Selling Calls at rebalance points

[doodle]

I just thought of a strategy to generate a little income. What about the idea of selling calls at the various rebalance points in asset classes?

In other words you could sell a call for gold right now at the price that would trigger your 35% or 30% rebalance point. If it hits the price, the call triggers and you rebalance. If it doesn't hit the price you collect a little income from the call.

Anyone tried this?

[doodle]

You could do the same thing I guess by selling puts at your lower rebalance bands.

[doodle]

This gets a little tough to figure out beforehand because all the assets are moving willy nilly, but it could be accomplished as one approaches a rebalance in one of the particular assets. It would be more profitable as well being that the asset was closer to the price level that you are selling the call or put at.

[Storm]

Covered calls are a great way of doing a little bit of hedging, but they do limit your upside potential.  In all cases, if the rebalance band was hit, you would have made more total profit by not doing a covered call.  The covered call just gives you a little immediate income now, in exchange for some of the upside potential.

It would be difficult to model, but I suspect that if you modeled a 4x25 PP where you sold covered calls at the 30% mark for a 35% price, I think your overall return would be lower than a traditional 4x25 PP.

If anyone would care to model it and prove me wrong, please feel free!

[doodle]

Storm..why would you make less if you were going to rebalance at that point anyways? Wouldn't you make more because of the income from selling the call or the put?

[doodle]

SPY is trading at 112 currently. If I know that I will need to buy 50,000 dollars worth to rebalance to 25% if it hits $100 dollars why wouldn't I just sell the Aug 19 100 put for .85 cents and collect .85 * (50,000/100) = $425.00

[Storm]

I guess the reason why you would make less is because usually the rebalance band is passed, not just hit dead on.

So, for example, shares of XYZ are $8 currently, your rebalance band is $10, so you sell covered calls for $0.25 each.

Let's consider the possible scenarios:

1.  XYZ never reaches $10 - best possible outcome - you pocket the $0.25 a share as pure profit.

2.  XYZ reaches $10 but never rises above it - still a good outcome - you pocket $2.25 as profit, better than the $2.00 you would have made.

3.  XYZ reaches $10.50 - the options got exercised at $10.00, so you made $2.25, but you would have made $2.50 if you would have rebalanced normally.

I guess I shouldn't have said "in all cases", I should have said in most cases.

The reason most brokers recommend covered calls is because if they never get exercised, it's a great way to juice extra income from dividend stocks.  However, if they do get exercised, you almost always get a lower profit than you would have normally, greatly limiting your upside potential, and creating potential tax events if you are trading in a taxable account.

http://www.fool.com/investing/dividends ... calls.aspx

[doodle]

Storm,

3.  XYZ reaches $10.50 - the options got exercised at $10.00, so you made $2.25, but you would have made $2.50 if you would have rebalanced normally.

What about if you were going to sell at $10 dollars anyways and rebalance? You still would have missed out on the additional upside in that case as well.

It seems that 2/3 out of the three options you make additional money, and in the third option where you would have rebalanced at that price point anyways you still make money.

For example, if I know that I want to buy the S&P 500 if it declines 10% more. As soon as it hits that price point, I will buy. I can even set that order up ahead of time.

Why not just sell the put instead. Sure, it could decline more. But, I will not have lost anymore than I would have anyways from executing a rebalance at that price. In fact, I will have gained from selling the put.

It seems that this is a sure-fire way to add income to already strict rebalance points of the PP.

[melveyr]

What about just buying puts?

Part of me at some point would like to start a VP of super cheap way out of the money puts. Every 10 years or so, when those "one in a trillion years" events happen I could see fat gains.

[doodle]

I like the consistent extra income that comes from selling puts and calls at the rebalance points that you would use under normal circumstances anyways.

If you are going to rebalance gold at $2000 because at that price it hits 35% of your portfolio, and it hits $2100 by the time your option expires, I don't see how it would have changed the overall profit you would have made by selling it at $2000 by way of a call option as you would under normal rebalancing situation and watching it later climb higher after you rebalanced.

It seems that all rebalances should be undertaken by selling puts and calls. What am I missing here? It seems like free money to take no additional risk with PP strategy.

[Storm]

Doodle, I think what you are missing here is that the PP is meant to be a "lazy portfolio", in the sense that you're not supposed to check it every day.

You're supposed to just check it every 3-6 months, and rebalance if necessary.  If you're watching like a hawk and have stock alerts setup so that you can put in a sell order the second it passes some arbitrary threshold, you've already gone way outside of what HB recommends for the PP.

"Keep it simple" is one of the rules.  Not that there isn't a lot of fun and optimization that can be made if you're willing to spend all day trading.  I certainly have fun messing around with my variable portfolio.

In the end, I think you might actually end up with a better overall return over time by not checking your portfolio so often.  In the HBPP world, if gold happens to hit $2000, and you didn't rebalance, it's not the end of the world.  After all, you didn't even check your account until gold hit $2100 and the extra $100 an ounce is just gravy.  In this case you might be saying "whoops, I guess gold is 36% and I should have rebalanced 1% ago, oh well."

I guess it is just a different approach, following the HB rules, keep it simple, etc.

[Gumby]

Doodle, I think what you are missing here is that the PP is meant to be a "lazy portfolio", in the sense that you're not supposed to check it every day.

You're supposed to just check it every 3-6 months, and rebalance if necessary.  If you're watching like a hawk and have stock alerts setup so that you can put in a sell order the second it passes some arbitrary threshold, you've already gone way outside of what HB recommends for the PP.

"Keep it simple" is one of the rules.  Not that there isn't a lot of fun and optimization that can be made if you're willing to spend all day trading.  I certainly have fun messing around with my variable portfolio.

In the end, I think you might actually end up with a better overall return over time by not checking your portfolio so often.  In the HBPP world, if gold happens to hit $2000, and you didn't rebalance, it's not the end of the world.  After all, you didn't even check your account until gold hit $2100 and the extra $100 an ounce is just gravy.  In this case you might be saying "whoops, I guess gold is 36% and I should have rebalanced 1% ago, oh well."

I guess it is just a different approach, following the HB rules, keep it simple, etc.

I completely agree with storm.

Time = Money

Harry Browne's #1 rule was that your wealth came from your career. If you can practically eliminate the amount of time you spend watching and optimizing your investments, it will likely reap even greater rewards than eeking out another few percentage points in your investments. In other words, it's probably not worth the extra time/effort to juice your PP returns.

A better strategy might be to try to save and make as much cash as you can, so as to trigger a cash rebalancing band quicker!

Turn the 4x25 gyroscope on, leave it alone, come back after a few months and take a peek to see if your rebalancing bands are hit. That's all there is to it.

[AdamA]

Storm..why would you make less if you were going to rebalance at that point anyways? Wouldn't you make more because of the income from selling the call or the put?

I think the real problem is that it requires you to delay rebalancing.

If there's a big move down in SPY or GLD or whatever, you're stuck in the position waiting for your call to expire, instead of locking in your profits as soon as you hit a rebalancing band.