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Increase Portfolio Beta - Buying Equities on Margin

7,625 Views | 56 Replies | Last: 4 yr ago by RogerEnright
RogerEnright
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I plan to buy equities on margin and wanted to see if you have suggestions.

I have a view that it is odd that conventional thinking is to get a portfolio beta of 1 or less. I would like to push that assumption a bit.

- Currently I own a portfolio of about $115k that I don't mind adding "extra" risk to. This is not money that my family "needs" and I am willing to suffer the consequences.
- The portfolio currently has about $20k of fixed income type etfs.
- Historically I would have cash reserves and setup limit orders to purchase equities at 10% to 20% of the market and hope they hit

The plan (I am still optimizing the amount of leverage):
1. Get the fund up to about $150k
2. Move the account (in process) to Interactive Brokers (lowest margin rates)
3. Write $20k (sell) naked put options of SPY (seems to have the most option liquidity) at about two months periods at a strike price 15% below current market prices and write another $30k of put options at 25% below the market.

If the first 20k of options are exercised, I would sell the fixed income ETFs to pay for them, if the second 30k of options are exercised this will result in the margin debt that I am looking to add to this portfolio.

Questions
1. Has anyone read much research on optimal option length to optimize price deterioration?
2. Is targeting ETFs with significant option liquidity the right choice?
3. I hope to dust off my statistics knowledge and run some Monte Carlo simulations to optimize the size of the contracts that I write. Do you have any suggestions on this?

Is there anything else that I am missing?

Thank you in advance.
Wrighty
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AG
So this is the top ?
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RogerEnright
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I have been acting like we are near the top for over a year now.
RogerEnright
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SoupNazi2001 said:

I have seen research that 2x or 3x leveraged portfolios can significantly outperform a long only portfolio with well defined rules. The paper I saw used the Emini future (one contract controls about $150K notional) and would own when the S&P 500 is above the 200 day moving average and sell when it is below. This helps you stay with the long term trend but avoids the significant damage that can occur in a bear market. You would have to be disciplined to employ this approach.
Interesting. Using some trend following to mitigate the downside. I really don't know enough about trend following yet.

There are many that believe that one of the Bridgewater funds (I forget which fund) can be replicated by adding leverage to a portfolio of securities (something like 40% leverage). I have heard the same about replicating LBO private equity performance.

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Bob Knights Paper Hands
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RogerEnright said:


The plan (I am still optimizing the amount of leverage):
3. Write $20k (sell) naked put options of SPY (seems to have the most option liquidity) at about two months periods at a strike price 15% below current market prices and write another $30k of put options at 25% below the market.

If the first 20k of options are exercised, I would sell the fixed income ETFs to pay for them, if the second 30k of options are exercised this will result in the margin debt that I am looking to add to this portfolio.

For us laymen what does this mean?
What will happen if the SPY continues going up? Do you just make money by selling the puts?
What will happen if the SPU goes down? You will end up owning SPY at a reduced rate from what it is today and having margin debt?
RogerEnright said:


Questions
1. Has anyone read much research on optimal option length to optimize price deterioration?
2. Is targeting ETFs with significant option liquidity the right choice?
3. I hope to dust off my statistics knowledge and run some Monte Carlo simulations to optimize the size of the contracts that I write. Do you have any suggestions on this?

Is there anything else that I am missing?

Thank you in advance.

What parameters would you use to build a monte carlo model? What parameters would you vary?
oldarmy1
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AG
You've backtested this master plan with small trades over a period of time? This includes knowing when to take profit and exit the trade, stop loss, roll a position etc. Would you be considered a "professional trader"? If the answer is no to any of these then you have no business going on to margin.

Just trying to help, but saying you don't mind suffering the consequences is code in my mind that you shouldn't be going down this road, at this point.
RogerEnright
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oldarmy1 said:

You've backtested this master plan with small trades over a period of time? This includes knowing when to take profit and exit the trade, stop loss, roll a position etc. Would you be considered a "professional trader"? If the answer is no to any of these then you have no business going on to margin.

