LEAPS PP

A place to talk about speculative investing ideas for the optional Variable Portfolio

Moderator: Global Moderator

User avatar
AdamA
Executive Member
Executive Member
Posts: 2336
Joined: Sun Jan 23, 2011 8:49 pm

Re: LEAPS PP

Post by AdamA » Fri Oct 21, 2011 4:35 pm

Storm wrote: I'm beginning to think that short term options are better because you're not paying as much for the time value... The 2013 options really have a premium for time value that isn't present in a 90 or 120 day option.
It occurred to me that you may be able to pull this off just using SPY and TLT.

They basically have a negative correlation, whereas gold seems to do it's own thing.

Again, all just conjecture. 
"All men's miseries derive from not being able to sit in a quiet room alone."

Pascal
User avatar
Storm
Executive Member
Executive Member
Posts: 1652
Joined: Tue Aug 24, 2010 1:04 pm

Re: LEAPS PP

Post by Storm » Fri Oct 28, 2011 9:15 am

Adam1226 wrote:
Storm wrote: I'm beginning to think that short term options are better because you're not paying as much for the time value... The 2013 options really have a premium for time value that isn't present in a 90 or 120 day option.
It occurred to me that you may be able to pull this off just using SPY and TLT.

They basically have a negative correlation, whereas gold seems to do it's own thing.

Again, all just conjecture. 
That's a very good insight, Adam.  I plan on doing 4 quarterly investments of $10K each with the LEAPS (~15 month maturity), and I will stick with the gold allocation as is, however, I think if I were to do short term call options (90-120 day maturity) a 50/50 SPY/TLT split would give the most bang for the buck.

My reasoning is that over a 1 year timeframe it seems gold will come out ahead, while over 90 day timeframes gold might be flat or negative.
"I came here for financial advice, but I've ended up with a bunch of shave soaps and apparently am about to start eating sardines.  Not that I'm complaining, of course." -ZedThou
User avatar
Storm
Executive Member
Executive Member
Posts: 1652
Joined: Tue Aug 24, 2010 1:04 pm

Re: LEAPS PP

Post by Storm » Thu Nov 03, 2011 9:01 am

So far I'm up 10.402% in 3 weeks.


                Cost Current Price Change Gain/Loss
GLD165JAN13 $4,609.50 $4,990.00 $380.50
SPY125JAN13 $3,109.27 $3,771.00 $661.73
TLT120JAN13 $3,079.04 $3,160.00 $80.96
Totals        $10,797.81 $11,921.00 $1,123.19 110.4020%
"I came here for financial advice, but I've ended up with a bunch of shave soaps and apparently am about to start eating sardines.  Not that I'm complaining, of course." -ZedThou
clacy
Executive Member
Executive Member
Posts: 1128
Joined: Mon Mar 14, 2011 8:16 pm

Re: LEAPS PP

Post by clacy » Thu Nov 03, 2011 9:20 am

Not too shabby.  This could be a very good way to run a VP with 10 or 20% of your money, while the rest stays in a standard HBPP.
User avatar
AdamA
Executive Member
Executive Member
Posts: 2336
Joined: Sun Jan 23, 2011 8:49 pm

Re: LEAPS PP

Post by AdamA » Thu Nov 03, 2011 10:24 am

clacy wrote: Not too shabby.  This could be a very good way to run a VP with 10 or 20% of your money, while the rest stays in a standard HBPP.
Could is the key word. 

These options will have trouble if the markets run flat for a year or two.  Be sure to find a way to take profits or set some cash aside, so you don't lose everything in stagnant markets.  (I think this is the hardest part with this portfolio).
"All men's miseries derive from not being able to sit in a quiet room alone."

