LEAPS PP

[AdamA]

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.

[Rick S]

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





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.

[Storm]

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.

[Gosso]

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.

[Storm]

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.

[Gosso]

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.

[Storm]

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.

[Gosso]

...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).

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.

[AdamA]

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.  

[clacy]

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.

[Gosso]

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 & 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.

[AdamA]

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.

[Gosso]

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...

[Gosso]

I was looking at the Dec 22, 2012 call options and noticed that a few were overpriced in comparison to the Black–Scholes model:

- SPY: +48%
- GLD: +24%
- TLT: -1%

Does this mean that the options on SPY and GLD have already factored in a significant price increase?  Then if there was a price increase, is it possible the call options would actually decrease in value?

I'm beginning to like this scenario less and less.

Any expert option traders want to throw in their two cents on this?  Is it normal for GLD and SPY to be overpriced like this?

[AdamA]

The cash effectively lowers you leverage from ~10x down to ~3x...

It also would lower your yield.  I suspect this setup would probably not do as well as the regular PP.

[clacy]

Clive, I possess 1/10th of your backtesting abilities (and I'm not joking).  My backtesting is more or less relegated to etfreplay.  What rebalance time interval are you using on your etfreplay charts?

[Gosso]

If I ever decide to buy options, then I'd likely use a Bull Call Spread.  What this does is limit your upside to a 10-20% gain in the underlying stock, and for this sacrifice you are given back about 20% of your initial investment.  This seems to be perfect for the PP's moderately volatile assets.  Another benefit is that it takes greed off the table since once the stock moves 10-20% then you can no longer profit from it, so you might as well rebalance and take your profits off the table.

The downside is the additional transaction costs, and inability to profit from a massive move...although you can simply purchase a new Bull Spread once the previous one reaches the cap, but again the transaction costs hurt.

Think of it as a forced rebalancing, but still pays back ~20% (Edit: of your original investment) even if the stock falls below your strike price.  An 80% loss is better than 100%.

I don't believe that this hurts the leverage, although I could be wrong.

***

Something else I was thinking about is buying call options with equal premium prices, instead of all ATM.  For example, lets say we want to buy Dec 21, 2012 call options for TLT GLD SPY all at $10.  This means we'd have to go moderately ITM for TLT, slightly ITM for SPY, and ATM for GLD.  Does this give a more appropriate risk and leverage profile?  Since TLT is historically less volatile, it would make sense to buy moderately ITM, since it is more likely to remain flat.

Or does it not make a difference?

[Storm]

I was looking at the Dec 22, 2012 call options and noticed that a few were overpriced in comparison to the Black–Scholes model:

- SPY: +48%
- GLD: +24%
- TLT: -1%

Does this mean that the options on SPY and GLD have already factored in a significant price increase?  Then if there was a price increase, is it possible the call options would actually decrease in value?

I'm beginning to like this scenario less and less.

Any expert option traders want to throw in their two cents on this?  Is it normal for GLD and SPY to be overpriced like this?

Gosso, I'm about as novice of an options trader as they come, but I think you're correct.  It seems like the futures price tends to be what most market participants believe is going to happen: they think gold and stocks will rise by December, so the consensus is already priced in.

The reason I would caution you to not use our previous test data (especially the $20K to $32K increase) is that we made those options bets a month or so before the debt ceiling deadline last summer.  The market had already priced in what they thought was going to happen, which, according to general consensus, was that treasury yields were going to soar and all of that outflow from the bond selloff was going to rush into equities.  As we all know, the exact opposite happened.  Treasury yields fell and this made our TLT options soar in value.

You can make a lot of money when the market is wrong, but if you bet money now that gold is going to $2000 an ounce, don't be too surprised if it does, and you still don't make a lot of money, because the market has already priced that consensus view in.

Good luck.

[MachineGhost]

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.

Time decay and volatility collapse will get you every time.  There is no way to do options succesfully without factoring those two variables into it.  Options aren't straight up substitutes for the underlying, like stock futures.  Even though 100 shares of stock, 1 ATM option and 1 ATM stock futures are all equivalent in terms of $ gain.

MG

[AdamA]

I just setup a virtual trading account at OptionsExpress.com with the following positions

1/3 SPY Jan 2013 Call
1/3 GLD Jan 2013 Call
1/3 TLT Jan 2013 Call

(all at the money options).

My plan would be to rebalance in one year, selling losers with one day left in the year, and winners the next day for tax reasons.  I'd then rebuy the options with later expiration dates.

Does anyone think that such a plan could work?

