Author Topic: Leverage/Long Options for cash flow + taking advantge of low market?  (Read 1944 times)

Seadog

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So background is Semi-FIREd, had roughly $1m in investments living on about 3.5-4%, and like many here also experienced, the last few months have not been kind. Let's just say that my net worth spread sheet graph which has an axis centered on $1m, running +/-250k needed the axis expanded this week....

It may be face punch worthy, but started investing with a company stock plan, and continued investing overweight in that industry (oil) and while saving 75%+ of my income stock picked a varied batch after considerable research for the rest. Results have been more or less with the market. A few home runs, a few duds, likely averaged out.

Anyways, always the pragmatist I realize that these are fundamentally the same companies, and are essentially on sale. I was stoic enough to avoid selling in 08/09, but didn't have the balls to dive deeper as didn't have capital or experience then, but would like to avoid the same mistake. Sadly though, I do not have any uninvested money kicking around, and I do however need cash to pay things like rent and food as divs don't quite cover my expenses.

To that end, I'm curious what people's thoughts are on either margin or selling long dated naked puts. With margin, you can essentially borrow the banks money to buy it's own depressed stock, and the dividend will pay (slightly) more than the interest charged which can be then used to write off the divs. Given that the banks have never in their history cut their dividend, you can simply hold for long term appreciation while getting in at multi-year lows (contingent on what the interest rates do of course), and margin would allow for indirect cashflow to live off.

Long dated naked puts on the other hand would provide income today which is certainly useful for living expenses while stocks are in the gutter, and provided these stocks at multi year lows don't further deteriorate and remain there for the entire next two years, the options would provide some return and tide me over this bad market.  Essentially these options are a bet against the idea that the market today is 10% higher than it will be in a month, and at any point in the next two years. Possible sure. But likely?

Further since the sale options make a profit (expire worthless) in the vast majority of cases it further entices me to go down this path. While anything is possible, to lose would require that stocks which are already a bargain continue you drop 5-15% (to offset the premium), and stay there for the next 2 years. Off the top of my head using BRK since it was mentioned in another thread, $192 for what already looks like a solid bargain stock with a PE of 8, yet someone will give me almost $20 (~10%) to commit to buying it at the same price in Jan 2021. Even in 2008 once it dropped 20% from it's local high it didn't take 2 years to get back there. Loads of stocks in those categories. Single digit PEs, no risk of bankruptcy, solid balance sheets, multi year lows, and people who will give you cash today to commit to buying at today's bargain prices in 2 years.

I'm also tossing around the idea of using some of the naked put money to buy long calls as well. My two lizard brains fighting each other. One saying that prices for strikes at current valuations are "can't lose" 2 years out even though I know that the most of call buyers do lose, vs the other lizard brain saying "why would you commit to today's prices? The market's fallen almost 20% in 3 months. At this rate it will be worth 0 by Xmas next year."

chasesfish

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #1 on: December 22, 2018, 06:03:44 PM »
I saw this has been viewed a lot, but no real responses.

It all depends on your comfort level.  If you're planning on working a few years and think some stocks are on discount, sure use some margin.  Naked puts are another idea, but to me the return/risk isn't worth it.

I have been buying some call options.  I tend to flip them if I can make 10-20% in a day or two, then hold them otherwise.  Returns have been about like the market, I'm down 13% vs a 19% loss in the market, but its tough to exactly track because the amount of capital I'm using is small.  If the market rockets up, I'll do pretty well.  If it stays down or is mediocre, it'll be a loss that's around what the market is down. 

The challenge with options is they have two values, the time until maturity and the underlying value of the security.  Watching the T part of the equation deteriorate in value each day if you're long is painful. 

I did take on some margin and buy some company stock that looks undervalued.  Underlying security's dividends pay more than half of my interest carry.  Disclaimer: Its a VERY small part of my net worth, maybe 2% at this point.

Seadog

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #2 on: December 23, 2018, 03:11:47 PM »
I saw this has been viewed a lot, but no real responses.

It all depends on your comfort level.  If you're planning on working a few years and think some stocks are on discount, sure use some margin.  Naked puts are another idea, but to me the return/risk isn't worth it.

I have been buying some call options.  I tend to flip them if I can make 10-20% in a day or two, then hold them otherwise.  Returns have been about like the market, I'm down 13% vs a 19% loss in the market, but its tough to exactly track because the amount of capital I'm using is small.  If the market rockets up, I'll do pretty well.  If it stays down or is mediocre, it'll be a loss that's around what the market is down. 

Why specifically? Before I researched it fairly heavily, I like many was almost scared of options. Way too complex, only for pros, and heard several horror story about people losing their shirt.

Options are at their most basic, insurance. It's a financial zero sum game, but due to marginal utility of money, people can lose money (hopefully to you) in exchange for assurances that a security or commodity will stay above (or below) a certain value which would otherwise result in them losing their house/farm/factory/etc which is far more valuable than the dollars associated with said commodity. This is why large companies, who can weather a $2m storm often self insure vehicles , as it's cheaper in the long run.

