skewed reward-risk opportunities. Don’t ever let them get into your pocket – that means there’s no reason to leverage substantially. There’s no reason to take substantial amounts of financial risk ever, because you should always be able to find something where you can skew the reward risk relationship so greatly in your favor that you can take a variety of small investments with great reward risk opportunities that should give you minimum draw down pain and maximum upside opportunities.

If you leverage up near the top and lose 80% in the next bear market, you have to make ALOT of money back in the next bull market to get back to even. Look at the drawdown % vs upside % to get back to even:

% Loss of Capital          % Profit to Recovery
     10%                                  11.11%
     20%                                  25%
     30%                                  42.85%
     40%                                  66.66%
     50%                                  100%
     60%                                  150%
     70%                                  233%
     80%                                  400%
     90%                                  900%
     100%                                Put a fork in it bro

Leveraging up a buy and hold portfolio 2X would probably make me go through so many possible scenarios of what could go wrong that I'd eventually throw it in the "too hard" pile, like Buffett and Munger would say. That's why guys go to diversification/risk-parity/stop-losses/trend following/options etc.
« Last Edit: March 19, 2015, 10:41:45 AM by hodedofome »

DrF

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Re: Indexing with leverage
« Reply #79 on: March 19, 2015, 11:30:58 AM »
This is fairly apples to apples, and proves why you should rebalance. Especially if you have a small portion of your portfolio leveraged.

portfolio 1 = 10% equity (SPY or ULPIX) 90% VBLTX
portfolio 2 = 20% equity (SPY or ULPIX) 80% VBLTX
portfolio 3 = 30% equity (SPY or ULPIX) 70% VBLTX

all have $1MM starting with $40K annual WR

« Last Edit: March 19, 2015, 12:55:29 PM by DrFunk »

forummm

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Re: Indexing with leverage
« Reply #80 on: March 23, 2015, 05:14:23 PM »
While Ayres and Nalebuff confine their analysis to stocks, I believe one could improve on their recommendation by including other asset classes, particularly long term bonds. There is a recent Bogleheads thread on leveraging a balanced fund, which is closer to how I'd recommend using leverage today: https://bogleheads.org/forum/viewtopic.php?f=10&t=143037

Do you mean owning unleveraged long term bonds as well as leveraged equities or owning leveraged long term bonds? Since bonds tend to have mild price swings, but provide a lot of dividends, and many leveraged instruments (like options) don't payout dividends, it seems like the upside to leveraging bonds is limited and the expense is considerable.

Currently, due to technical reasons involving optimal early exercise and low interest rates, I'd recommend avoiding LEAPS. Futures are my preferred investment vehicle, as they are extremely liquid and allow one to borrow essentially at the risk-free rate.

Can you explain more of why you recommend against LEAPS? It seems like they are a great way to avoid the margin calls that did you in. Whereas futures like e-minis could give you an unmanageable margin call at any moment. Some people don't even recommend holding them overnight since they never stop trading.

forummm

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Re: Indexing with leverage
« Reply #81 on: March 23, 2015, 05:37:06 PM »
There are various ways to implement this strategy: options, futures, leveraged ETFs, etc. Currently, due to technical reasons involving optimal early exercise and low interest rates, I'd recommend avoiding LEAPS.

Is there a difference between LEAPS and the 2-3 year options you can find in option chains (e.g. http://finance.yahoo.com/q/op?s=^SPXPM&date=1513296000)?

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Re: Indexing with leverage
« Reply #82 on: March 23, 2015, 06:12:43 PM »

Is there a difference between LEAPS and the 2-3 year options you can find in option chains (e.g. http://finance.yahoo.com/q/op?s=^SPXPM&date=1513296000)?

No.  Those are LEAPS

There are even longer dated options you won't find in those option chains on Yahoo! Finance but they are known as "warrants."

hodedofome

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Re: Indexing with leverage
« Reply #83 on: March 23, 2015, 08:06:00 PM »
You'd have to be pretty leveraged to get a margin call on e-minis. Currently the margin on ES is like 1/20th of the value of the contract.

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Re: Indexing with leverage
« Reply #84 on: March 23, 2015, 11:28:13 PM »
What do you guys think of portfolio margin?  Not to increase initial leverage, but hopefully to increase safety margin by lowering overall maintenance?  Is it more or less likely to act unpredictably during times of market unrest (e.g., raised maintenance margins)?