Pascal
User avatar
AdamA
Executive Member
Executive Member
Posts: 2336
Joined: Sun Jan 23, 2011 8:49 pm

Re: LEAPS PP

Post by AdamA » Thu Nov 03, 2011 2:26 pm

Clive wrote: If you buy at the money then one of the holdings is more likely to move into the out of money dead zone and might not counterbalance as intended.
That's a good point.  I think one way to avoid this without buying deep in the money options is to sell the options 3 months or so prior to expiration.  This is when the options start to lose value more rapidly (I think).
Clive wrote:
Also - if the Options based scaling is say 10:1 compared to a classic PP, then perhaps the Options approach is better suited to a 10:90 (10% in Options, 90% in cash) Taleb type overall allocation. Which might imply that in 10% of cases the Options might all expire worthless. Under a 10-90 approach you'd still have 90 cash with which to start the next run. (All very generally speaking). In return you might anticipate perhaps the 10% Options on average achieving a 40% annualised gain (i.e. 10% of fund gain 40% = 4% relative to total fund value, whilst 90% perhaps grows at inflation+1%, for an overall 4% real type reward (similar to classic PP)).
I think that's a good observation. 

What's the point of doing this if for all the extra work/expenses you wind up with the same return as the regular PP?
"All men's miseries derive from not being able to sit in a quiet room alone."

Pascal
User avatar
Storm
Executive Member
Executive Member
Posts: 1652
Joined: Tue Aug 24, 2010 1:04 pm

Re: LEAPS PP

Post by Storm » Thu Nov 03, 2011 3:01 pm

Some very good insights, Clive.
Clive wrote: Also - if the Options based scaling is say 10:1 compared to a classic PP, then perhaps the Options approach is better suited to a 10:90 (10% in Options, 90% in cash) Taleb type overall allocation. Which might imply that in 10% of cases the Options might all expire worthless. Under a 10-90 approach you'd still have 90 cash with which to start the next run. (All very generally speaking). In return you might anticipate perhaps the 10% Options on average achieving a 40% annualised gain (i.e. 10% of fund gain 40% = 4% relative to total fund value, whilst 90% perhaps grows at inflation+1%, for an overall 4% real type reward (similar to classic PP)).
I plan on doing something similar to this, however, what I will be doing is investing quarterly around $10K each time, so if you consider my VP around $120K then I should be able to invest quarterly 10%.  There might be a few quarters that lose, but I have yet to see 3 years in a row where the PP was down significantly.  In years where the PP underperformed, it usually made up for it in the following year.  I fully plan on having at least 1 out of 12, if not as many as 4 out of 12 quarters that turn out as a complete loss.  Hopefully the outsized gains from the other 8-11 quarters make up the difference.

Cheers,
Storm
"I came here for financial advice, but I've ended up with a bunch of shave soaps and apparently am about to start eating sardines.  Not that I'm complaining, of course." -ZedThou
Reido

Re: LEAPS PP

Post by Reido » Fri Nov 04, 2011 1:08 am

One issue with options is that there will be times when the PP shows slight gains but the options will lose due to the time-decay.  I would suspect that if the portfolio sees performance like it had in the late 90's again, you might see several consecutive years of losses on your options.

If you were really trying to hit a home-run, perhaps wait until the PP has a losing year, then buy the 3 options for the following year at slightly out-of-the-money strike prices, and hold all the way to expiration.  The PP seems to follow negative years with pretty significant gains in the following year and historically less likely to see another underperforming year.

Just a thought.
Reido

Re: LEAPS PP

Post by Reido » Sat Nov 05, 2011 7:49 pm

As always, thanks for the data Clive.

I do like the idea of the leveraged funds for the exact reason you've stated - when calculating REAL returns, you can gain a lot from the leverage.

If we make the assumption that the PP will return rougly 4% greater than inflation, then I'm assuming it would be wise to leverage as long as the LIBOR is less than 4% plus the prevailing inflation rate??

The only issue I think we would encounter is that it will require some bit of prediction about future inflation and interest rates...

