Why is everyone so optimistic?

[Cardboard]

"Also, the psychological state is much better than when deciding to sell a great company that has gone down a moderate amount to buy a not so good company that has gone down a lot."

 

It has nothing to do with trading a high quality company for a lower quality one. The "quality" element should always been taken into consideration whenever a buying decision is made. It should all be included into the price to value ratio. In other words, if someone sees a BAC at 30 cents on the dollar and another BAC at 60 cents on the dollar, then I hope that the "love" factor won't interfere in the decision. Moreover, if you hold mostly high quality companies, then what are you hedging for? You think that they will fail in the coming depression? If it is just to take advantage of anticipated volatility, then let's make sure we call this speculation and not hedging.

 

Regarding psychology, holding a notional amount of puts on the S&P equivalent to your entire portfolio is going to affect how you look at things. You will be cheering for a market drop, looking for data to support a negative stance and if you are right for a while, it will make you think that you can outsmart the market and swap these puts for cheap stocks at the most opportune time. Been there, done that.

 

If the professor firmly believing in Efficient Market Theory sees a $20 on the ground and refuses to pick it up thinking that it should not be there based on the theory, then someone fully hedged will find all kind of excuses to not grab that same bill thinking that it will lose its value in the coming crash or ensuing depression. Exactly what happened to Watsa in 2009. Didn't load up in any meaningful way when some of the best companies on Earth were trading for a pittance.

 

If you are very disciplined, it can work out ok since you will sell some tranches as it plays out. However, you have no yardstick other than your instincts. I heard that Fibonacci numbers work well  ;). Trading value on the other hand increases your chances of success since you can always compare the price to value ratio between all securities. And since you are in the game, you play it and don't get stuck sucking your thumb. Of course, if you are unwilling to sell your current holdings no matter what is presented to you, then this won't work.

 

A quote that always stays in my mind is: "Where are the short sellers yachts?". Maybe that now I should add: "Where are the put buyers yachts?"

 

Cardboard

[twacowfca]

"Also, the psychological state is much better than when deciding to sell a great company that has gone down a moderate amount to buy a not so good company that has gone down a lot."

 

It has nothing to do with trading a high quality company for a lower quality one. The "quality" element should always been taken into consideration whenever a buying decision is made. It should all be included into the price to value ratio. In other words, if someone sees a BAC at 30 cents on the dollar and another BAC at 60 cents on the dollar, then I hope that the "love" factor won't interfere in the decision. Moreover, if you hold mostly high quality companies, then what are you hedging for? You think that they will fail in the coming depression? If it is just to take advantage of anticipated volatility, then let's make sure we call this speculation and not hedging.

 

Regarding psychology, holding a notional amount of puts on the S&P equivalent to your entire portfolio is going to affect how you look at things. You will be cheering for a market drop, looking for data to support a negative stance and if you are right for a while, it will make you think that you can outsmart the market and swap these puts for cheap stocks at the most opportune time. Been there, done that.

 

If the professor firmly believing in Efficient Market Theory sees a $20 on the ground and refuses to pick it up thinking that it should not be there based on the theory, then someone fully hedged will find all kind of excuses to not grab that same bill thinking that it will lose its value in the coming crash or ensuing depression. Exactly what happened to Watsa in 2009. Didn't load up in any meaningful way when some of the best companies on Earth were trading for a pittance.

 

If you are very disciplined, it can work out ok since you will sell some tranches as it plays out. However, you have no yardstick other than your instincts. I heard that Fibonacci numbers work well  ;). Trading value on the other hand increases your chances of success since you can always compare the price to value ratio between all securities. And since you are in the game, you play it and don't get stuck sucking your thumb. Of course, if you are unwilling to sell your current holdings no matter what is presented to you, then this won't work.

 

A quote that always stays in my mind is: "Where are the short sellers yachts?". Maybe that now I should add: "Where are the put buyers yachts?"

