Author Topic: Selling put & call options as a rebalancing technique  (Read 4020 times)

Nords

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Selling put & call options as a rebalancing technique
« on: August 25, 2015, 10:12:17 PM »
I'm occasionally asked about rebalancing in retirement, so here's a full-disclosure post.  This is a little fast and sloppy because I'm trying to get it up before the markets open on Wed 26 Aug.  Follow along with me for the next six months as we see what happens.

Our asset allocation plan includes shares in Berkshire Hathaway and a small-cap value ETF (ticker IJS).  We've held these assets for over a decade.  Once every 2-3 years, market volatility gives us a rebalancing opportunity.  When that happens, though, it's hard to take action.  You feel like an idiot as the market goes up while you're watching your asset allocation, yet when the market drops-- and opportunity knocks-- then you're terrified to answer the door.

During these times my spouse and I could rebalance by buying or selling shares, but we always do that too soon.  Always.  I have a perfect batting average of 0.000 in that sport.  I've given up market timing.

I could walk into our livingroom right now and say "Honey, the market's down more than 10% in the last week and our rebalancing criteria have triggered.  It's time for us to buy more shares!"  We've been together for over 30 years and we get along just fine.  She'd entertain a thoughtful discussion of our choices.  We generally agree on the need to do something.  Yet somehow we've always found a flimsy excuse to delay taking action, and then the opportunity has passed. 

In my 13 years of retirement I've explored just about every investing technique (although that activity has declined every year).  I've realized that selling options gives you a way to rebalance and get a little profit from it.  We started this in 2010 and we did it several times during the recovery, but it's been nearly two years since our last option sale.

Most investors should not do this.  It's a behavioral finance tweak.  The financial motive is minor.  In fact, there's some research questioning whether rebalancing is even necessary.  I would only suggest this if you have annuity income, like a military pension or Social Security.  If you screw up an options trade then you'll still be able to buy cat food with next month's annuity deposit.  Those of you from E-R.org may remember Dixonge blowing up a few years ago from his leveraged option trades. 

But since we have enough assets (and reliable income), we can afford to take risks with money that we don't need.  It satisfies my testosterone-poisoned urges with a small percentage of our assets so that I'm not tempted to go nuts with the rest of the portfolio.  Better still, perhaps you'll learn from my experience and decide whether it's suitable for your situation. 

My education started with McMillan's "Options As A Strategic Investment" textbook.  Next I read through the CBOE's education center.  Both of these resources are designed to stupify you with eye-glazing boredom, but I'm a nuclear submariner who used to read reactor plant manuals for fun & profit.  My point is that if these two references don't fascinate you to your core, then you shouldn't trade options.

The last thing I did was open a margin account (with Fidelity).  You can sell covered calls without a margin account, but most brokerages want you to have assets on hand before selling naked puts.  The approval process for a margin account is filled with dire warnings designed to intimidate the crap out of you (and your spouse). 

This morning (Tue 25 Aug) I sold two puts.  One of them gives the buyer the option to sell me 500 Berkshire Hathaway "B" shares at $125/share until 18 Dec.  (BRK/B was at $132 when I opened the trade, and it closed today at $127.79.  Probably oversold, but yowza.)  BRK's book value is ~$100/share and rising, and Buffett has stated that he might start buying his own shares at 110% of book value.  In technical terms, I opened to sell at a limit order of $2.95/share for just that trading day.  If the order wasn't filled by the end of the day then it'd be canceled. 

After the commission, I received a $1463 premium (short-term capital gains).  This is the equivalent of earning 7% APY ($2.92/125 x 12/4) before taxes but at a much higher risk.  If I get exercised then I'll eventually cough up another $62,500 to cover the margin loan.  I'm pretty sure I can sell $125 Berkshire shares at a profit during the next five years, even if ("especially if"?) Buffett steps down.

The second put option lets the buyer sell me 500 IJS shares at $97/share until 19 Feb.  (It closed at $103.69.)  I received a $1738 premium, which is also about a 7% APY ($3.47/$97 x 12/6).  If I get exercised... $48,500 on margin.  Again, I'm willing to ride out the volatility for at least five years and would expect to sell at a profit.