DrF

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Re: Indexing with leverage
« Reply #85 on: March 24, 2015, 07:57:41 AM »
Do you mean owning unleveraged long term bonds as well as leveraged equities or owning leveraged long term bonds? Since bonds tend to have mild price swings, but provide a lot of dividends, and many leveraged instruments (like options) don't payout dividends, it seems like the upside to leveraging bonds is limited and the expense is considerable.

The way Rob Bertrum at Bogleheads has set up his leverage experiment is to buy 40% VTI 60% BND, then using his margin account to purchase another 40% VTI and 60% BND.

I think recently he states that he would have just bought treasuries instead of BND (like TLT/IEI or similar).

Once his account reaches $110k he will leverage 4x, always keeping his portfolio at 40% stock 60% bond.

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Re: Indexing with leverage
« Reply #86 on: March 24, 2015, 10:24:41 AM »
Do you mean owning unleveraged long term bonds as well as leveraged equities or owning leveraged long term bonds? Since bonds tend to have mild price swings, but provide a lot of dividends, and many leveraged instruments (like options) don't payout dividends, it seems like the upside to leveraging bonds is limited and the expense is considerable.

The way Rob Bertrum at Bogleheads has set up his leverage experiment is to buy 40% VTI 60% BND, then using his margin account to purchase another 40% VTI and 60% BND.

I think recently he states that he would have just bought treasuries instead of BND (like TLT/IEI or similar).

Once his account reaches $110k he will leverage 4x, always keeping his portfolio at 40% stock 60% bond.

Not sure how he can leverage 4x.  At 8% maintenance margin that would allow only an 18% drop.  Maybe he's planning (hoping) to always be able to meet a margin call?

forummm

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Re: Indexing with leverage
« Reply #87 on: March 24, 2015, 10:54:40 AM »
You'd have to be pretty leveraged to get a margin call on e-minis. Currently the margin on ES is like 1/20th of the value of the contract.

But if the market drops a lot, like what happened to Market Timer, you could need to keep ponying up lots and lots of cash. And if most of your investments are in a different account, you wouldn't get credit for them. For example, I don't know if Vanguard even lets you do e-minis. And I don't know if they credit you for all the Vanguard mutual funds you own. So if I had a bunch of money and Vanguard and then had the e-minis elsewhere, it could be a problem, right?

hodedofome

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Re: Indexing with leverage
« Reply #88 on: March 24, 2015, 11:21:09 AM »
But if the market drops a lot, like what happened to Market Timer, you could need to keep ponying up lots and lots of cash. And if most of your investments are in a different account, you wouldn't get credit for them. For example, I don't know if Vanguard even lets you do e-minis. And I don't know if they credit you for all the Vanguard mutual funds you own. So if I had a bunch of money and Vanguard and then had the e-minis elsewhere, it could be a problem, right?

If you bought 1 e-Mini S&P contract from Interactive Brokers today, and margin requirements didn't change, at 2X margin on a $50k account it would take a ~900 point drop in the S&P to get a margin call. Margin requirement is currently $4,600 per contract. Each point is worth $50. The contract is worth ($50 x S&P index) so currently $105,000. I'm not saying it can't happen, so I'd never leverage myself this much on a single asset class. If you only leveraged 1.5 times, it would take a 1308 point drop in the S&P to get a margin call. Again, it's possible. Not probable, but possible.

This is why I'd only leverage with market timing or a diversified portfolio. Ideally market timing on a diversified portfolio. You gotta protect the downside.

Vanguard doesn't offer futures so it would have to be with someone like TDAmeritrade or Interactive Brokers or someone like that. You would have to make sure that the excess cash in your account is used up on treasury bills or something similar (a 'risk-free' asset). Never leave cash in a brokerage account.

hodedofome

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Re: Indexing with leverage
« Reply #89 on: March 24, 2015, 11:24:08 AM »
Do you mean owning unleveraged long term bonds as well as leveraged equities or owning leveraged long term bonds? Since bonds tend to have mild price swings, but provide a lot of dividends, and many leveraged instruments (like options) don't payout dividends, it seems like the upside to leveraging bonds is limited and the expense is considerable.

The way Rob Bertrum at Bogleheads has set up his leverage experiment is to buy 40% VTI 60% BND, then using his margin account to purchase another 40% VTI and 60% BND.

I think recently he states that he would have just bought treasuries instead of BND (like TLT/IEI or similar).