 

Cardboard

 

Cardboard, you have found me out.  If this were a true hedge, I would be hedging only the delta on the portfolio because I guesstimate our portfolio will likely have only half the down volatility of the market in a substantial decline.  The puts are at least half speculation, not normally a good bet as shorting is generally a losing strategy. 

 

The S&P 500 at the close today is just a hair from being down 3% for the month of January.  If there is not a big uptick tomorrow, I think it is possible that we may see some herding toward the tropical climes. 

 

If I'm wrong -- well, it won't be the first time.  If I 'm right, Dhandho!

[giofranchi]

A quote that always stays in my mind is: "Where are the short sellers yachts?". Maybe that now I should add: "Where are the put buyers yachts?"

 

Well, let me speak for the average investor who seeks above average returns… Because that’s exactly how I look at myself! ;) Some insurance, whether in the form of keeping a cash reserve or buying some puts, makes a lot of sense to us… because we are just average, not outstanding investors! Still, we are looking for above average returns… You might think that to be average and to look for above average returns is simply a foolish dream… But the way our investing world works, it might be not! There is at least one chance for us, average investors, to achieve above average returns: and that is to be ready and able to grab those few, rare, and great opportunities, that once in a while come along. And this is precisely why insurance matters to us: we don’t buy insurance against a market crash, or against an investment of ours that goes south… instead, we buy insurance against the fact we might miss the boat, when a rare and great opportunity finally presents itself. If we, average investors, are able to fully take advantage of 3 or 4 rare and great opportunities in a lifetime of investments, we might truly achieve above average returns after all. On the contrary, if we are not able to do so, we, average investors, will certainly end up with average returns.

 

Gio

 

[twacowfca]

A quote that always stays in my mind is: "Where are the short sellers yachts?". Maybe that now I should add: "Where are the put buyers yachts?"

 

Well, let me speak for the average investor who seeks above average returns… Because that’s exactly how I look at myself! ;) Some insurance, whether in the form of keeping a cash reserve or buying some puts, makes a lot of sense to us… because we are just average, not outstanding investors! Still, we are looking for above average returns… You might think that to be average and to look for above average returns is simply a foolish dream… But the way our investing world works, it might be not! There is at least one chance for us, average investors, to achieve above average returns: and that is to be ready and able to grab those few, rare, and great opportunities, that once in a while come along. And this is precisely why insurance matters to us: we don’t buy insurance against a market crash, or against an investment of ours that goes south… instead, we buy insurance against the fact we might miss the boat, when a rare and great opportunity finally presents itself. If we, average investors, are able to fully take advantage of 3 or 4 rare and great opportunities in a lifetime of investments, we might truly achieve above average returns after all. On the contrary, if we are not able to do so, we, average investors, will certainly end up with average returns.

 

Gio

 

Very well put, Gio. (no pun intended)  :)

 

My sentiments exactly.

 

 

 

 

[giofranchi]

Very well put, Gio. (no pun intended)  :)

 

My sentiments exactly.

 

But you must have patience.

In another thread I have written that Mr. Watsa has an iron will. And Dazel commented: an iron will comes from doing your homework… I would say instead: an iron will comes from doing your homework and having patience. While it could be easily enough understood how “doing your homework” is begotten and nourished, “having patience” is a bit more of a mystery… It seems to be very tough to teach patience to those characters who naturally lack it.

 

Gio

 

[rjstc]

A quote that always stays in my mind is: "Where are the short sellers yachts?". Maybe that now I should add: "Where are the put buyers yachts?"

 

Well, let me speak for the average investor who seeks above average returns… Because that’s exactly how I look at myself! ;) Some insurance, whether in the form of keeping a cash reserve or buying some puts, makes a lot of sense to us… because we are just average, not outstanding investors! Still, we are looking for above average returns… You might think that to be average and to look for above average returns is simply a foolish dream… But the way our investing world works, it might be not! There is at least one chance for us, average investors, to achieve above average returns: and that is to be ready and able to grab those few, rare, and great opportunities, that once in a while come along. And this is precisely why insurance matters to us: we don’t buy insurance against a market crash, or against an investment of ours that goes south… instead, we buy insurance against the fact we might miss the boat, when a rare and great opportunity finally presents itself. If we, average investors, are able to fully take advantage of 3 or 4 rare and great opportunities in a lifetime of investments, we might truly achieve above average returns after all. On the contrary, if we are not able to do so, we, average investors, will certainly end up with average returns.