Share prices can dip below those strike prices without exercising the option.  Until expiry, that's up to the buyer of the option.  If the share prices are below the strike on the day they expire, then the brokerage will exercise them (just in case the buyer forgot).  I might get an exercise alert before Dec/Feb, or the options might expire worthless.  Either way we keep the premiums.

$3200 won't make a difference to my life, although it gives our portfolio a little breathing room (and buys a lot of surf wax).  However it encourages us to rebalance our portfolio at a very scary time with a minimum of spouse debate and no emotion.  Once the order is filled and until it expires, it's almost like autopilot and I sleep better at night.

Again, if you need a nudge to rebalance, or if you wish you could "do something" when the markets drop, then this might help you feel better about taking action.  But I only do it because we have the assets & income and because this tinkering at the margins helps keep me out of even bigger trouble.  Statistically I'm at the peak of my cognition right now, and I expect to shut off my margin account in five years when I turn age 60. 

milesdividendmd

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Re: Selling put & call options as a rebalancing technique
« Reply #1 on: August 26, 2015, 12:12:09 AM »
Great post Nords. A lot of wisdom in there. I particularly like the behavioral justification of forcing you to take action on rebalancing when the time comes.

I have no experience with options trading, so please pardon my ignorance. Your post has certainly inspired me to read further.

My assumption is that you are overweight these assets relative to your desired allocation, which is why you you are selling puts on these particular assets in the first place?

Questions.

When you sell at a loss relative to market value when the the option is called can you harvest a tax loss on that loss relative to the true value?  I would assume not.

As a rebalancing mechanism, isn't there the risk that the equity that you are selling a put on will be underweight at the time you were forced to sell it, becoming counterproductive to the rebalancing exercise?

Isn't this a real example of big downside with extremely limited upside? arent you taking on the possibility of complete loss of capital if the company (like Berkshire Hathaway) goes bankrupt and you're forced to buy their shares and hold them in exchange for 7% APR?

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Re: Selling put & call options as a rebalancing technique
« Reply #2 on: August 26, 2015, 07:22:57 AM »
I'm occasionally asked about rebalancing in retirement, so here's a full-disclosure post.  This is a little fast and sloppy because I'm trying to get it up before the markets open on Wed 26 Aug.

If only the best posts of the rest of us could be as polished as this "fast and sloppy" one of yours!

Quote
My education started with McMillan's "Options As A Strategic Investment" textbook.  Next I read through the CBOE's education center.  Both of these resources are designed to stupify you with eye-glazing boredom, but I'm a nuclear submariner who used to read reactor plant manuals for fun & profit.  My point is that if these two references don't fascinate you to your core, then you shouldn't trade options.

For my money, this is the most important bit of wisdom in the entire post.  I'm a corporate lawyer with a borderline-unhealthy interest in investing, and, generally speaking, I wouldn't touch derivatives with a ten foot pole.

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Re: Selling put & call options as a rebalancing technique
« Reply #3 on: August 26, 2015, 07:54:04 AM »
  Statistically I'm at the peak of my cognition right now, and I expect to shut off my margin account in five years when I turn age 60.

Another good point.

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Re: Selling put & call options as a rebalancing technique
« Reply #4 on: August 26, 2015, 08:14:51 AM »
This is a great post - hopefully will be repeated in a similar form on your blog also.

Nords

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Re: Selling put & call options as a rebalancing technique
« Reply #5 on: August 26, 2015, 02:36:56 PM »
My assumption is that you are overweight these assets relative to your desired allocation, which is why you you are selling puts on these particular assets in the first place?
Rebalancing, not so much overweighting.  Right now we're at the lower end of our desired asset allocation for these shares.  If the market keeps dropping then we'd need to buy more shares in Berkshire Hathaway and IJS to stay within their asset allocation band.  Of course if the market goes racing up next week then we might end up overweighted in those assets and have to sell some shares... but it's probably too soon to start talking about market recoveries.