Just trying to help, but saying you don't mind suffering the consequences is code in my mind that you shouldn't be going down this road, at this point.
Thank you for the input. I certainly will try a smaller version of the naked puts prior to going "live". I will do that to get the mechanics down with the new platform. Except for muscle memory and learning the basics, this exercise will do nothing to tell me the risks with the strategy. It reminds me of Nassim Taleb's turkey story.
RogerEnright
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"Consider a turkey that is fed every day," Taleb writes. "Every single feeding will firm up the bird's belief that it is the general rule of life to be fed every day by friendly members of the human race 'looking out for its best interests,' as a politician would say.

"On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey. It will incur a revision of belief."



- Nassim Taleb
RogerEnright
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On the margin side of this strategy, I think it lends itself more to analysis a Monte Carlo simulation and reviewing the impact of peek to trough of recent corrections.


Does anyone have experience selling naked puts?
RogerEnright
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I think you get what I am trying to do.

Quote:

For us laymen what does this mean?
What will happen if the SPY continues going up? Do you just make money by selling the puts?
What will happen if the SPU goes down? You will end up owning SPY at a reduced rate from what it is today and having margin debt?
Exactly! In two months the puts expire and if they aren't exercised then I would write new puts.
You are correct on how the margin debt is added as well.

I have heard that the biggest problem with selling naked puts is discipline. At some point there is pressure to move beyond picking up dollars and try to do something more.

Selling naked puts is as infamous as buying securities on margin. It is generally a bad idea...

Quote:

What parameters would you use to build a monte carlo model? What parameters would you vary?
I am still working on this and will report back.

AgBank
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AG
Quote:


What parameters would you use to build a monte carlo model? What parameters would you vary?
I would like to see this as well.
og_ag99
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AG
Quote:

Questions

1. Has anyone read much research on optimal option length to optimize price deterioration?

I have watched some of the videos on Tastytrade.com. They do various studies on the SPY options on selling premium. Their optimal option length is to sell the premium, naked put in your instance, about 45 days to expiration and close or manage the position at 21 days to expiration.

Anything longer than 45 days and the premium decays slowly. Anything closer to expiration increases the gamma risk, which causes the option prices to fluctuate heavily with regards to price movement in the underlying.
JP76
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RogerEnright said:


I think you get what I am trying to do.

Quote:

For us laymen what does this mean?
What will happen if the SPY continues going up? Do you just make money by selling the puts?
What will happen if the SPU goes down? You will end up owning SPY at a reduced rate from what it is today and having margin debt?
Exactly! In two months the puts expire and if they aren't exercised then I would write new puts.
You are correct on how the margin debt is added as well.

I have heard that the biggest problem with selling naked puts is discipline. At some point there is pressure to move beyond picking up dollars and try to do something more.

Selling naked puts is as infamous as buying securities on margin. It is generally a bad idea...

Quote:

What parameters would you use to build a monte carlo model? What parameters would you vary?
I am still working on this and will report back.




The biggest problem with selling naked puts is a black swan


https://steadyoptions.com/articles/how-victor-niederhoffer-blew-up-twice-r124/
ATM9000
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AG
RogerEnright said:


Questions
1. Has anyone read much research on optimal option length to optimize price deterioration?
.


... writing puts isn't option length.
RogerEnright
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ATM9000 said:

RogerEnright said:


Questions
1. Has anyone read much research on optimal option length to optimize price deterioration?
.


... writing puts isn't option length.

Is it more accurate to say optimize price decay? I don't often trade options.
ATM9000
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AG
RogerEnright said:

ATM9000 said:

RogerEnright said:


Questions
1. Has anyone read much research on optimal option length to optimize price deterioration?
.


... writing puts isn't option length.

Is it more accurate to say optimize price decay? I don't often trade options.


Are you talking about option price decay? Respectfully, I don't know what you are trying to say still.
RogerEnright
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I recall that story. Thank you for reminding me of it. I do enjoy Nassim Taleb. His book Fooled by Randomness is applicable to this topic and a must read.


The article's author Kim states:
Quote:

If he had sized the trade correctly, he would have survived the ride and took home a small profit. But the guy was playing on tilt, got greedy, maybe a bit arrogant, and lost all of his client's money.
This is where the discipline is important. I planning to sell deeply out of the money puts. I intend to make the crux of the money on the "buy" not by selling the puts. Just as in your article, I would be "stuck" with equity securities at the perfect time.
RogerEnright
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Yes. Exactly.
ATM9000
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AG
RogerEnright said:


I think you get what I am trying to do.