Thoughts?
Rick S
Junior Member
Junior Member
Posts: 14
Joined: Fri Mar 18, 2011 8:32 am

Re: LEAPS PP

Post by Rick S » Wed Nov 16, 2011 4:26 pm

I ran a backtest to 2005 and the results did not look promising.  I'm new to options and the process to backtest options is difficult.  I started in 2005 with $10,000 and purchased at-the-money calls 1 year out at the beginning of each year and sold them at the end of each year.  I then rolled that money over to the next years and repeated the process.    My $10,000 ended up as $12,540 after six years compared to $15,780 for the PP. The LEAPS also had some wild swings. Has anyone else run a backtest to validate my math?  I'll post a graph as soon as I figure out how.
User avatar
Storm
Executive Member
Executive Member
Posts: 1652
Joined: Tue Aug 24, 2010 1:04 pm

Re: LEAPS PP

Post by Storm » Wed Nov 16, 2011 6:02 pm

Rick S wrote: I ran a backtest to 2005 and the results did not look promising.  I'm new to options and the process to backtest options is difficult.  I started in 2005 with $10,000 and purchased at-the-money calls 1 year out at the beginning of each year and sold them at the end of each year.  I then rolled that money over to the next years and repeated the process.    My $10,000 ended up as $12,540 after six years compared to $15,780 for the PP. The LEAPS also had some wild swings. Has anyone else run a backtest to validate my math?  I'll post a graph as soon as I figure out how.
What site or data did you use to do your back testing?  I would like to test the following:
  • Monthly $10k invested in deep in the money options with a 120 day maturity, sold at 90 days.
  • Monthly $10k invested in deep in the money options with a 14 month maturity, sold at 1 year + 1 day.
My personal belief is that due to the time value component of options, the entry/exit time is critical to the performance of those particular options.  By spreading out your purchases over 12 months you should be pretty much guaranteed to capture all of the market conditions in a given year.  Of course some will lose and some will win.

Another theory this will test is that the ROI for shorter term options might indeed be much higher than LEAPS.  In this case, I need to find out if it provides enough benefit to justify the higher tax rate for short term capital gains.
"I came here for financial advice, but I've ended up with a bunch of shave soaps and apparently am about to start eating sardines.  Not that I'm complaining, of course." -ZedThou
Rick S
Junior Member
Junior Member
Posts: 14
Joined: Fri Mar 18, 2011 8:32 am

Re: LEAPS PP

Post by Rick S » Wed Nov 16, 2011 10:05 pm

Here's a chart for the backtest.  I pulled the data for SPY, TLT, and GLD from yahoo and computed the volatility and then plugged that into the options pricing formula.  I used excel for the crunching.

Image

Stone...how deep in the money do you want to go?  The options deepest in the money are $20 less than the current price of the stock.  You could buy a $20 strike SPY call option for $104 or SPY for $124.  Not much leverage if you go that deep.  I'll run a chart for the options deepest in the money to see if there is a payoff.

I was a little suprised at the numbers in the chart. I expected it to move like a levered PP but that's not really what happened.  It could be, as Clive mentioned, related to the at-the-money model that I used.  We'll see if the deep-in-the-money model works better.
User avatar
AdamA
Executive Member
Executive Member
Posts: 2336
Joined: Sun Jan 23, 2011 8:49 pm

Re: LEAPS PP

Post by AdamA » Wed Nov 16, 2011 10:13 pm

Rick S wrote: My $10,000 ended up as $12,540 after six years compared to $15,780 for the PP. The LEAPS also had some wild swings.
I'm surprised it did even that well. 

After watching it for a while, I can see where it would easily lose money in slowly trending or sideways markets. 

It's also a gamble timing wise.  For example, right when we started discussing this idea, LTT's shot up very quickly.  However, they could easily be back down around $100 by the time it's time to sell and roll over the LEAPS. 

The more I watch this, the more convinced I become that it's a bad idea.
"All men's miseries derive from not being able to sit in a quiet room alone."