Much like when you buy insurance, when you buy options, expect to lose money. In exchange you get an assurance that the long tails of unpredictability which would result in ruin have been eliminated. Same thing here. If you're the kind of person who can weather a financial storm, it makes sense to do this. Your volatility will be higher, but the market is fickle in that it generally doesn't care what happened last month. A bit of a pull back now, but its still more likely than not next year will see gains.

You also touched on buying calls. For the same reason that's why I'm hesitant. The sellers of said options make money something like 90% of the time and it is in fact peddled as a long term income strategy to multiply gains. Your shares might get called away a few times, but that's the nature of the beast. But that said, even with the premium, you can buy many stocks in 2021 for prices from less than a month ago, which themselves were 52w lows. Fear is a powerful motivator, and people think what happened yesterday will happen tomorrow. The data proves that to be not the case at all. 

I think the issue with options is people trade them seeing $ signs as a result of 50% swings in a day. Especially with near expiration dates where volatility is magnified they've almost tied their hands by eliminating the thing (time) long options have going for it.

I looked and couldn't really find a general options thread here. I thought here might be the place, given people are generally above average intelligence, and financially literate and focused on very long haul. MMM's article about the uselessness of most insurance products for most people is a perfect example. Which, at it's heart, what options are.

 

chasesfish

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #3 on: December 23, 2018, 08:06:29 PM »
Options are a near zero sum game.  Just buying income producing assets long seems to be a better choice.

I see successful option traders/investors do one of two things:  Make a lot of small, little wins and loose a few big ones, or have a lot of small losses and hit a home run.

It appears you already have this figured out, so I'm going to bow out of the post

marty998

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #4 on: December 23, 2018, 08:24:39 PM »
I think you'd be mad, but that is my personal experience getting my fingers burned with leverage like that.

Given that the banks have never in their history cut their dividend

That's a comment requiring a response.

*If* true, this would be because they tend to go bust quite quickly before the dividend gets cut.

Wiki lists almost 500 US banks that have failed since 2008.

https://en.wikipedia.org/wiki/List_of_bank_failures_in_the_United_States_(2008–present)


chasesfish

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #5 on: December 24, 2018, 06:59:12 AM »
"Given that the banks have never cut their dividend"

Dude, are you a US based investor?

Almost every bank cut their dividend in 2008-2009.  I work in that industry for one of the players that actually remained profitable through the recession.  Our dividend was whacked by 2/3rds.

The only US bank I know of with any size that did NOT cut their dividend was Bank of Hawaii.

bwall

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #6 on: December 24, 2018, 07:35:46 AM »
I prefer selling out of the money calls. If you selling calls on stock that you already own, there is very little downside risk, other than it being called away and so in theory you didn't sell it for as much as you could have. This is why I enjoy selling out of the money calls.

For example, bio-pharma stock trades for $150.  A front month call with a strike price of $160 or $170 can sell for 2-3%, depending on how many weeks away the execution date is. If it goes up and your stock is called away, well, then you sold at an even better price than was available on the date you sold the calls. If the stock stays flat or still goes up, but not above the strike price, then you can keep the entire premium, which can be huge in % terms.

I've earned about 20% this year using this strategy. I could earn even more with more risk, but, you have to draw the line somewhere.

ILikeDividends

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #7 on: December 24, 2018, 06:37:23 PM »
I'm also tossing around the idea of using some of the naked put money to buy long calls as well.
I would never sell a put against an equity that I didn't want to own at the puts strike price.  I might employ a downward biased directional structure using a put spread on an equity I didn't like (or didn't want more of), but I wouldn't just sell a put against such an equity, because that has an upward directional bias.

Selling a naked put (as opposed to a cash-secured put) which would put me on margin if assigned, even if I did want to own the equity, is truly face-punch worthy in my humble opinion.  If you don't want to own the equity (or more of it) in the first place, committing to buying it on margin is also kick-to-the-groin worthy.

Then turning around and spending that put premium on long calls just gets deeper into the realm of cutting a finger or two off, in addition to a thorough pummeling of various body parts.

It seems as though you are laser-focused on generating extra income without regard to a massive increase in risk.  This is how you blow up an account.  Options can be used judiciously to reduce risk, or recklessly to magnify risk, depending on the structure you employ.  Mixing margin into that structure just magnifies risk even more.


« Last Edit: December 24, 2018, 08:49:17 PM by ILikeDividends »

clifp

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #8 on: December 24, 2018, 11:21:21 PM »
Almost exactly 10 years ago, I made one of my better trades in my life by selling naked puts on Apple.  I think the $VIX at 35 and other indication that fear is becoming real make this a good time to consider this strategy. As @Seadog say selling puts is basically selling an insurance policy. Just like the most profitable time to sell insurance is after a hurricane or forest fire, the best time to sell portfolio insurance is after scary down days.