In the case of "you are overweight these assets relative to your desired allocation", you might be thinking of selling covered call options.  If the price of the shares rose above the strike price of the covered call option then those shares would be called away and our asset allocation would be rebalanced.

When you sell at a loss relative to market value when the the option is called can you harvest a tax loss on that loss relative to the true value?  I would assume not.
I sold put options, which means the owner of the options can make us buy the shares at the strike price.  Ideally the put options would never be exercised and they'd expire.

If the markets dropped way below the strike price of the put option then we'd still pay the strike price for the shares.  I'd feel pretty stupid for buying too soon, but we got paid a premium for selling the put so that makes up for some of the gap.  We also got a good discount on shares that we'd be happy to own for at least a few years. 

I'm not sure how the owner of the option would calculate their capital loss.  It'd be the difference between what they paid for the shares and the strike price at which I bought them.  But they might not have a loss-- when the other guy buys my put option, they may be simply trying to protect their gains. 

The brokerage's 1099 statement (and tax software) would have a pretty firm opinion on how to calculate the capital gain/loss.
 
As a rebalancing mechanism, isn't there the risk that the equity that you are selling a put on will be underweight at the time you were forced to sell it, becoming counterproductive to the rebalancing exercise?
The reason for selling a put is to commit to buying shares if the share price drops below the put's strike price.  By the time the share price drops enough for that to happen, the shares we already own will be below the asset allocation we want.  The put will be exercised and we'll end up with more shares.  We'll be back in our asset allocation band.

Isn't this a real example of big downside with extremely limited upside? arent you taking on the possibility of complete loss of capital if the company (like Berkshire Hathaway) goes bankrupt and you're forced to buy their shares and hold them in exchange for 7% APR?
Options can quickly magnify the downside (and the upside).  One of the factors in the price of the option is the market volatility, so the bigger the volatility then the more valuable the option.

In the BRK case, we've agreed to buy at $125/share.  If Buffett steps down before the expiration of the option, it's quite likely that a bunch of panicked "investors" will dump their BRK shares and drive the market price down below $100/share (below book value).  At that point the owner of my put option would gleefully force me to pay them $125 for shares that are currently selling for less than $100.  Right off the trade we'd have over a 20% loss. 

From then on I'd hope that committed investors would start buying BRK shares and help drive the price back up.  (One of the buyers would be Berkshire Hathaway itself, because they know a bargain when they see it.)  If the owner of the put option sold to me at $125/share and thought BRK was still worth more than market price of <$100/share, then they'd probably use their cash (received from me) to buy more BRK shares right away at the bargain price of <$100/share.

I'd be holding BRK shares that I paid $125 for, and I'd be a little pouty-faced about the loss, but I knew that this low-probability event was one of the risks.  I have enough assets and income to hold the shares until they recover their value, even if it takes five years or more.  In fact I'd probably be having an intense discussion with my spouse about buying more of those BRK shares for less than $100... either by selling more put options or by simply buying the shares at the market price.

It's also possible that the value of BRK could go to zero, which would be a total loss from $125/share.  I suspect there's a higher probability that I'd be struck by lightning during a shark attack.  But that's what makes it very difficult to quantify the risk of the option.

By the way, there's a small group of people who think that Buffett & Munger's continued management of the business (and the unknown identity of the successor) is actually holding down the share price.  If Buffett & Munger stepped down tomorrow, Berkshire's share price might actually shoot up.

I'm occasionally asked about rebalancing in retirement, so here's a full-disclosure post.  This is a little fast and sloppy because I'm trying to get it up before the markets open on Wed 26 Aug.
If only the best posts of the rest of us could be as polished as this "fast and sloppy" one of yours!
Thanks.  I still edited, but it was a long day.