 

Gio

 

Very well put, Gio. (no pun intended)  :)

 

My sentiments exactly.

 

+1 Exactly

[Cardboard]

Yeah sure +1...

 

Still, I can't recall Buffett telling the average investor to buy puts on the market in order to improve their returns.  :o

 

Regarding cash, I never said that it was bad to hold cash. I do hold some cash at the moment but, not by choice. That is simply because like many other have observed on this board, bargains are tougher to find. So it is normal for my cash portion to rise because some of my holdings have been taken over, some have been trimmed and I cannot redeploy now in new holdings where I feel comfortable. If the market continues to correct, I will likely find places to redeploy that cash and best of all, I am absolutely certain that it won't cost me a dime.

 

Market puts or insurance on the other hand is very expensive. Even when the VIX was at around 12, I figured it would cost me just over 5% of my net worth to be insured for a year via at the money puts. This is more than any return you can get from cash, treasuries and most dividend yielders.

 

However, this morning at the open I would have felt like a genius holding these puts but, by noon I would be sad and worried having missed the bottom. If I am to draw on my past experience, the week-end is coming and with it unpredictable interventions by Feds around the world. You don't think coordinated interventions are possible this week-end in the forex markets?

 

Then Monday, is the start of a new month. For some reasons, the first trading day of the month seems to be mostly quite positive especially when the last one was bad. Maybe it is just human nature to write off the old month and being more positive at the start of a new one.

 

Then when I look at the SPY chart, combined with I just said, I see a strong possibility for a rally back to the 181-182 level for a few weeks to complete a near perfect "head and shoulders" pattern that would have started in mid-November. After it is complete, market pundits will try to figure out which way it will go...

 

Bottom line is that no one has a clue about the direction of the market. Right now the sentiment is negative but, it could snap in an instant. They could start again to compare the 10 year treasury yield and the earnings yield on stock and claim that the correction has now run its course. They may have David Tepper in on CNBC on Monday and the market rallies 3%.

 

Looking back, there was ton of negative signs in 2006 about housing and the market didn't go down. Funds blew up in the summer of 2007 and the market still reached a new high afterwards. Bear Stearns blew up and the market still stood solid. Even Freddie and Fannie being nationalized was not enough to really get a big downswing going. It took AIG, Lehman, TARP and so many other disasters for someone to finally make big bucks on SPY puts. The problem is that it takes so much time for things to manifest that your timing is likely way off. Then again when to let go???

 

Regarding opportunities of a lifetime, it kind of makes me laugh. Where were you in early 2009? Where were you when BAC was trashed in December 2011? And now you are begging for a market collapse to make money from puts to then redeploy proceeds in these once in a lifetime opportunities. Taking advantage of an event that typically occurs once in every 100 year to occur again just 5 years after?

 

Truly hedging is like Ericopoly is doing. He has bought a near all in stake in BAC, wants to hold it and likes the prospects. Since he knows that shit happens and any company can blow up, he bought puts on BAC to protect his net worth. He knows the cost going in and what is being sacrificed buying that insurance. That makes a ton of sense to me. However, buying puts to take advantage of volatility on something not 100% correlated to what you own is pure speculation and as I am trying to explain based on my past pain, costly and frustrating.

 

Cardboard

 

 

[giofranchi]

Regarding opportunities of a lifetime, it kind of makes me laugh. Where were you in early 2009? Where were you when BAC was trashed in December 2011? And now you are begging for a market collapse to make money from puts to then redeploy proceeds in these once in a lifetime opportunities. Taking advantage of an event that typically occurs once in every 100 year to occur again just 5 years after?