Once his account reaches $110k he will leverage 4x, always keeping his portfolio at 40% stock 60% bond.

Not sure how he can leverage 4x.  At 8% maintenance margin that would allow only an 18% drop.  Maybe he's planning (hoping) to always be able to meet a margin call?

Yeah and a 40/60 VTI/BND portfolio experienced a 21.75% drawdown in 2008/09.

40/60 VTI/TLT experienced an 18.47% drawdown in the same period.

But what happens when stocks AND bonds both drop?

forummm

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Re: Indexing with leverage
« Reply #90 on: March 24, 2015, 01:19:39 PM »
But if the market drops a lot, like what happened to Market Timer, you could need to keep ponying up lots and lots of cash. And if most of your investments are in a different account, you wouldn't get credit for them. For example, I don't know if Vanguard even lets you do e-minis. And I don't know if they credit you for all the Vanguard mutual funds you own. So if I had a bunch of money and Vanguard and then had the e-minis elsewhere, it could be a problem, right?

If you bought 1 e-Mini S&P contract from Interactive Brokers today, and margin requirements didn't change, at 2X margin on a $50k account it would take a ~900 point drop in the S&P to get a margin call. Margin requirement is currently $4,600 per contract. Each point is worth $50. The contract is worth ($50 x S&P index) so currently $105,000. I'm not saying it can't happen, so I'd never leverage myself this much on a single asset class. If you only leveraged 1.5 times, it would take a 1308 point drop in the S&P to get a margin call. Again, it's possible. Not probable, but possible.

This is why I'd only leverage with market timing or a diversified portfolio. Ideally market timing on a diversified portfolio. You gotta protect the downside.

Vanguard doesn't offer futures so it would have to be with someone like TDAmeritrade or Interactive Brokers or someone like that. You would have to make sure that the excess cash in your account is used up on treasury bills or something similar (a 'risk-free' asset). Never leave cash in a brokerage account.
Thanks for the information. Could you describe the process a little more? So I put $50k in Interactive Brokers, get $50 matching through margin. Then if I buy an e-mini contract, it could be for up to a year? Is the contract price (I see $2080 quoted for an ESH16 March 2016 on a website) what I pay, or is it 50x that? And then any movement in the S&P 500 is tallied against that contract price? If the margin requirement is $4,600, do I only need to have $4,600 in the account besides the contract? Obviously I'd keep more to avoid margin calls.

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Re: Indexing with leverage
« Reply #91 on: March 24, 2015, 01:43:28 PM »
I haven't read every single reply, but I would definitely recommend leveraged index investing, with a few caveats:
- it should be done in a cost effective way; the cheapest I know of would be S&P futures, where only a fraction of the notional investment amount is needed for initial margin (so one could theoretically leverage as much as desired); it is priced using an institutional risk free borrowing rate as opposed to broker call rate: the difference can be hundreds of basis points per annum; additionally the brokerage costs as a % of notional are much lower than using ETFs
- the downside to futures is that the contracts need to be rolled periodically, which incurs transactions costs as well as becomes a taxable event
- the taxes are automatically split 60/40% long/short term cap gains, and realized periodically upon rolling of contracts (typically quarterly) vs potentially 100% long term cap gains upon sale (if ever) of ETFs

I would strongly advise against using leveraged (2x, 3x, etc) ETFs as an investment vehicle, as a buyer is 100% guaranteed to underperform in the medium to long run.  This is a mathematical certainty based on the way the leveraged ETFs are rebalanced (by the ETF sponsor/provider) in order to maintain the leverage effect.

hodedofome

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Re: Indexing with leverage
« Reply #92 on: March 24, 2015, 02:24:07 PM »
Thanks for the information. Could you describe the process a little more? So I put $50k in Interactive Brokers, get $50 matching through margin. Then if I buy an e-mini contract, it could be for up to a year? Is the contract price (I see $2080 quoted for an ESH16 March 2016 on a website) what I pay, or is it 50x that? And then any movement in the S&P 500 is tallied against that contract price? If the margin requirement is $4,600, do I only need to have $4,600 in the account besides the contract? Obviously I'd keep more to avoid margin calls.

It's not really 'matching' with futures. The contract size is whatever it is that day. It more depends on how much money you have in your account. The contract size today is $104,250 because the index is at 2085. 2085 x $50 is $104,250 contract value. How much you have in your account is how much you want to be leveraged. If you have $52,125, then you'd effectively be leveraged 2X. If you only had $26,062.25 in your account, then you'd be leveraged 4X. Futures are as risky or unrisky as you want them to be, it all depends on your account size and how many contracts you want to buy.