Quote:

For us laymen what does this mean?
What will happen if the SPY continues going up? Do you just make money by selling the puts?
What will happen if the SPU goes down? You will end up owning SPY at a reduced rate from what it is today and having margin debt?
Exactly! In two months the puts expire and if they aren't exercised then I would write new puts.
You are correct on how the margin debt is added as well.

I have heard that the biggest problem with selling naked puts is discipline. At some point there is pressure to move beyond picking up dollars and try to do something more.

Selling naked puts is as infamous as buying securities on margin. It is generally a bad idea...

Quote:

What parameters would you use to build a monte carlo model? What parameters would you vary?
I am still working on this and will report back.



This is why I'm so confused by this thread... if you write both puts and the price drops and they both strike, you aren't owning SPY at a reduced rate... you are going to have to buy them to go sell them to the option owners.
RogerEnright
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Ahh... I see the confusion.


If the price drops below the strike price, then I will have to buy SPY from the option owner at the strike price.
RogerEnright
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I am selling the option buyer the right to PUT the security (i.e., I agreed to buy it at a certain price).


I sell the option to someone who wants protection and the ability to sell their security to me at a predefined price.
ATM9000
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AG
RogerEnright said:

I am selling the option buyer the right to PUT the security (i.e., I agreed to buy it at a certain price).


I sell the option to someone who wants protection and the ability to sell their security to me at a predefined price.
I'm a dork... I get what you are doing now.... Friday and had a couple of beers. If you sell puts you are delta longer and you want to either buy on margin at a 'reduced' price or just pick up option theta.

Interesting... keep in mind that you'll probably get margin called on the way down and theta on options that far out of the money on 2 month calls won't be that much.
Casey TableTennis
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AG
As you are increasingly OTM, your Greeks will trend toward smaller/worthless (except Rho) leading to an immaterial benefit from the long delta (albeit very small) achieved by writing the puts. Ultimately your investment should be able to support taking advantage of a thesis better than this.

I hate discouraging intellectual curiosity, but this strategy is unlikely to produce the results you are seeking.
RogerEnright
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from ATM9000

Quote:

options that far out of the money on 2 month calls won't be that much.
from TableTennis
Quote:

this strategy is unlikely to produce the results you are seeking

In the past writing covered calls hasn't been worth the time it takes for me to do it. In my initial discovery of pricing, I thought it could add something "material" to my annualized returns. The time it takes to write these calls every two months is really only justified by my intellectual curiosity. I certainly am not targeting the 30% returns as described in JP76's article link above.

My wife gave me time to work on "work" this morning, but if I finish before the baby gets up I will share the impact of writing these calls.
RogerEnright
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Thank you og_ag99. I am looking forward to learning more about price decay.
ATM9000
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AG
RogerEnright said:

from ATM9000

Quote:

options that far out of the money on 2 month calls won't be that much.
from TableTennis
Quote:

this strategy is unlikely to produce the results you are seeking

In the past writing covered calls hasn't been worth the time it takes for me to do it. In my initial discovery of pricing, I thought it could add something "material" to my annualized returns. The time it takes to write these calls every two months is really only justified by my intellectual curiosity. I certainly am not targeting the 30% returns as described in JP76's article link above.

My wife gave me time to work on "work" this morning, but if I finish before the baby gets up I will share the impact of writing these calls.


Put Call parity will nearly always hold on liquid instruments not factoring in transaction/mkt friction costs, I can tell you your returns are going to be pretty damn close to covered calls (it's the same position)... and if it isn't in your MC sims, re-evaluate your cash flows.
RogerEnright
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Quote:

As you are increasingly OTM, your Greeks will trend toward smaller/worthless (except Rho)
On Rho, I assume you are talking about writing the puts.

On the margin portfolio side, as interest rates increase it will be less attractive for me to have margin debt and I will reduce my equity position or add cash to the portfolio to reduce debt.
jwoodmd
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oldarmy1 said:

You've backtested this master plan with small trades over a period of time? This includes knowing when to take profit and exit the trade, stop loss, roll a position etc. Would you be considered a "professional trader"? If the answer is no to any of these then you have no business going on to margin.