 

Cardboard,

as always I am very happy to make you laugh… ;)

 

Anyway, a great buying opportunity imo is LRE that trades below 700 GBp. Do you think it is so impossible to happen? Or ALS that goes down 20% from here. Or FFH that trades around today’s BV… I could go on. If one of those opportunities comes, I want to be ready with a lot of liquidity.

 

I almost don’t care about what the general market does, and surely I don’t care about BAC… If you had taken the time to understand how I invest my firm’s capital, you would certainly have not talked about BAC… not that it would have been time particularly well spent… but usually I laugh only when I think I know what I am talking about… (and don’t worry: in 2009 I scooped up plenty of bargains!)

 

Gio

 

[ERICOPOLY]

Realism is not optimism.

 

You can get a high quality bank for 80 cents of optimal value, hold it for three years, and the earnings accumulated over those three years in effect means you bought it for 50 cents of the value you hold in three years.

 

Now, is that not the same as waiting 3 years for the market to give it to you for 50 cents?

 

So what if the market never does?  You then sit in cash for 3 years and are faced with the same decision again.

 

You have to be Johnny on the spot with your timing to get out of the market right before it crashes (within a year or two).  Otherwise, getting the 80 cent values isn't any worse, and probably better over the long haul.

 

[frommi]

 

Market puts or insurance on the other hand is very expensive. Even when the VIX was at around 12, I figured it would cost me just over 5% of my net worth to be insured for a year via at the money puts. This is more than any return you can get from cash, treasuries and most dividend yielders.

 

 

Most people don`t understand that buying stock+put is the same as buying a call option but with a lot of additional capital tied into the portfolio. In Erics case it makes only sense because of taxes. But i find even that questionable. When buying puts would be a great idea, than why don`t we buy only puts?

The best way to hedge is to diversify into non correlated assets with a positive expected return. That can be bonds, cash, gold, real estate etc. Or you can try to be an options trader, but then you are possibly in the 90% camp of people that lose money in the long run. So as long as you are not able to trade options profitable stand alone, don`t try to hedge with them because it will cost you a lot of money. Viewing options as insurance is the first step forward to losing money with them, this is a game where you are the patsy when you think that way.

[ERICOPOLY]

In Erics case it makes only sense because of taxes. But i find even that questionable. When buying puts would be a great idea, than why don`t we buy only puts?

 

It's not just about taxes.  The outright explicit purchase of puts makes more tax-strategy sense than going with either the warrants or the calls (but both of those alternatives have implicit puts).

 

I do not have any other income!  This money is my entire bread-and-butter.  I don't keep cash on the side.  I can't let BAC slide to $5 again in the next super-worry of the market.  So I have puts to ensure a given level of wealth.

 

Lately I "raised a bit of cash" by moving up the strike prices of the BAC puts and writing a notional-value-offsetting set quantity of "somewhat" in-the-money puts on JPM and C.  For example, today I wrote a few $52.5 strike C puts to pay for some $17 strike BAC puts.  This gives me less "notional value at risk", but I expect C to close above $52.50 at expiry so I expect the cost to be zero despite lowering my risk.

 

Anyways... too much info.

 

[sys]

Then Monday, is the start of a new month. For some reasons, the first trading day of the month seems to be mostly quite positive especially when the last one was bad. Maybe it is just human nature to write off the old month and being more positive at the start of a new one.

 

maybe it is human nature for everyone's 401k deduction to be deposited and deployed on the first trading day of the month?  on the other hand, it would also probably be human nature for every retired person's distribution to be withdrawn on the same day?

 

would this show up in trading volume data, if either or both patterns exist?  or be swamped by hf trading?

[frommi]

I do not have any other income!  This money is my entire bread-and-butter.  I don't keep cash on the side.  I can't let BAC slide to $5 again in the next super-worry of the market.  So I have puts to ensure a given level of wealth.