Pascal
Rick S
Junior Member
Junior Member
Posts: 14
Joined: Fri Mar 18, 2011 8:32 am

Re: LEAPS PP

Post by Rick S » Wed Nov 16, 2011 10:59 pm

Here's one with the deepest in the money options.


Image


This one is better but it performs closer to the PP with more risk.  There might be some opportunity to play the swings.  When the total of all three (spy,tlt,gld) are down big then you could buy in with some at-the-money calls.  This, of course, would be trying to time the market and be speculative but it would be more levered.
User avatar
Storm
Executive Member
Executive Member
Posts: 1652
Joined: Tue Aug 24, 2010 1:04 pm

Re: LEAPS PP

Post by Storm » Fri Nov 18, 2011 9:49 am

Clive, it occurred to me that perhaps the reason our test options and my recently purchased ones have done so well was that in those cases I was actually buying slightly out of the money call options.  This increases the leverage and hopefully assures that we don't pay the "in the money" premium, and then later have them fall out of the money.

It seems that as tested, the deeper you go in the money, the greater both leverage and volatility are reduced.  Eventually you end up with something that looks almost like a 33/33/33 PP with no cash component.
"I came here for financial advice, but I've ended up with a bunch of shave soaps and apparently am about to start eating sardines.  Not that I'm complaining, of course." -ZedThou
User avatar
Gosso
Executive Member
Executive Member
Posts: 1052
Joined: Fri Jan 06, 2012 8:22 am
Location: Canada

Re: LEAPS PP

Post by Gosso » Tue Apr 17, 2012 9:57 am

AdamA & Storm,

Anything interesting to report?  The US PermPort has been relatively flat over the past 6 months -- it appears that SPY has increased 15%, while TLT and GLD have been flat.

I have some USD burning a hole in my pocket, and I'm tempted to dip a toe into the options market.  Worst case scenario is that I can chalk this up as the cost of tuition.
User avatar
Storm
Executive Member
Executive Member
Posts: 1652
Joined: Tue Aug 24, 2010 1:04 pm

Re: LEAPS PP

Post by Storm » Wed Apr 18, 2012 8:34 am

Gosso wrote: AdamA & Storm,

Anything interesting to report?  The US PermPort has been relatively flat over the past 6 months -- it appears that SPY has increased 15%, while TLT and GLD have been flat.

I have some USD burning a hole in my pocket, and I'm tempted to dip a toe into the options market.  Worst case scenario is that I can chalk this up as the cost of tuition.
I wouldn't do it.  It's depressing to look at my positions right now.  SPY options are up 72.71% but GLD is down 58.78% and TLT is down 48.69%.  Overall I'm down $1,947.81 on a ~10K initial investment.

If you know a big market move is about to happen, like QE3, or the US debt ceiling fiasco, that the market hasn't priced in, or the market predicts incorrectly what is going to happen (like the debt ceiling issue), perhaps it's worth doing.

Basically, I'm just holding these options until January of next year and hoping there is a big move in gold or equities due to QE3.  If things stay relatively flat I've lost money.
"I came here for financial advice, but I've ended up with a bunch of shave soaps and apparently am about to start eating sardines.  Not that I'm complaining, of course." -ZedThou
User avatar
Gosso
Executive Member
Executive Member
Posts: 1052
Joined: Fri Jan 06, 2012 8:22 am
Location: Canada

Re: LEAPS PP

Post by Gosso » Wed Apr 18, 2012 11:08 am

Storm,

Thanks for the update.  It is a good reality check to see how these leveraged instruments work during periods of low volatility.  I would hold onto them as well -- all it would take is something dumb to happen in Europe and GLD or TLT could take off -- things have been far to quiet lately, we're due for something interesting to happen.

But you haven't scared me off yet.  :)

I'm thinking about using a small portion of the PP, maybe 3%, to buy 8 month at-the-money call options on GLD, TLT, SPY.  I would then roll them over at the six month mark.  I full expect that I will lose the entire 3% over a few of these six month periods, but then I just ante-up again with cash from the non-leveraged PP (I know I'm breaking several of HB's rules).  In theory this should provide PP like returns similar to a 1.3x leveraged PP.  I'm also thinking that I would rebalance if the options hit a gain of 100% (I may tweak this figure though).