Ten years ago Apple was trading in the $80-90 range (this was before the 7 to 1 stock split so divide by 7 for todays prices.) After doing a lot of calculation, I ended up writing long term leaps that expired in Jan 2010. At the time the premium was about $8 and the company had $12 in cash, meaning I was buying the companies terrific, iPhone, iPod and Mac business for $50 share, less than 1/3 the $175 price it been at just 6 months before.  Even if I assumed the Apple 2009 earning would be cut in 1/2 , at $50 share it still had a PE of about 10.  I was getting paid an annualized return of ~12% to buy the company in the year in the future at 20% discount to current prices at 60% discount to a recent peak.  Now there is absolutely risk that market could have continued to drop all through 2009 and I would have had to scramble to come up with $70K to buy the Apple.  In hindsight, I'm pretty sorry it didn't since that would now be 7,000 Apple share worth about $1 million dollars today. 

Eventhough, I'm very bearish over the next few months. I did sell a Google 900 Jan 20 put last Thursday, even at the time of the sale I knew that I was too early.  But I think another 2-8 weeks of this scary market after the panic gets worse, it is a very attractive strategy.  There is a big risk of over extending yourself. You really need to look at individual companies, assume that both the stock price and earning will crater and make sure you still want to own the stock at the price.

Seadog

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #9 on: December 27, 2018, 01:19:07 PM »

That's a comment requiring a response.

*If* true, this would be because they tend to go bust quite quickly before the dividend gets cut.

Wiki lists almost 500 US banks that have failed since 2008.

https://en.wikipedia.org/wiki/List_of_bank_failures_in_the_United_States_(2008–present)

Fair enough, I sometimes forget that this isn't a Canada-Centric forum. *Canadian* banks have never in their history cut their dividend. In fact after living in the US their banking system is something I want nothing to do with. "National" banks which with a 3 hour drive to the next state over literally have zero presence. That regional banks with micro capitalization and a only a handful of branches dominate, Pins and Chips for credit cards which were novel inventions circa 2017, and the fact that I'd have to wait at Wal-Mart for the 3 old ladies ahead of me to write cheques.  Merely dealing with the US banking industry didn't inspire a whole lot of confidence. 

Options are a near zero sum game.  Just buying income producing assets long seems to be a better choice.

I see successful option traders/investors do one of two things:  Make a lot of small, little wins and loose a few big ones, or have a lot of small losses and hit a home run.

It appears you already have this figured out, so I'm going to bow out of the post

Financial zero sum game, but just like insurance is a negative sum game, depending on your degree of liquidity and balance sheet, both parties can be making a financially winning move. Despite pet insurance being cliche for being a ripoff, if you want an assurance old fluffy wont die, and you're cashflow is so strapped to the tune that you can't come up with $3k on short notice, than the pet insurance *is* the most financially sensible route, as presumably, the value you give to the pet, is higher than the expected loss of $100 a month.

I further agree that simply going long is the smarter play, but how does one do that with no money?

I'm also tossing around the idea of using some of the naked put money to buy long calls as well.
I would never sell a put against an equity that I didn't want to own at the puts strike price.  I might employ a downward biased directional structure using a put spread on an equity I didn't like (or didn't want more of), but I wouldn't just sell a put against such an equity, because that has an upward directional bias.

Selling a naked put (as opposed to a cash-secured put) which would put me on margin if assigned, even if I did want to own the equity, is truly face-punch worthy in my humble opinion.  If you don't want to own the equity (or more of it) in the first place, committing to buying it on margin is also kick-to-the-groin worthy.

Then turning around and spending that put premium on long calls just gets deeper into the realm of cutting a finger or two off, in addition to a thorough pummeling of various body parts.

It seems as though you are laser-focused on generating extra income without regard to a massive increase in risk.  This is how you blow up an account.  Options can be used judiciously to reduce risk, or recklessly to magnify risk, depending on the structure you employ.  Mixing margin into that structure just magnifies risk even more.


Curious what you mean by "massive" increase in risk. Let's throw some numbers out. AAPL today ~150. I own 2000 shares, then 500k of other similarly discounted stocks. I sell 5 $150 Jan 21 contracts for $25 each. I generate $12.5k today to cover bills and other cash flow issues for next 6 months. Even with a 17% fall through Jan 2021, I would be even. Naturally losses would multiply from there out, but only after another 20% fall, and staying there or below over the next two years. Real harm/potential bankruptcy would be possible, but only with sustained losses across all asset classes of 90% plus, at which point things are already pretty much fucked.   

I agree with the sense that not selling puts on things I don't want to own. I do want to own it, that's the thing. If I had a spare few hundred k I'd be backing up the truck to buy a bunch of things. I don't however, hence the need to get creative. And I use the term 'naked' in the sense I won't have a corresponding short. I will have roughly 15-20x the assets to complete the trade in 2 years if the put gets executed.