Yes you can buy the ESH16 contract for $2080. You would sell the contract before it expires in March 2016 and buy another contract in the future (called rolling). If you purchased 1 contract, only $4,600 would be reserved for margin after the first day. The rest of the money in your account is just sitting there. The easiest thing to do with the rest of the money in your account is to buy SHY. Never leave cash with a broker unless you want them to be tempted to steal it.

As the market goes up and down your account balance will change by $50 per S&P point per contract. So if the index drops from 2080 to 1950 tomorrow, your account will be down $6,500.

I don't believe TheNewNormal is correct on the taxes. It is my understanding that your profit/loss for the year is calculated on 12/31 and if you have a profit, then you owe taxes. I've never held futures contracts through 12/31 so I can't say this is fact, but it's always been my understanding. Therefore if you are up $20k by 12/31, then you'll owe 60/40 long/short term cap gains on that $20k whether you sell your position or not. This was done back in the '80s because futures guys were getting around short term taxes (I can't remember exactly how they were doing it). So everyone settled on 60/40 each year.
« Last Edit: March 24, 2015, 02:26:51 PM by hodedofome »

forummm

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Re: Indexing with leverage
« Reply #93 on: March 24, 2015, 02:56:17 PM »
Yes you can buy the ESH16 contract for $2080. You would sell the contract before it expires in March 2016 and buy another contract in the future (called rolling). If you purchased 1 contract, only $4,600 would be reserved for margin after the first day. The rest of the money in your account is just sitting there. The easiest thing to do with the rest of the money in your account is to buy SHY. Never leave cash with a broker unless you want them to be tempted to steal it.

So you're saying not to keep any cash in the account? So if I have 1 e-mini contract and I buy SHY with all the rest in the account, and the S&P goes down 20 points that day, then I have to sell $1000 in SHY to pay for the dip that day? That sounds like a lot of transaction costs buying and selling each day.

Do brokers actually steal cash?

hodedofome

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Re: Indexing with leverage
« Reply #94 on: March 24, 2015, 03:18:19 PM »
You'll get 50% margin on the SHY so you'll have a good bit of play room before you sell some. You'll pay about $1-2 a trade at Interactive Brokers for small accounts on ETFs so it won't be as much as you think.

As far as the brokers go, look up MF Global and PFG Best and Refco for recent examples:
http://en.wikipedia.org/wiki/MF_Global
http://en.wikipedia.org/wiki/Peregrine_Financial_Group
http://en.wikipedia.org/wiki/Refco

They can't steal your positions but they can steal your cash.

dragoncar

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Re: Indexing with leverage
« Reply #95 on: March 24, 2015, 03:53:36 PM »
You'll get 50% margin on the SHY so you'll have a good bit of play room before you sell some. You'll pay about $1-2 a trade at Interactive Brokers for small accounts on ETFs so it won't be as much as you think.

As far as the brokers go, look up MF Global and PFG Best and Refco for recent examples:
http://en.wikipedia.org/wiki/MF_Global
http://en.wikipedia.org/wiki/Peregrine_Financial_Group
http://en.wikipedia.org/wiki/Refco

They can't steal your positions but they can steal your cash.

Most retail brokers have FDIC sweeps though, right?

PEIslander

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Re: Indexing with leverage
« Reply #96 on: March 24, 2015, 06:02:02 PM »
I would strongly advise against using leveraged (2x, 3x, etc) ETFs as an investment vehicle, as a buyer is 100% guaranteed to underperform in the medium to long run.  This is a mathematical certainty based on the way the leveraged ETFs are rebalanced (by the ETF sponsor/provider) in order to maintain the leverage effect.

I've seen many writers say essentially the same thing TheNewNormal2015 has written. Perhaps I'm missing something but it seems to be a myth. I have investments in leveraged-ETF's UPRO, SOXL, CURE, and BIB. Because of such cautions, I just have my 'fun' money invested in them in a sheltered account (TFSA).

Looking at Yahoo Finance we can see the 5-year performance of UPRO - ProShares UltraPro S&P500 (3x Daily) relative to the S&P500 Index (^GSPC):



If you had invested $1000 in UPRO on March 22, 2010 it would on March 23, 2015 be worth $4,917.50 [That's a 391.75% increase].
In contrast if your $1000 had matched the Index, it would now be worth $1,803.90 [That's a 80.39% increase].