Another advantage for me is that I can avoid forex charges (1-2%) simply by leveraging my USD's, rather than converting CAD to USD, to buy the US PP.

Edit:  The downsides (besides the leverage risk) is tax drag since I will realize the capital gains every year, and the transaction cost of ~$70 to rollover the call options.
Last edited by Gosso on Fri Apr 20, 2012 2:39 pm, edited 1 time in total.
User avatar
Storm
Executive Member
Executive Member
Posts: 1652
Joined: Tue Aug 24, 2010 1:04 pm

Re: LEAPS PP

Post by Storm » Wed Apr 18, 2012 12:25 pm

I had contemplated doing something similar as well, Gosso.  I noticed that in the 3-6 month timeframe you definitely can get cheaper options, rather than paying the LEAPs premium.  I figured if you had about $120,000 investment capital and deployed $10,000 every month, you might end up losing a few months of the year, but I would think the winners would outperform the losers.

After contemplating this further, and looking at the tax efficiency, trading costs, and just flat out volatility, I think I would prefer to do the 2xHBPP or 3xHBPP instead, with the levered funds.  It seems that hitting those rebalancing bands more often really might eke out some gains in the levered PP space.
"I came here for financial advice, but I've ended up with a bunch of shave soaps and apparently am about to start eating sardines.  Not that I'm complaining, of course." -ZedThou
User avatar
Gosso
Executive Member
Executive Member
Posts: 1052
Joined: Fri Jan 06, 2012 8:22 am
Location: Canada

Re: LEAPS PP

Post by Gosso » Wed Apr 18, 2012 2:31 pm

Storm wrote: ...you might end up losing a few months of the year, but I would think the winners would outperform the losers.
That's what I figured.  In addition, by rebalancing at every 100% gain from the options, you are able to store these gains in cash to use as dry powder for when the leverage works against you.  I still have a lot of thinking and research to do before I pull the trigger, but so far I like what I see (although I may not thoroughly understand everything yet).
Storm wrote: After contemplating this further, and looking at the tax efficiency, trading costs, and just flat out volatility, I think I would prefer to do the 2xHBPP or 3xHBPP instead, with the levered funds.  It seems that hitting those rebalancing bands more often really might eke out some gains in the levered PP space.
That is likely the better route to take.  I would do this if Canada had decent levered ETF's.
User avatar
AdamA
Executive Member
Executive Member
Posts: 2336
Joined: Sun Jan 23, 2011 8:49 pm

Re: LEAPS PP

Post by AdamA » Wed Apr 18, 2012 6:15 pm

Gosso wrote: AdamA & Storm,

Anything interesting to report?  The US PermPort has been relatively flat over the past 6 months -- it appears that SPY has increased 15%, while TLT and GLD have been flat.
Mine is still doing well.  I started with about $20k and it's still around $32k (all virtual, no real money).  I put around $5k in each of Jan 13 LEAPS for GLD, TLT and SPY initially. I bought 3 for GLD, 4 for SPY and 10 for TLT.

It would have been exciting to have done this for real, but I think it's ultimately bound to fail, for multiple reasons.  

One, I think you'd eventually wind up taking a giant loss.  

Two, I doubt I'd be capable of waiting until October to sell them and rebuy (which was the original plan).  I'd have probably sold all of my positions months ago to take profits.  God only knows what I would have done if the positions would have started off with a big loss.

Three, requires frequent trading.  Very bad in a taxable account.  
"All men's miseries derive from not being able to sit in a quiet room alone."

Pascal
clacy
Executive Member
Executive Member
Posts: 1128
Joined: Mon Mar 14, 2011 8:16 pm

Re: LEAPS PP

Post by clacy » Wed Apr 18, 2012 6:42 pm

My $0.02....