My education started with McMillan's "Options As A Strategic Investment" textbook.  Next I read through the CBOE's education center.  Both of these resources are designed to stupify you with eye-glazing boredom, but I'm a nuclear submariner who used to read reactor plant manuals for fun & profit.  My point is that if these two references don't fascinate you to your core, then you shouldn't trade options.
For my money, this is the most important bit of wisdom in the entire post.  I'm a corporate lawyer with a borderline-unhealthy interest in investing, and, generally speaking, I wouldn't touch derivatives with a ten foot pole.
Yep.  Another one of my motives (besides the experiential learning) is "immunization".  If I learn from this in my 50s (and ideally get over it) then I won't be tempted to start going on margin with option chains in my 80s. 

  Statistically I'm at the peak of my cognition right now, and I expect to shut off my margin account in five years when I turn age 60.
Another good point.
The emphasis is on the word "statistically".  I'd like to think I'm getting better.  Some think I may have already peaked.

My spouse's Reserve pension kicks in when she turns age 60.  At that point she's also agreed that it's her turn to take the next 30-40 years of financial management.  Before I can turn the duty over to her, though, she wants it all cleaned up and simplified and in autopilot.  I suspect that's because she's going to ignore the whole thing for another two or three decades and then dump it on our daughter.

This is a great post - hopefully will be repeated in a similar form on your blog also.
Thanks-- I'm ambivalent.  I have plenty of hardcore military topics to write about (like Reserve retirement) and selling options is definitely an edge topic.  I think this topic is also more compelling during the event: "what I'm doing now, let's see how it works".  It won't be as interesting if I write it up in six months as "here's what I did last August and how brilliantly it worked out". 

But if I'm presented with another "opportunity" in six months or so (when I've cleared my topic backlog) then maybe I'll write it up. 

Or I could write a post about "If you must trade options, here's how to stay out of trouble".  That might work well as a guest post on someone else's investing site.

I bet Google AdSense pays a lot of money for options-related keywords!

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Re: Selling put & call options as a rebalancing technique
« Reply #6 on: August 27, 2015, 06:24:32 AM »
I have plenty of hardcore military topics to write about (like Reserve retirement)

Actually, I'd love for you to elaborate.  I understand the calculation and factors.  But in a recent post (don't remember which), you stated your wife will start collecting $67k/year soon from a reserve retirement.

This seems very high to me.  My best guess is that there was a lot of active duty time, and probably O-6 as final rank?  If that gets too personal, no worries. 

I know how easy it is in Hawaii to find ADT, ADSW, etc at the major commands (although harder now than it used to be).  Was this part of the reason for the final pay to be so high?

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Re: Selling put & call options as a rebalancing technique
« Reply #7 on: August 27, 2015, 11:43:48 AM »
I ordinarily advise against selling naked puts (e.g. have cash on hand to cover the potential obligation).  I think what you are doing makes sense though.  If you are rebalancing, something else is overweight and can be sold to satisfy your margin loan.  You have 3 days of margin loan (over the weekend) at worst.

If you are going to use material margin, I recommend Interactive Brokers.  Their margin rate runs about 1.6% annually.

Fyi, the put holder calculates profit/loss for taxes on the option only not the collective position.  The service wants to know what you bought the put for and what you sold it for (else zero proceeds if you let it expire or exercise).  Their gain/loss on the underlying security is a separate calculation and will be detailed thusly on 1099/8498 from broker (else the position is still open if they take short assignment and do not buy to close before year end.)  Clear as mud?

Nords

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Re: Selling put & call options as a rebalancing technique
« Reply #8 on: August 27, 2015, 07:10:52 PM »
I have plenty of hardcore military topics to write about (like Reserve retirement)
Actually, I'd love for you to elaborate.  I understand the calculation and factors.  But in a recent post (don't remember which), you stated your wife will start collecting $67k/year soon from a reserve retirement.

This seems very high to me.  My best guess is that there was a lot of active duty time, and probably O-6 as final rank?  If that gets too personal, no worries. 

I know how easy it is in Hawaii to find ADT, ADSW, etc at the major commands (although harder now than it used to be).  Was this part of the reason for the final pay to be so high?
Understanding the Reserve pension calculation puts you ahead of 75% of my readers... including some Reservists who are already retired awaiting pay.  That post has 50% more traffic than the blog's #2 post.

My spouse has 25 good years and 7404 points. 