 

 

But why don`t you diversify a bit more? 100% or 150% in one idea is much too much. You never know what black swan event will kill your good idea. I wouldn`t want to quote WB, but even he said that you should hold around 4-5 different businesses. And when you need income just sell otm calls against your position without leverage. Then you are in a situation where you don`t have to fear anything, get regular income and win even when the stock goes sideways. You won`t make 100% per year that way, but your sleep will be a lot better.  ;D

[gary17]

I wonder if people like Zuckerberg and bill Gates who have almost their entire networth in their firms write puts to hedge the risk. I think that makes sense.

[ERICOPOLY]

I do not have any other income!  This money is my entire bread-and-butter.  I don't keep cash on the side.  I can't let BAC slide to $5 again in the next super-worry of the market.  So I have puts to ensure a given level of wealth.

 

 

But why don`t you diversify a bit more? 100% or 150% in one idea is much too much. You never know what black swan event will kill your good idea. I wouldn`t want to quote WB, but even he said that you should hold around 4-5 different businesses. And when you need income just sell otm calls against your position without leverage. Then you are in a situation where you don`t have to fear anything, get regular income and win even when the stock goes sideways. You won`t make 100% per year that way, but your sleep will be a lot better.  ;D

 

Yeah, I wouldn't want to quote WB either on this topic -- because he has 99% in one stock!

 

Just one!

 

But seriously, that's why I have the puts.  It doesn't matter how much notional upside you have -- it just matters your notional downside positioning.

 

I think having 100% notional upside is just fine -- no Black Swan can wipe you out.

 

Black Swans only hurt your notional downside exposure.

 

[frommi]

I do not have any other income!  This money is my entire bread-and-butter.  I don't keep cash on the side.  I can't let BAC slide to $5 again in the next super-worry of the market.  So I have puts to ensure a given level of wealth.

 

 

But why don`t you diversify a bit more? 100% or 150% in one idea is much too much. You never know what black swan event will kill your good idea. I wouldn`t want to quote WB, but even he said that you should hold around 4-5 different businesses. And when you need income just sell otm calls against your position without leverage. Then you are in a situation where you don`t have to fear anything, get regular income and win even when the stock goes sideways. You won`t make 100% per year that way, but your sleep will be a lot better.  ;D

 

Yeah, I wouldn't want to quote WB either on this topic -- because he has 99% in one stock!

 

Just one!

 

But seriously, that's why I have the puts.  It doesn't matter how much notional upside you have -- it just matters your notional downside positioning.

 

I think having 100% notional upside is just fine -- no Black Swan can wipe you out.

 

Black Swans only hurt your notional downside exposure.

 

Perhaps i am not up to date, do you have your complete portfolio hedged with puts or only the margin part?

When you have your complete portfolio hedged with puts than make a profit graph where you see where the stock has to move to profit and then overlay that with a standard distribution of price movements and you will see that you have a <50% chance of winning and your hurdle rate to profit is relative high. This only works when the stock market is booming like last year. In a normal or sideway year you will lose money even when the stock does not move. You are fighting against the mathematics here simply because you are paying an "insurance" premium and implied volatility is nearly always higher than realised volatility. (There are scientific studies on that theme.)

 

When you only do it for the margin part, then probably its cheaper to just buy calls on margin because you save the interest costs for the additional capital. And i don`t think you can make up that interest cost with tax savings through additional compounding when you don`t plan to hold longer than 5 years. (Its hard to plan so far into the future when you are buying on margin.)

 

And one additional example for the S&P500. When future market returns are prospected to 6-7% and your puts are costing 5% of your returns you are essentially earning the risk free rate and nothing more. (the free lunch here is earned by the market makers and option sellers.)

[frommi]

I wonder if people like Zuckerberg and bill Gates who have almost their entire networth in their firms write puts to hedge the risk. I think that makes sense.

 

Gates has nearly sold his stake in MSFT out and Zuckerberg is slowly diversifying. And you can`t really compare businesses with a monopolistic marketshare or a conglomerate of businesses where you are the CEO and have full control and insight with a bank where you get a quick look into the books every quarter and a fat finger trader can ruin the company in 20 seconds.