I guess that thing that clinches it for me are the cold hard numbers. It seems there is often an irrational fear of options, much the same way as many of the general public have a fear of the market. Recent performance has pretty much zero impact on future performance. Another 20% fall is possible, but far more likely is you see your typical 7% or so appreciation. While selling calls is another income strategy I've considered, it seems like the time to do so is after the market has rocketed higher, and people think it will continue forever, and premiums reflect that. As someone mentioned about selling insurance after a hurricane, some people are convinced the market will go to zero, and are willing to pay well in excess of the true risk to ensure that doesn't happen.     

Now, naturally you can't time the market which I only feel is half true. As for buying, the timing today is better than two months ago. 

ILikeDividends

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #10 on: December 27, 2018, 03:38:13 PM »

Curious what you mean by "massive" increase in risk. Let's throw some numbers out. AAPL today ~150. I own 2000 shares, then 500k of other similarly discounted stocks. I sell 5 $150 Jan 21 contracts for $25 each. I generate $12.5k today to cover bills and other cash flow issues for next 6 months. Even with a 17% fall through Jan 2021, I would be even. Naturally losses would multiply from there out, but only after another 20% fall, and staying there or below over the next two years. Real harm/potential bankruptcy would be possible, but only with sustained losses across all asset classes of 90% plus, at which point things are already pretty much fucked.   
Options can be assigned at any point after they go into the money.  You are not guaranteed that your position will not unravel long before 2021 at a much greater loss than 17%.  Apple is down much more than that in just the last two months.

The hazards of using margin are well discussed elsewhere in this forum, so I will not attempt to cover that in my response here.

Quote
I agree with the sense that not selling puts on things I don't want to own. I do want to own it, that's the thing. If I had a spare few hundred k I'd be backing up the truck to buy a bunch of things.

Got it.  But the fact is you don't have a few hundred k to back up the truck with.

I presume you like apple stock, and want to own it as an investment.  But my point about writing puts against stock you don't want to own still stands; i.e., do you want to own more of apple stock than you already own by buying more of it on margin?  That's what you are committing to do when you sell those puts.

No offense, but I don't think you've gamed this out past the point of getting assigned.  In other words, are you prepared to stay on margin forever?  Are you going to double down and go deeper into margin?  In a worst case scenario, say a 50% bear, are you prepared to sell at the lows in order to get off margin?  Game out some of those scenarios and then you'll understand your full risk.

The premium you collect by selling a put isn't actually earned, so to speak, until you exit your position.  Spending it before then is making an assumption that the trade will go your way, and essentially increases your margin maintenance requirements if the trade goes against you.  Actually, it increases your margin maintenance requirements until you exit the position; regardless of whether the trade goes your way or not.
« Last Edit: December 27, 2018, 04:07:35 PM by ILikeDividends »

jjcamembert

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #11 on: December 27, 2018, 04:01:33 PM »
I wouldn't recommend taking on additional risk with the money that you need for rent and food, in fact I'd actually consider removing risk altogether for that. Why would you want to risk not being able to meet your basic needs? It sort-of seems like you want an options strategy that will provide you cake and allow you to eat it too, but there's not really such a thing.

So you're bullish, already own shares, want to buy more, but don't have the money? By going on margin and exposing yourself to more risk in the same asset you're essentially gambling 50/50 that you'll lose half your account in a bear market or double it in a bull market.

However I think there are still some things you could do with options to free up some buying power (BP) and grab some passive income without additional risk. I'm just going to use the 2000 shares of AAPL as an example. Right now those are using around $300k buying power. Each AAPL naked put in a margin account will today cost you around $3k buying power, so x20 that's only $60k BP. Your delta exposure to AAPL will be roughly half though, so you're giving up upside if it rallies fast, but you also collect a fat premium which means you have less risk than just owning the shares!

So now you have $240k cash sitting in your account. No, you don't throw it all into more AAPL puts, lol. If the market goes down your margin requirements for the puts will increase, so you want a healthy amount of extra cash around, usually more than 50% cash:options. So you have a little cash to play with, and if there's a big crash you'll be able to sell more puts at a better price. If the market goes up, well you just make money: close the puts and sell more if you are still bullish.

One other thing I'll mention since you're talking about multiple options: consider selling puts at different expiration dates to reduce your risk at any given time. Selling all 2021's gets you kinda screwed if AAPL rises in 2020 then crashes in '21. You're also not getting any of the benefits of the increased volatility right now or of time decay by selling so far out.

You could do the same thing buying LEAP calls as you know, it's just the other side of the coin: you pay a premium for defined downside risk and more upside potential vs (selling puts) receive a premium for defined upside potential, more downside risk. Or of course, covered calls: limited upside, receive premium, but uses a lot of BP to hold the stock.

Keep in mind you don't have to do all or nothing. You could sell 1/4 or 1/2 the shares, do CC's on some, try some LEAPs, sell some puts. Mixing up your strategies will generally reduce your risk.

Seadog

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #12 on: December 28, 2018, 03:20:56 PM »
No offense, but I don't think you've gamed this out past the point of getting assigned.  In other words, are you prepared to stay on margin forever?  Are you going to double down and go deeper into margin?  In a worst case scenario, say a 50% bear, are you prepared to sell at the lows in order to get off margin?  Game out some of those scenarios and then you'll understand your full risk.