Just trying to help, but saying you don't mind suffering the consequences is code in my mind that you shouldn't be going down this road, at this point.
Straight from the horse's mouth and on the money (no pun intended). I don't have the time to trade myself as I've got too many pots on the stove so I let my money manages handle investments. However, whenever I can catch a few minute I really enjoy reading oldarmy1's activities on the stock market thread. It's fun and it also helps me in talking to my brokers. Unless you're as active as he is, margin is like saying I'll try to do my own surgery today and not go to the doctor.
jh0400
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AG
ATM9000 said:

RogerEnright said:

from ATM9000

Quote:

options that far out of the money on 2 month calls won't be that much.
from TableTennis
Quote:

this strategy is unlikely to produce the results you are seeking

In the past writing covered calls hasn't been worth the time it takes for me to do it. In my initial discovery of pricing, I thought it could add something "material" to my annualized returns. The time it takes to write these calls every two months is really only justified by my intellectual curiosity. I certainly am not targeting the 30% returns as described in JP76's article link above.

My wife gave me time to work on "work" this morning, but if I finish before the baby gets up I will share the impact of writing these calls.


Put Call parity will nearly always hold on liquid instruments not factoring in transaction/mkt friction costs, I can tell you your returns are going to be pretty damn close to covered calls (it's the same position)... and if it isn't in your MC sims, re-evaluate your cash flows.


I'm glad 9000 and CTT got to the same place I did when reading the OP. To get more beta why not just buy calls on the high vol S&P constituents? Because they are in the index you can assume reasonably high correlation, and you're long volatility. Since beta is a function of correlation and volatility that should get you to where you want to be easier than the plan you concocted.
ATM9000
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AG
jh0400 said:

ATM9000 said:

RogerEnright said:

from ATM9000

Quote:

options that far out of the money on 2 month calls won't be that much.
from TableTennis
Quote:

this strategy is unlikely to produce the results you are seeking

In the past writing covered calls hasn't been worth the time it takes for me to do it. In my initial discovery of pricing, I thought it could add something "material" to my annualized returns. The time it takes to write these calls every two months is really only justified by my intellectual curiosity. I certainly am not targeting the 30% returns as described in JP76's article link above.

My wife gave me time to work on "work" this morning, but if I finish before the baby gets up I will share the impact of writing these calls.


Put Call parity will nearly always hold on liquid instruments not factoring in transaction/mkt friction costs, I can tell you your returns are going to be pretty damn close to covered calls (it's the same position)... and if it isn't in your MC sims, re-evaluate your cash flows.


I'm glad 9000 and CTT got to the same place I did when reading the OP. To get more beta why not just buy calls on the high vol S&P constituents? Because they are in the index you can assume reasonably high correlation, and you're long volatility. Since beta is a function of correlation and volatility that should get you to where you want to be easier than the plan you concocted.


Yup... safer too. If you aren't an experienced trader, honestly you have no business writing naked options. The mechanics can get muddy and you need to have contingencies if liquidity gets hairy on the options and you need an out.
RogerEnright
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ATM9000 said:



Put Call parity will nearly always hold on liquid instruments not factoring in transaction/mkt friction costs, I can tell you your returns are going to be pretty damn close to covered calls (it's the same position)... and if it isn't in your MC sims, re-evaluate your cash flows.
Thank you for the suggestion, I will model out the cash flows etc. and run through the MC sim.


Azeew
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Great idea. Leverage double what you have in mind.
Casey TableTennis
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AG
RogerEnright said:

Quote:

As you are increasingly OTM, your Greeks will trend toward smaller/worthless (except Rho)
On Rho, I assume you are talking about writing the puts.

On the margin portfolio side, as interest rates increase it will be less attractive for me to have margin debt and I will reduce my equity position or add cash to the portfolio to reduce debt.



Regarding Rho, I was referring to the moneyness of the option having little/no impact on the option price, as interest rate change, ceteris paribus. The direction of the impact flips around depending on whether you are long/short and whether a put/call, but the magnitude of the impact does not.

The other Greeks have increasingly small impact the farther out of the money you get.
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