[giofranchi]

Taking advantage of an event that typically occurs once in every 100 year to occur again just 5 years after?

 

This also really doesn’t make much sense to me… The S&P500 has actually declined 50% two different times in 10 years… And 2011 in Europe has been almost worse than 2008… Simply put, if we keep inflating bubbles, they will keep blowing up… no matters what statistics seem to suggest! ;)

 

Gio

 

[giofranchi]

Truly hedging is like Ericopoly is doing. He has bought a near all in stake in BAC, wants to hold it and likes the prospects. Since he knows that shit happens and any company can blow up, he bought puts on BAC to protect his net worth. He knows the cost going in and what is being sacrificed buying that insurance. That makes a ton of sense to me. However, buying puts to take advantage of volatility on something not 100% correlated to what you own is pure speculation and as I am trying to explain based on my past pain, costly and frustrating.

 

Well, I also agree that Eric is doing the right thing! Because I simply don’t understand how anyone could develop any kind of faith in such a gigantic organization run by bureaucrats. Its price is low? Very well then, buy it! But, if you also hedge your position, it makes a lot of sense to me! ;)

 

On the contrary, I invest only in businesses run by entrepreneurs, and not the average entrepreneurs, but those who have been the most successful during the past two decades, are still relatively young, are still very much motivated, and still have a lot of skin in the game. And I want to stay invested with them for a very long time (for the next two decades, or even more if possible!). In the company of such men, with such a long term view, I don’t really feel the need to buy insurance.

 

I want to keep ready cash at hand, when I think other investors are too euphoric and behaving recklessly, simply because, no matter what my investments will do in the long run, their stock price might fluctuate, even violently, in the short run… Let’s put it this way: I don’t buy insurance on my investments, because I think their correlation with the “ineptitude of others” in the long run approaches 0%; I keep ready cash at hand, because I think their correlation with the “ineptitude of others” in the short run is 80%? 90%? 100%? Whatever!

 

I want to enjoy the safety such investments provide in the long run, and also to take advantage of their inevitable short run fluctuations!

 

Gio

 

[Uccmal]

Truly hedging is like Ericopoly is doing. He has bought a near all in stake in BAC, wants to hold it and likes the prospects. Since he knows that shit happens and any company can blow up, he bought puts on BAC to protect his net worth. He knows the cost going in and what is being sacrificed buying that insurance. That makes a ton of sense to me. However, buying puts to take advantage of volatility on something not 100% correlated to what you own is pure speculation and as I am trying to explain based on my past pain, costly and frustrating.

 

Well, I also agree that Eric is doing the right thing! Because I simply don’t understand how anyone could develop any kind of faith in such a gigantic organization run by bureaucrats. Its price is low? Very well then, buy it! But, if you also hedge your position, it makes a lot of sense to me! ;)

 

On the contrary, I invest only in businesses run by entrepreneurs, and not the average entrepreneurs, but those who have been the most successful during the past two decades, are still relatively young, are still very much motivated, and still have a lot of skin in the game. And I want to stay invested with them for a very long time (for the next two decades, or even more if possible!). In the company of such men, with such a long term view, I don’t really feel the need to buy insurance.

 

I want to keep ready cash at hand, when I think other investors are too euphoric and behaving recklessly, simply because, no matter what my investments will do in the long run, their stock price might fluctuate, even violently, in the short run… Let’s put it this way: I don’t buy insurance on my investments, because I think their correlation with the “ineptitude of others” in the long run approaches 0%; I keep ready cash at hand, because I think their correlation with the “ineptitude of others” in the short run is 80%? 90%? 100? Whatever!

 

I want to enjoy the safety such investments provide in the long run, and also to take advantage of their inevitable short run fluctuations!

 

Gio

 

 

Gio, The insurance is implicit, and sometimes explicit, in the investments you have bought. 