Note, this is a virtual account and contains no real money.  

I didn't use a cash ETF b/c none of them have LEAPS as far as I can tell.

This portfolio returned about 100% over the past year, almost exclusively due to the TLT LEAPS which basically quadrupled (!) in value.  

I will sell all of the positions and repeat again this year.  I will sell the TLT and SPY LEAPS on Aug 2 (1 year + 1 day) b/c they were winners, and the GLD LEAPS tomorrow b/c it was a loser.

As interesting as this idea is to me, there is no amount of backtesting that would ever make me comfortable using it...unless maybe I was really really really rich, and using a very small portion of my invested money.

[Storm]

I just setup a virtual trading account at OptionsExpress.com with the following positions

1/3 SPY Jan 2013 Call
1/3 GLD Jan 2013 Call
1/3 TLT Jan 2013 Call

(all at the money options).

My plan would be to rebalance in one year, selling losers with one day left in the year, and winners the next day for tax reasons.  I'd then rebuy the options with later expiration dates.

Does anyone think that such a plan could work?

Note, this is a virtual account and contains no real money.  

I didn't use a cash ETF b/c none of them have LEAPS as far as I can tell.

This portfolio returned about 100% over the past year, almost exclusively due to the TLT LEAPS which basically quadrupled (!) in value.  

I will sell all of the positions and repeat again this year.  I will sell the TLT and SPY LEAPS on Aug 2 (1 year + 1 day) b/c they were winners, and the GLD LEAPS tomorrow b/c it was a loser.

As interesting as this idea is to me, there is no amount of backtesting that would ever make me comfortable using it...unless maybe I was really really really rich, and using a very small portion of my invested money.

My actual LEAPS purchased after the debt ceiling showdown of last year have been negative for most of the year.  Just recently they have started to push into almost break-even territory (around $9600 out of $10,000).  I'm on track to sell them in October, so if there are no major market moves until then, it's highly likely I'll take a small loss, or a small profit.

If you try this strategy, you run the very real risk that the PP is mostly flat during your short term time horizon, and that pretty much sucks for options.

AdamA, if only we'd put real money on those "fake trades"...  By the way, I think this is what Harry Browne talks about in his books.  He says something like "the best winning trading strategy will lose money when you try it."

[Gosso]

AdamA,

Have you checked the "real" spread on the TLT options.  For some reason the very deep ITM options for TLT have giant spreads on them -- I'm talking 15-20%.  The spread for ITM options on GLD and SPY are much more reasonable at approx 1-2%.

For me, this almost makes TLT a non-starter for options, since if the TLT does perform well and ends deep ITM then you have to pay a 15% spread to close the trade.  Although, I suppose you could let the option expire and then sell the shares on the open market...

[clacy]

AdamA,

Have you checked the "real" spread on the TLT options.  For some reason the very deep ITM options for TLT have giant spreads on them -- I'm talking 15-20%.  The spread for ITM options on GLD and SPY are much more reasonable at approx 1-2%.

For me, this almost makes TLT a non-starter for options, since if the TLT does perform well and ends deep ITM then you have to pay a 15% spread to close the trade.  Although, I suppose you could let the option expire and then sell the shares on the open market...

I would assume most who are trading options on long bonds are trading futures options on the 30-yr bond future instead.

[AdamA]

AdamA,

Have you checked the "real" spread on the TLT options.  For some reason the very deep ITM options for TLT have giant spreads on them -- I'm talking 15-20%.  The spread for ITM options on GLD and SPY are much more reasonable at approx 1-2%.

For me, this almost makes TLT a non-starter for options, since if the TLT does perform well and ends deep ITM then you have to pay a 15% spread to close the trade.  Although, I suppose you could let the option expire and then sell the shares on the open market...

As the options get closer to expiration, the spread closes. 

[Gosso]

AdamA,

Have you checked the "real" spread on the TLT options.  For some reason the very deep ITM options for TLT have giant spreads on them -- I'm talking 15-20%.  The spread for ITM options on GLD and SPY are much more reasonable at approx 1-2%.

For me, this almost makes TLT a non-starter for options, since if the TLT does perform well and ends deep ITM then you have to pay a 15% spread to close the trade.  Although, I suppose you could let the option expire and then sell the shares on the open market...

As the options get closer to expiration, the spread closes. 

I had a closer look at the TLT options and you're right.  But the spread is still greater than GLD and SPY.  Although there is a lot disparity, the options with increments of 5 have the most open interest and lowest spreads, but even a few of those have large spreads.  I guess this highlights the importance of limit orders.