Am I missing something? Looks like the UPRO outperformed the index nicely. The "100% guaranteed to underperform in the medium to long run" doesn't hold up very well.

Another example is BIB - ProShares Ultra Nasdaq Biotechnology (2x Daily) relative to the Nasdaq Biotechnology Index (NBI). Again, we can look to Yahoo Finance for the 5-year performance:



If you had invested $1000 in BIB on April 9, 2010 it would on March 23, 2015 be worth $11,525.00 [That's a 1,052.52% increase].
In contrast if your $1000 had matched the Index, it would now be worth $3,939.50 [That's a 293.95% increase].

Again the "100% guaranteed to underperform in the medium to long run" doesn't hold up very well. Perhaps not enough evidence to say "myth-busted" but I'd hope it might be enough to get at least a few who have heard that "guaranteed to underperform" to do a bit of backtesting themselves before regurgitating that 'guarantee' to others. What I like about the leverage in leveraged-ETF's is you'll never get a margin call. I think of them just like any other ETF except they have bigger moves up & down --- exciting! Perhaps too exciting for many?

« Last Edit: March 24, 2015, 06:08:36 PM by PEIslander »

Financial.Velociraptor

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Re: Indexing with leverage
« Reply #97 on: March 24, 2015, 06:12:33 PM »

Another example is BIB - ProShares Ultra Nasdaq Biotechnology (2x Daily) relative to the Nasdaq Biotechnology Index (NBI). Again, we can look to Yahoo Finance for the 5-year performance:



PEI,

I hold a synthetic long position in BIB.   It is not intended to be a "hold forever" investment because of the daily balancing friction.  Take the return of the underlying index, multiply by two: this is not the return of BIB.  It is quite a lot lower than double due to fees and 'tracking error' caused by compounding the daily ups and downs.  These instruments are great when you have a rising tide but make no mistake, you have taken on twice the risk for less than twice the return.  This is the type of thing you only want to do with high conviction trade ideas.  Same applies to the other daily balancing issues.

I also hold MORL which rebalances monthly and has much less frictional cost than a daily balancing fund and NIO which uses modest 33% leverage.  Those are my only leveraged instruments except for written options of which I have many.

PEIslander

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Re: Indexing with leverage
« Reply #98 on: March 24, 2015, 06:38:03 PM »
I hold a synthetic long position in BIB.   It is not intended to be a "hold forever" investment because of the daily balancing friction.  Take the return of the underlying index, multiply by two: this is not the return of BIB.  It is quite a lot lower than double due to fees and 'tracking error' caused by compounding the daily ups and downs.  These instruments are great when you have a rising tide but make no mistake, you have taken on twice the risk for less than twice the return.  This is the type of thing you only want to do with high conviction trade ideas.  Same applies to the other daily balancing issues.

I understand lots of the bad press that leveraged-ETF's have had relates to the observation that a 2x daily leverage likely will not deliver 2x results on periods longer than daily. No doubt there were investors who did not understand that and suffered losses with lots of kicking and screaming. That said, look at the chart I posted for BIB. Over a five year period it did better than 2x. Much better! .

Financial.Velociraptor, I get your point that "you have taken on twice the risk for less than twice the return", and it is well worth keeping in mind if you invest in any leveraged-ETF. I personally am willing to accept higher risk in a portion of my portfolio. 

hodedofome

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Re: Indexing with leverage
« Reply #99 on: March 24, 2015, 06:47:46 PM »
You'll get 50% margin on the SHY so you'll have a good bit of play room before you sell some. You'll pay about $1-2 a trade at Interactive Brokers for small accounts on ETFs so it won't be as much as you think.

As far as the brokers go, look up MF Global and PFG Best and Refco for recent examples:
http://en.wikipedia.org/wiki/MF_Global
http://en.wikipedia.org/wiki/Peregrine_Financial_Group
http://en.wikipedia.org/wiki/Refco

They can't steal your positions but they can steal your cash.

Most retail brokers have FDIC sweeps though, right?
Futures brokers are a little different http://www.elitetrader.com/et/index.php?threads/how-safe-are-my-funds-with-a-us-futures-broker.269774/

I personally will not gamble with someone's promises to protect my money. Having all my cash invested in treasury bills is not that difficult for me, and helps me sleep at night.