I would like to see how the leveraged ETF's react in a major draw down event first.  When I look at SSO and SHY rebalanced quarterly, I see a significant drag compared to SPY and I think the main culprit is 2008.

Secondly, I think one of these leveraged approaches (2-3x ETF's or options) would be far more lucrative if you instigated them after a 10%+ draw down event.  The next time the PP is down 10%, I very well may try one of them, as I feel like the odds would be much more in your favor at that point.
User avatar
Gosso
Executive Member
Executive Member
Posts: 1052
Joined: Fri Jan 06, 2012 8:22 am
Location: Canada

Re: LEAPS PP

Post by Gosso » Wed Apr 18, 2012 9:21 pm

clacy wrote: My $0.02....

I would like to see how the leveraged ETF's react in a major draw down event first.  When I look at SSO and SHY rebalanced quarterly, I see a significant drag compared to SPY and I think the main culprit is 2008.

Secondly, I think one of these leveraged approaches (2-3x ETF's or options) would be far more lucrative if you instigated them after a 10%+ draw down event.  The next time the PP is down 10%, I very well may try one of them, as I feel like the odds would be much more in your favor at that point.
There does appear to be more tracking error between the SPY, and SSO and SHY.  I'm not sure why that combo would be different than what Clive has posted. 
AdamA wrote:
Gosso wrote: AdamA & Storm,

Anything interesting to report?  The US PermPort has been relatively flat over the past 6 months -- it appears that SPY has increased 15%, while TLT and GLD have been flat.
Mine is still doing well.  I started with about $20k and it's still around $32k (all virtual, no real money).  I put around $5k in each of Jan 13 LEAPS for GLD, TLT and SPY initially. I bought 3 for GLD, 4 for SPY and 10 for TLT.

It would have been exciting to have done this for real, but I think it's ultimately bound to fail, for multiple reasons. 

One, I think you'd eventually wind up taking a giant loss. 

Two, I doubt I'd be capable of waiting until October to sell them and rebuy (which was the original plan).  I'd have probably sold all of my positions months ago to take profits.  God only knows what I would have done if the positions would have started off with a big loss.

Three, requires frequent trading.  Very bad in a taxable account. 
Not too shabby!

I agree with your concerns.  There will be a point in time when all three call options will expire worthless, or at least down over ~75%.  This just means you need enough dry powder to buy back in.  Of course the problem with this is if we see two or three six month periods in a row where all the PP assets perform poorly or remain flat, which I think is highly unlikely, but possible.
User avatar
AdamA
Executive Member
Executive Member
Posts: 2336
Joined: Sun Jan 23, 2011 8:49 pm

Re: LEAPS PP

Post by AdamA » Wed Apr 18, 2012 9:37 pm

Gosso wrote: Of course the problem with this is if we see two or three six month periods in a row where all the PP assets perform poorly or remain flat, which I think is highly unlikely, but possible.
It only has to happen once to kill the portfolio.
"All men's miseries derive from not being able to sit in a quiet room alone."

Pascal
User avatar
Gosso
Executive Member
Executive Member
Posts: 1052
Joined: Fri Jan 06, 2012 8:22 am
Location: Canada

Re: LEAPS PP

Post by Gosso » Wed Apr 18, 2012 10:12 pm

AdamA wrote:
Gosso wrote: Of course the problem with this is if we see two or three six month periods in a row where all the PP assets perform poorly or remain flat, which I think is highly unlikely, but possible.
It only has to happen once to kill the portfolio.
Yes, it would kill the VP portfolio if you decided to go 100% call options.  But you could use 1/3 of the VP for call options, while keeping the rest in cash, so that if the call options blow up then you have some dry powder to buy new call options at rock bottom prices (hopefully).  The cash effectively lowers you leverage from ~10x down to ~3x.  Although if you drop down to 3x, then it might be easier to just buy a 3x levered ETF...
Post Reply