She doesn't like to discuss the details of her active-duty community or their assignment policies, and most of those issues have been rendered irrelevant by the last 14 years of progress. 

This story would be more appropriate for the FU Money thread, but here's the big picture.

Her active duty was in a very small specialty community.  We both made a number of career compromises for co-location (and I was afraid to leave my active duty) but at her 15-year point her assignment officer played the "we own you now" card.  (She still has those e-mails.)  It was the proverbial un-refusable offer.

We'd put up with as much dual-military crap as we could handle (and I will admit that some of it is #NavyFirstWorldProblems) but when the hardball started we were also financially independent.  You know that Navy officer resignation letters are routinely regarded as merely the opening bluff for assignment negotiation poker.  Nobody in her chain of command (let along BUPERS) believed that she would "really resign".  She felt like she was speaking Klingon.  Nobody understood financial independence, let alone the idea of not working until you die.  They didn't believe it even when she moved household goods on her separation orders.  She was polite and professional the whole way, and she reached out in several different official and unofficial paths, but bridges were burned and then smashed into rubble. 

She left active duty in March 2001 with 17 years, 11 months, and 10 days.  It was about 6550 points.

For those who are not military, keep in mind that when she left active duty I was about to be approved for my active-duty retirement to start in June 2002.  We were financially independent but there was not much margin on the 4% SWR and it was still subject to debate (even more than today).  I was a little concerned about the NASDAQ collapse but we didn't have much exposure to tech and 9/11 was still months away.  (Oh, 20/20 hindsight.)  The Navy Reserve had no money and was still in a drawdown.  We expected that she'd leave active duty, hopefully earn a Reserve retirement at her separation rank, and start her Reserve pension at age 60.  The decision to leave short of her active-duty retirement cost her about $750K of pension (and two years of $125K/year salary).  We felt that we had "enough" and she knew she could get a bridge career.  It was very scary to make FI work for us, but we felt that the alternatives were not worth tolerating when we had choices.

It took her paperwork a few months to affiliate her with the Oahu Navy's PACOM NR DET 120 Reserve unit, but she immediately felt the love.  Instead of the active-duty grudging acknowledgment of her skills, the Reservists threw her into action right away.  PACOM J5 was thrilled to have someone who could overhaul an OPORD, prep a presentation, and brief a flag officer.  After a year of drill weekends she stepped into the Reserve unit's XO job.  (I was retired by then.  I covered the home front and she was free to unleash her career.)  In 2003 the unit CO was mobilized and she took CO Acting for another year.

She was only 21 days short of sanctuary, so BUPERS immediately canceled her mobilization orders.  (I would've loved to have overheard the conversation between the PACOM and BUPERS flag officers.)  No mobilizations or ADSW-- only "training" orders.  She was sanctuary-restricted to no more than 29 days of AT or ADT at a time.  She'd work for 29 days, take a week off, work for 29 days, take a week off... if COMNAVRESFOR complained about paying for it, PACOM would cough up the money from contingency funds.  She spent most of that time on J3's 12-hour JOC midwatches and we live 30 minutes from the parking lot, so she got a lot of "Can you work this weekend?" phone calls.  The money was showering down in those years and I think one year she logged 100 midwatches.  PACOM's active-duty billets were over 40% filled by Reservists and they were still horribly short-handed.

In the middle of the JOC marathons she selected for O-6.  That made her eligible for a "Navy Emergency Preparedness Liaison Officer" billet with the Army EPLO command at Fort Schafter.  She worked with state Civil Defense and FEMA.  It was a great fit with her active-duty specialty and we learned a lot of very scary reality about life and logistics after the hurricane.  Again she logged many drills but she'd finished her Reserve obligation and had seen enough.  She retired in 2008. 

She's USNA '83 (DIEMS date before 8 Sep 80) which makes her one of the last of the Final Pay woolly mammoths.  In today's dollars, her Reserve pension is 7404 points / 360 x 2.5% x $10,952.40/month =  $5631/month = $67,572/year.  She'll start her Reserve pension in 2022, and I expect that number will be pretty close to the change in ECI and CPI until then.