None taken. As said I'm somewhat new to the whole options thing, and aside from a couple books worth of knowledge and a few months reading tidbits online alonside following prices, I'm wholly new to this.

To answer the question, I thought that if assigned, again using APPL lets say at $100, then I need to come up with money to buy 500 shares at $150. Why would I not just be able to sell some of either the same APPL stock, or any of the others to come up with said needed $75k while avoiding margin, effectively just sacrificing some of those AAPL shares? 2000 shares becomes 1800.

Obviously I would take a bit of a financial hit to the tune of $12k, but that's the game then. However, If I'm at the point of taking said 12k hit, I'm likely at the point where the rest of the portfolio has taken a much bigger one. Essentially I guess I'm saying that if we continue the drop to 50%, the fact my losses have been magnified from 200k now, to 500k then, to 512k with an options play, is a moot point.

Merely being in the market with a 7 figure portfolio exposes you to say $500k risks

I wouldn't recommend taking on additional risk with the money that you need for rent and food, in fact I'd actually consider removing risk altogether for that. Why would you want to risk not being able to meet your basic needs? It sort-of seems like you want an options strategy that will provide you cake and allow you to eat it too, but there's not really such a thing.

Everything I've read has basically said to do the opposite of that. While it's true that taking money off the table removes the risk of it shrinking in say the current market, the collective 6-12 months you always have to keep in cash, out of the market hurts you even more in the long run.

I'm also curious what you mean when you say "not meet your basic needs"? That's not on the table, unless a "basic need" is to not sell stocks for the same price I bought them at a year ago. If it was between selling at a loss and starving, I would take the loss. That said, according to every 4% rule or simulation I've done, I should be fine to continue pulling 4% out, even though it now represents over 5%.


So you're bullish, already own shares, want to buy more, but don't have the money? By going on margin and exposing yourself to more risk in the same asset you're essentially gambling 50/50 that you'll lose half your account in a bear market or double it in a bull market.

However I think there are still some things you could do with options to free up some buying power (BP) and grab some passive income without additional risk. I'm just going to use the 2000 shares of AAPL as an example. Right now those are using around $300k buying power. Each AAPL naked put in a margin account will today cost you around $3k buying power, so x20 that's only $60k BP. Your delta exposure to AAPL will be roughly half though, so you're giving up upside if it rallies fast, but you also collect a fat premium which means you have less risk than just owning the shares!

So now you have $240k cash sitting in your account. No, you don't throw it all into more AAPL puts, lol. If the market goes down your margin requirements for the puts will increase, so you want a healthy amount of extra cash around, usually more than 50% cash:options. So you have a little cash to play with, and if there's a big crash you'll be able to sell more puts at a better price. If the market goes up, well you just make money: close the puts and sell more if you are still bullish.

One other thing I'll mention since you're talking about multiple options: consider selling puts at different expiration dates to reduce your risk at any given time. Selling all 2021's gets you kinda screwed if AAPL rises in 2020 then crashes in '21. You're also not getting any of the benefits of the increased volatility right now or of time decay by selling so far out.

You could do the same thing buying LEAP calls as you know, it's just the other side of the coin: you pay a premium for defined downside risk and more upside potential vs (selling puts) receive a premium for defined upside potential, more downside risk. Or of course, covered calls: limited upside, receive premium, but uses a lot of BP to hold the stock.

Keep in mind you don't have to do all or nothing. You could sell 1/4 or 1/2 the shares, do CC's on some, try some LEAPs, sell some puts. Mixing up your strategies will generally reduce your risk.

Exactly, I'm leaning towards the latter options you pointed out. Selling a fraction of the shares I own as puts, then putting it into LEAPs. People here are pontificating about accounts blowing up, but would like solid examples exactly *how*, ideally with numbers. Afterall, anyone with a credit card is risking losses over 100%. What if all markets go to zero, and then you get held up and the crook makes you pull money off your CC at gun point? How do you cover that debt? But then how likely is that? How does that risk compare to say selling $12k worth of puts committing me to a 75k buy with only 750k of other assets? If this 20% drop further becomes 92% (ie dow at 2200) then yes, I will have a problem as my net worth will be almost 0. Would I not have a problem otherwise though?

We're all here for the same reasons. Just as people poo-poo the stock market because they knew a guy in 2000 who lost $4m on paper, I think people do the same thing with options. Obviously money can be made, just as the fact that many people call it a sure fire path to losses is proof enough (since by definition then, the other side of the bet is a surefire win).  If you want to win at blackjack it's easy. Merely take the role of the casino.

jjcamembert

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #13 on: December 28, 2018, 05:09:10 PM »
I'm also curious what you mean when you say "not meet your basic needs"? That's not on the table, unless a "basic need" is to not sell stocks for the same price I bought them at a year ago. If it was between selling at a loss and starving, I would take the loss. That said, according to every 4% rule or simulation I've done, I should be fine to continue pulling 4% out, even though it now represents over 5%.
I know most people on here are in Vanguard mostly and do studies based off that. Not bringing up the "stocks vs ETFs" debate, but for money you need to withdraw I'd be concerned that your portfolio volatility is much higher being concentrated in individual companies, possibly leading to higher drawdowns at times when you need the money. If you're comfortable with that feel free.