For those of you on active duty who are concerned about the "we own you now" comment, I'd be happy to share more details via PM or e-mail.  We're quite familiar with the Navy's personnel manuals and I'm afraid that I've become one of the military's leading experts on Reserve sanctuary.

I ordinarily advise against selling naked puts (e.g. have cash on hand to cover the potential obligation).  I think what you are doing makes sense though.  If you are rebalancing, something else is overweight and can be sold to satisfy your margin loan.  You have 3 days of margin loan (over the weekend) at worst.

If you are going to use material margin, I recommend Interactive Brokers.  Their margin rate runs about 1.6% annually.

Fyi, the put holder calculates profit/loss for taxes on the option only not the collective position.  The service wants to know what you bought the put for and what you sold it for (else zero proceeds if you let it expire or exercise).  Their gain/loss on the underlying security is a separate calculation and will be detailed thusly on 1099/8498 from broker (else the position is still open if they take short assignment and do not buy to close before year end.)  Clear as mud?
It's clear to me!  One set of taxes for the option, and another set for any shares that are bought/sold if the option is exercised.

We've been with Fidelity since 1986.  I'd pay the margin rate (whatever it is) until I could deposit a check from our HELOC or cash in a CD.  I'd really hate to sell any of our other shares.

The margin interest would've been bearable.  I was surprised to find such high options prices for such short times of only 4-6 months.  I expected to go out at least nine months, and in 2014 I couldn't even get equivalent prices at the 15-month point.  During last week's trades, volatility was a much bigger factor than time decay.

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Re: Selling put & call options as a rebalancing technique
« Reply #9 on: August 28, 2015, 02:23:43 AM »
I have plenty of hardcore military topics to write about (like Reserve retirement)
Actually, I'd love for you to elaborate.  I understand the calculation and factors.  But in a recent post (don't remember which), you stated your wife will start collecting $67k/year soon from a reserve retirement.

This seems very high to me.  My best guess is that there was a lot of active duty time, and probably O-6 as final rank?  If that gets too personal, no worries. 

I know how easy it is in Hawaii to find ADT, ADSW, etc at the major commands (although harder now than it used to be).  Was this part of the reason for the final pay to be so high?
Understanding ... Reserve sanctuary.

Thanks for the detailed explanation.  Makes sense. 

I never understood the rationale of detailers, and can certainly understand how they would've been perplexed by the decision.  Congrats to her (and you) for controlling the process - 99.99% of people would have just ground it out, despite the misery.

Nords

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Re: Selling put & call options as a rebalancing technique
« Reply #10 on: August 28, 2015, 03:06:54 PM »
Thanks for the detailed explanation.  Makes sense. 

I never understood the rationale of detailers, and can certainly understand how they would've been perplexed by the decision.
I've worked with a lot of detailers and with shipmates/bosses who were detailers.  It's a nasty tough job to tell people "needs of the Navy" but being a detailer is a signal that you've made the career cut.   

The enlisted community managers get the exposure and Navy-wide perspective to boost their careers to E-8/9 and the big leadership billets.  For the officers (particularly the submariners) it's a recognized path to O-6/flag.  Even at the lower officer ranks when you get offered jobs like flag lieutenant, or instructor at a nuclear training command, or junior detailer... it sends a signal to you that you're on the faster track.  When I responded to those offers by making retching sounds over the phone suggesting that I'd rather be co-located with my spouse, it sent a signal too.

The other problem is that at the more senior ranks (E-8/9, O-5) there are fewer billet choices.  If you want to stay in Hawaii instead of going to the Pentagon, you're going to get more "needs of the Navy" pushback.  Admittedly some detailers take more pleasure than others in delivering the bad news, but I feel sorry for them and the conditions under which they work.  Back in the 1990s, every officer detailer had a presentation every week with their admiral to go over the vacant billets list.  You can understand how they might choose to screw over a random officer to avoid an unpleasant meeting with an admiral.

During our second tours in Hawaii, one of my spouse's detailers offered her a "good deal" of a Norfolk ship.  When she said she'd rather have the same ship class/type duty in Yokosuka, he was personally insulted.  He could send anyone to Yoko anytime.  Apparently he'd done her a favor by bumping a lot of her peers to "move her up to Norfolk", and he couldn't understand why she'd want to go to a place that was so far from DC and HQ.  Why would we want to go to a foreign culture with an unfamiliar language?  He was not amused when she said that's how she felt about Norfolk. 

Congrats to her (and you) for controlling the process - 99.99% of people would have just ground it out, despite the misery.
We managed to work through the homeport issues and the separation challenge and we knew we could deal with that.  Our seven-year-old daughter was good with being separated from Mom for months and then leaving Hawaii for a few years.  But for us, the tipping point was when a friend kept gushing about how good the mental-health services were in Yoko and how we'd be able to get Tricare to pay for our daughter's appointments with a family psychologist if there were problems.

Um, maybe it'd make more sense to not put ourselves into situations where the "good news" was the quality of the mental-health services.  And we didn't need the money.  Why were we doing this?

The month after she left active duty (and while I was still working), we were shocked at how quickly all the stress melted away and how good our lives became.  Boiled-frog syndrome.
« Last Edit: August 28, 2015, 03:23:01 PM by Nords »

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Re: Selling put & call options as a rebalancing technique
« Reply #11 on: August 28, 2015, 03:18:22 PM »
This is so fascinating to read. I have never served in the military, but to hear your perspective on it is beyond interesting.

I especially liked the part where your wife said "that's how she felt about Norfolk." 

Priceless.

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Re: Selling put & call options as a rebalancing technique
« Reply #12 on: September 29, 2015, 01:36:29 PM »
I have plenty of hardcore military topics to write about (like Reserve retirement)
Actually, I'd love for you to elaborate.  I understand the calculation and factors.  But in a recent post (don't remember which), you stated your wife will start collecting $67k/year soon from a reserve retirement.

This seems very high to me.  My best guess is that there was a lot of active duty time, and probably O-6 as final rank?  If that gets too personal, no worries. 

I know how easy it is in Hawaii to find ADT, ADSW, etc at the major commands (although harder now than it used to be).  Was this part of the reason for the final pay to be so high?
Understanding the Reserve pension calculation puts you ahead of 75% of my readers... including some Reservists who are already retired awaiting pay.  That post has 50% more traffic than the blog's #2 post.

My spouse has 25 good years and 7404 points. 

She doesn't like to discuss the details of her active-duty community or their assignment policies, and most of those issues have been rendered irrelevant by the last 14 years of progress. 

This story would be more appropriate for the FU Money thread, but here's the big picture.

Her active duty was in a very small specialty community.  We both made a number of career compromises for co-location (and I was afraid to leave my active duty) but at her 15-year point her assignment officer played the "we own you now" card.  (She still has those e-mails.)  It was the proverbial un-refusable offer.

We'd put up with as much dual-military crap as we could handle (and I will admit that some of it is #NavyFirstWorldProblems) but when the hardball started we were also financially independent.  You know that Navy officer resignation letters are routinely regarded as merely the opening bluff for assignment negotiation poker.  Nobody in her chain of command (let along BUPERS) believed that she would "really resign".  She felt like she was speaking Klingon.  Nobody understood financial independence, let alone the idea of not working until you die.  They didn't believe it even when she moved household goods on her separation orders.  She was polite and professional the whole way, and she reached out in several different official and unofficial paths, but bridges were burned and then smashed into rubble. 

She left active duty in March 2001 with 17 years, 11 months, and 10 days.  It was about 6550 points.

For those who are not military, keep in mind that when she left active duty I was about to be approved for my active-duty retirement to start in June 2002.  We were financially independent but there was not much margin on the 4% SWR and it was still subject to debate (even more than today).  I was a little concerned about the NASDAQ collapse but we didn't have much exposure to tech and 9/11 was still months away.  (Oh, 20/20 hindsight.)  The Navy Reserve had no money and was still in a drawdown.  We expected that she'd leave active duty, hopefully earn a Reserve retirement at her separation rank, and start her Reserve pension at age 60.  The decision to leave short of her active-duty retirement cost her about $750K of pension (and two years of $125K/year salary).  We felt that we had "enough" and she knew she could get a bridge career.  It was very scary to make FI work for us, but we felt that the alternatives were not worth tolerating when we had choices.