I think options are great instruments for investors who take the time to understand them, and used properly you can reduce your risk compared to holding stock. In my response I just wanted to make sure you understood that although you have more cash free with equivalent options positions, your total notional risk is still the same as holding stock so it's unwise spend that cash or invest more of it in the same position. For LEAPs, if it's 2021 and the stock price is less than the call strike you just lose that money. You can add more LEAPs further out but it will use more of your cash reserves. Also look up "Poor Man's Covered Call" if you want to add a positive theta component rather than just eating the time decay.

Just make sure you map out the scenarios and have a plan for each possibility. You mentioned you're new to options, so before doing something with real money at stake consider experimenting with a single contract or paper trade.

You don't want to end up in a situation where you don't know what to do: let's say the price rises 50% in a year, so now you're up on the LEAPs, but only have 1 year left, are you going to roll them? To what strike? How many contracts?

In May 2021 what are you going to do with June 2021 contracts? Do you still own them, or did you roll them already to 2022? What if price has dropped significantly?

Things happen and when you have a time-based contract you can't just sit around and ignore the price (at least not all the time) like you can with stock.


ILikeDividends

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #14 on: December 28, 2018, 06:11:05 PM »
No offense, but I don't think you've gamed this out past the point of getting assigned.  In other words, are you prepared to stay on margin forever?  Are you going to double down and go deeper into margin?  In a worst case scenario, say a 50% bear, are you prepared to sell at the lows in order to get off margin?  Game out some of those scenarios and then you'll understand your full risk.
To answer the question, I thought that if assigned, again using APPL lets say at $100, then I need to come up with money to buy 500 shares at $150. Why would I not just be able to sell some of either the same APPL stock, or any of the others to come up with said needed $75k while avoiding margin, effectively just sacrificing some of those AAPL shares? 2000 shares becomes 1800.
Indeed you could.  If that is a possible exit strategy for you, then that would validate my assertion that you are writing puts against stock that you don't want to own. ;)

According to my math, your 2000 shares would then become 1,750 shares ($75,000 / $100 per share = 750 shares sold to cover the puts, in return for 500 new shares put to you), but lets not quibble about details.  Your reward was $12,500 which you took in trade for a net 250 shares of stock.

Your realized loss on 750 shares would generate a wash sale by turning around and buying the 500 shares put to you within 30 days to get off margin, so you wouldn't get the full benefit of a tax loss.

Your 500 new shares would have a cost basis of just $62,500, not $75,000; the premium you collected when selling the puts is used to adjust your cost basis, from a tax standpoint.

If selling 750 shares at $100 was, instead, still profitable, you would then generate a taxable event by selling those shares just to settle your margin debt.

You also take a fairly notable hit in terms of opportunity cost, because that 250 shares will not be working for you when AAPL eventually recovers.

This is not a break-even scenario.

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Merely being in the market with a 7 figure portfolio exposes you to say $500k risks
I think you are conflating volatility with risk.  By that I mean that if your investment horizon is far enough out that you won't need to sell during a violent sell-off in the interim, then volatility is not a risk at all.

If your plan is to sell depressed equities in order to exit a short put position gone bad, then you are accepting whatever risk volatility represents in that near future time frame, and then volatility does become a very real risk.

Finally, the hypothetical loss discussed above is not your theoretical max-loss scenario.  If AAPL pulled an Enron, your entire 2000 share stake would be wiped out, and you would still have to sell other assets to make good on the puts.  That scenario seems unlikely, even to me, but that risk comes along with all single-stock investments, and is ignored at your peril.

Ask any Enron investor how likely they thought that collapse was before it happened.

You can mitigate single stock risk with diversification and prudent position sizing.  But your proposed strategy does neither, and it converts volatility into an actual risk factor.
« Last Edit: December 28, 2018, 08:19:36 PM by ILikeDividends »

Seadog

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #15 on: January 09, 2019, 10:56:06 PM »

If your plan is to sell depressed equities in order to exit a short put position gone bad, then you are accepting whatever risk volatility represents in that near future time frame, and then volatility does become a very real risk.

Finally, the hypothetical loss discussed above is not your theoretical max-loss scenario.  If AAPL pulled an Enron, your entire 2000 share stake would be wiped out, and you would still have to sell other assets to make good on the puts.  That scenario seems unlikely, even to me, but that risk comes along with all single-stock investments, and is ignored at your peril.

Ask any Enron investor how likely they thought that collapse was before it happened.

You can mitigate single stock risk with diversification and prudent position sizing.  But your proposed strategy does neither, and it converts volatility into an actual risk factor.

Fair enough, I don't actually own 2000 shares of apple, or any stock to that degree of non-diversificiation, I were merely throwing out a stock as an example.

At the same time, I think *you* are now conflating risk and volatility. In much the same way you expect the market to be higher in a year and be profitable, you can almost be assured of that fact if you "run the game" 10 times (ie stay invested for 10 years), you expect the options you sell to generally expire worthless, as is the case in something like 80% of cases. While it is certainly true if it does not my portofolio will take a hit on that one instance, I'm not seeing how it's different than if a stock does the opposite of what's expected (ie goes down).

I used to play a lot of poker (profitably), and these sort of statistical quirks are interesting. You can draw to an inside straight, knowing that you'll only hit it 1/13 times or whatever, but as long as you have the payouts and the numbers to make it worthwhile, it can still be a smart move. In that sense you both expect to lose a lot more hands and money (volatility), yet at the end after 130 or so inside straight draws, expect to also improve your returns based on those collective choices.

Delving into options in that sense to me seems similarly to magnify volatility, but if you stick with it and run the game taking bets where the odds favour it, over the long haul you should expect to win, no?

ILikeDividends

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #16 on: January 10, 2019, 03:03:16 PM »

At the same time, I think *you* are now conflating risk and volatility. In much the same way you expect the market to be higher in a year and be profitable, . . .
I made no such assumption nor expressed any expectations about where the market would be in such a trivially short time frame as a single year.  I'm not sure where you got that idea.

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Delving into options in that sense to me seems similarly to magnify volatility, but if you stick with it and run the game taking bets where the odds favour it, over the long haul you should expect to win, no?
Frankly, I find it difficult to have a serious discussion about options from within the metaphorical framework of a poker game.  Sure, options can be used to gamble.  But I think of options in terms of tools that can be applied to specific goals.  I don't consider the judicial use of options to manage risk within the same realm as gambling.

For instance, let's say you didn't own any AAPL at all, but you really wanted to own 200 shares because you've done your homework, you think it's a great company, and 200 shares is a prudent position size for you.  But you think $150/share is just a little bit more than you wanted to pay for it.  You could sell 2 ATM puts for $5 apiece (I'm just making these numbers up).

If you get assigned you get your desired stake at a discount; $145/share.  You have reduced your risk as compared to outright buying the stock at $150/share.  If you don't get assigned, you might be disappointed at not getting your position, and you'll be left at the station if AAPL goes on a tear.  But you still walk away with $1,000 in cash for trying to get into a discounted position and failing to do so.

Selling covered calls is another way to reduce risk by accepting a potentially lower return.  You are trading away potential (uncertain) near future gains for guaranteed cash today.

There's nothing wrong with either of these approaches.  Both approaches reduce risk.  But if you approach options through the lens of a poker game, backing your gambling stake using margin, I think you are headed for some pretty harsh lessons.  You can't calculate "pot odds" in the options markets the way you can in poker when the bet is to you.

Even with poker, I'm guessing you'll agree that playing the game with borrowed money is ill advised.  Why then would you consider doing that with your retirement account?  Are you prepared to "go all in" with your retirement?  Poker is a poor metaphor for risk management.

Options can be used to gamble, to magnify risk, or to manage risk.  The tool itself--just like a shotgun--isn't inherently good or bad.  It's how and why you use it that matters.
« Last Edit: January 10, 2019, 11:29:01 PM by ILikeDividends »

Seadog

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #17 on: January 11, 2019, 03:49:08 PM »

At the same time, I think *you* are now conflating risk and volatility. In much the same way you expect the market to be higher in a year and be profitable, . . .
I made no such assumption nor expressed any expectations about where the market would be in such a trivially short time frame as a single year.  I'm not sure where you got that idea.

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Delving into options in that sense to me seems similarly to magnify volatility, but if you stick with it and run the game taking bets where the odds favour it, over the long haul you should expect to win, no?
Frankly, I find it difficult to have a serious discussion about options from within the metaphorical framework of a poker game.  Sure, options can be used to gamble.  But I think of options in terms of tools that can be applied to specific goals.  I don't consider the judicial use of options to manage risk within the same realm as gambling.

For instance, let's say you didn't own any AAPL at all, but you really wanted to own 200 shares because you've done your homework, you think it's a great company, and 200 shares is a prudent position size for you.  But you think $150/share is just a little bit more than you wanted to pay for it.  You could sell 2 ATM puts for $5 apiece (I'm just making these numbers up).

If you get assigned you get your desired stake at a discount; $145/share.  You have reduced your risk as compared to outright buying the stock at $150/share.  If you don't get assigned, you might be disappointed at not getting your position, and you'll be left at the station if AAPL goes on a tear.  But you still walk away with $1,000 in cash for trying to get into a discounted position and failing to do so.

Selling covered calls is another way to reduce risk by accepting a potentially lower return.  You are trading away potential (uncertain) near future gains for guaranteed cash today.