It took her paperwork a few months to affiliate her with the Oahu Navy's PACOM NR DET 120 Reserve unit, but she immediately felt the love.  Instead of the active-duty grudging acknowledgment of her skills, the Reservists threw her into action right away.  PACOM J5 was thrilled to have someone who could overhaul an OPORD, prep a presentation, and brief a flag officer.  After a year of drill weekends she stepped into the Reserve unit's XO job.  (I was retired by then.  I covered the home front and she was free to unleash her career.)  In 2003 the unit CO was mobilized and she took CO Acting for another year.

She was only 21 days short of sanctuary, so BUPERS immediately canceled her mobilization orders.  (I would've loved to have overheard the conversation between the PACOM and BUPERS flag officers.)  No mobilizations or ADSW-- only "training" orders.  She was sanctuary-restricted to no more than 29 days of AT or ADT at a time.  She'd work for 29 days, take a week off, work for 29 days, take a week off... if COMNAVRESFOR complained about paying for it, PACOM would cough up the money from contingency funds.  She spent most of that time on J3's 12-hour JOC midwatches and we live 30 minutes from the parking lot, so she got a lot of "Can you work this weekend?" phone calls.  The money was showering down in those years and I think one year she logged 100 midwatches.  PACOM's active-duty billets were over 40% filled by Reservists and they were still horribly short-handed.

In the middle of the JOC marathons she selected for O-6.  That made her eligible for a "Navy Emergency Preparedness Liaison Officer" billet with the Army EPLO command at Fort Schafter.  She worked with state Civil Defense and FEMA.  It was a great fit with her active-duty specialty and we learned a lot of very scary reality about life and logistics after the hurricane.  Again she logged many drills but she'd finished her Reserve obligation and had seen enough.  She retired in 2008. 

She's USNA '83 (DIEMS date before 8 Sep 80) which makes her one of the last of the Final Pay woolly mammoths.  In today's dollars, her Reserve pension is 7404 points / 360 x 2.5% x $10,952.40/month =  $5631/month = $67,572/year.  She'll start her Reserve pension in 2022, and I expect that number will be pretty close to the change in ECI and CPI until then.

For those of you on active duty who are concerned about the "we own you now" comment, I'd be happy to share more details via PM or e-mail.  We're quite familiar with the Navy's personnel manuals and I'm afraid that I've become one of the military's leading experts on Reserve sanctuary.

I ordinarily advise against selling naked puts (e.g. have cash on hand to cover the potential obligation).  I think what you are doing makes sense though.  If you are rebalancing, something else is overweight and can be sold to satisfy your margin loan.  You have 3 days of margin loan (over the weekend) at worst.

If you are going to use material margin, I recommend Interactive Brokers.  Their margin rate runs about 1.6% annually.

Fyi, the put holder calculates profit/loss for taxes on the option only not the collective position.  The service wants to know what you bought the put for and what you sold it for (else zero proceeds if you let it expire or exercise).  Their gain/loss on the underlying security is a separate calculation and will be detailed thusly on 1099/8498 from broker (else the position is still open if they take short assignment and do not buy to close before year end.)  Clear as mud?
It's clear to me!  One set of taxes for the option, and another set for any shares that are bought/sold if the option is exercised.

We've been with Fidelity since 1986.  I'd pay the margin rate (whatever it is) until I could deposit a check from our HELOC or cash in a CD.  I'd really hate to sell any of our other shares.

The margin interest would've been bearable.  I was surprised to find such high options prices for such short times of only 4-6 months.  I expected to go out at least nine months, and in 2014 I couldn't even get equivalent prices at the 15-month point.  During last week's trades, volatility was a much bigger factor than time decay.

Wow, I did not understand half of what you said in this post. So many paths to FI...