There's nothing wrong with either of these approaches.  Both approaches reduce risk.  But if you approach options through the lens of a poker game, backing your gambling stake using margin, I think you are headed for some pretty harsh lessons.  You can't calculate "pot odds" in the options markets the way you can in poker when the bet is to you.

Even with poker, I'm guessing you'll agree that playing the game with borrowed money is ill advised.  Why then would you consider doing that with your retirement account?  Are you prepared to "go all in" with your retirement?  Poker is a poor metaphor for risk management.

Options can be used to gamble, to magnify risk, or to manage risk.  The tool itself--just like a shotgun--isn't inherently good or bad.  It's how and why you use it that matters.

I was referring to he statistical expectation. In just the same way you expect the face value of a roll of a die to be 3.5, you expect based on history that a dollar put in VTSAX today will be worth 1.07ish a year from now, the more trials you do (ie years in market), the closer you'd get to that number. There's no prediction there, that's just the factual statistical expected value. 

Same thing with poker, or options. I think poker is a spectacular metaphor for risk management, since you have approximate probabilities, lots of variability, unknowns, but as long as you do enough trials (sale of contracts, time in market, or hands played) and are making statistically +EV bets, you will generally come out ahead. if anything poker is more straight forward than options, since it's far easier to discern the odds of certain hands vs the time-adjusted odds of a particular stock "going on a tear".

Finally a pet peeve has always been mixing up gambling with poker. It's one of the few wagering games where you'll frequently encounter situations where you'd expect to make money. You literally get to be the casino for a few minutes. Mind you there are even more where you'd expect to lose as well, but therein lay the skill of knowing which is which. To that end, borrowing and poker? Question of magnitude I guess. You have a million dollar bank roll, are you playing with fire to borrow $20? $2m? different story.

Aren't you basically proposing the exact same thing as me then? Sell naked puts, and risk losing the entire 200 x $150 when it goes to 0? Why is it when you say it it's a good way to mitigate risk, but when I do it's going to lead to harsh lessons. 

ILikeDividends

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Re: Leverage/Long Options for cash flow + taking advantge of low market?
« Reply #18 on: January 11, 2019, 04:57:06 PM »
Aren't you basically proposing the exact same thing as me then?
No.  Superficially similar, yes.  Exactly the same, not even close.  I'm not advocating selling naked puts.  While I admittedly wasn't explicit, the only way to avoid potential for margin is to sell cash-secured puts (though, I can see now why that distinction wasn't made clear to you by me).  The difference is that if you get assigned against cash-secured puts you have enough cash to cover the assignment.  Getting assigned on a naked put can create margin debt.

And what I'm proposing is also distinctly different in that I would actually want to own the 200 shares for the long term.  And by long term, I mean decades, not years.  The only exit strategy you've suggested so far is to sell depressed equities to get rid of your margin debt.

In short, my goal is to sell puts to get a discount on my entry position of a stock I actually want to own, and at a price that I want to pay.  To me, the put premium is just a cash consolation prize for failing to accomplish my main goal.

It seems your main goal is simply to collect cash premiums, and to do that you are willing to go out on margin, and expose yourself to volatility in order to exit margin debt created by a trade gone bad.

We are both employing the same tool (short puts), but for two very different reasons.  That matters a lot.

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Sell naked puts, and risk losing the entire 200 x $150 when it goes to 0?  Why is it when you say it it's a good way to mitigate risk, but when I do it's going to lead to harsh lessons.
It's all about margin risk, and mitigating volatility to me.  For myself, I'm pretty intolerant of incurring any margin debt at all.  Likewise, I would never borrow money to play poker with.  But that's just me.  Different folks have different appetites for different levels (and types) of risk.

If you want to dial up your risk (and potential gain or loss), you can certainly use options + margin debt to dial up your risk to whatever degree you feel comfortable with.  As I said before, the horror stories of excessive margin debt are well documented in this forum already, and I won't try to replicate that here.

Whether you put 5% out on margin, or 10%, or 20% isn't really the salient point*.  The degree that you are willing to use margin defines the harshness of whatever lessons might be in store for you.  Only you know what that might be.  And again, it's what you plan to do with this margin debt after a trade goes against you that matters.

Just as with options and shotguns, margin debt is just another potential tool.  It's not inherently good or bad.  For me, personally, it just doesn't fit into my risk tolerance at all.  For you, it might be different.  In that case, I can only wish you the best of luck, and hope that you don't go overboard with it.

* If you commit to 5% margin exposure, a 50% bear market turns that into 10% of your portfolio.  Starting with 10% it becomes 20%, and starting with 20% it becomes 40%.  Much beyond that, and you are facing the very real risk of a margin call.  How disciplined do you intend to be at keeping your margin exposure capped at your maximum tolerance; whatever that limit might be?  Again, volatility becomes a very real risk in trying to manage that scenario. That's not a risk my proposal is exposed to; which is another distinguishing point between our two proposals.
« Last Edit: January 12, 2019, 01:15:31 AM by ILikeDividends »