 

 

[frommi]

I looked up the numbers for BAC, you are paying for the nearest 1-year ATM put 11%. So you are giving up 11% of your return for your security. I can`t see how you can earn more than the risk free rate buying stock+put that way. An OTM put at 10$ costs now 1%, that is probably acceptable. In this case we can speak of insurance, but you are still losing 41% in the worst case. But you can simply buy the 1 year 10$ call and get the exact same risk profile and have 60% cash on hand or have 60% less to borrow. I prefer not to waste the 1% of yearly return and diversify instead, but hey i am just a silly retail investor :D.

[gary17]

Eric explained to me his setup has tax benefits because you can keep rolling the puts and have taxable losses. And can borrow against the commons. . If you buy calls and you want to long bac, and it does go up, at some point you will need to pay tax.

 

So I think risk being similar the puts option makes sense to me.

[frommi]

Eric explained to me his setup has tax benefits because you can keep rolling the puts and have taxable losses. And can borrow against the commons. . If you buy calls and you want to long bac, and it does go up, at some point you will need to pay tax.

 

So I think risk being similar the puts option makes sense to me.

 

It depends on how long you want to hold the shares. When you only hold until fair value you have to pay taxes on the stock, too (and 1 or 2 years is too short to make a difference in compounding on the tax savements). When you plan to hold forever or longer than 10 years you are clearly better off buying the stock+put. But i wouldn`t do this with BAC, i would prefer WFC than.

[ERICOPOLY]

I do not have any other income!  This money is my entire bread-and-butter.  I don't keep cash on the side.  I can't let BAC slide to $5 again in the next super-worry of the market.  So I have puts to ensure a given level of wealth.

 

 

But why don`t you diversify a bit more? 100% or 150% in one idea is much too much. You never know what black swan event will kill your good idea. I wouldn`t want to quote WB, but even he said that you should hold around 4-5 different businesses. And when you need income just sell otm calls against your position without leverage. Then you are in a situation where you don`t have to fear anything, get regular income and win even when the stock goes sideways. You won`t make 100% per year that way, but your sleep will be a lot better.  ;D

 

Yeah, I wouldn't want to quote WB either on this topic -- because he has 99% in one stock!

 

Just one!

 

But seriously, that's why I have the puts.  It doesn't matter how much notional upside you have -- it just matters your notional downside positioning.

 

I think having 100% notional upside is just fine -- no Black Swan can wipe you out.

 

Black Swans only hurt your notional downside exposure.

 

Perhaps i am not up to date, do you have your complete portfolio hedged with puts or only the margin part?

When you have your complete portfolio hedged with puts than make a profit graph where you see where the stock has to move to profit and then overlay that with a standard distribution of price movements and you will see that you have a <50% chance of winning and your hurdle rate to profit is relative high. This only works when the stock market is booming like last year. In a normal or sideway year you will lose money even when the stock does not move. You are fighting against the mathematics here simply because you are paying an "insurance" premium and implied volatility is nearly always higher than realised volatility. (There are scientific studies on that theme.)

 

When you only do it for the margin part, then probably its cheaper to just buy calls on margin because you save the interest costs for the additional capital. And i don`t think you can make up that interest cost with tax savings through additional compounding when you don`t plan to hold longer than 5 years. (Its hard to plan so far into the future when you are buying on margin.)

 

And one additional example for the S&P500. When future market returns are prospected to 6-7% and your puts are costing 5% of your returns you are essentially earning the risk free rate and nothing more. (the free lunch here is earned by the market makers and option sellers.)

 

I have a $15 strike BAC put for every BAC common share that I own.  Then I've written some puts on JPM, C, and SHLD.  This has the effect of dampening single company risk and reducing total notional downside exposure.

 

Implicitly I hold a lot of cash that I can withdraw even during a situation where all these stocks go to zero).

 

However, in actual fact, I have a lot of margin debt.  Despite having less than 100% downside exposure, I have a lot of margin debt.

 

I think if you watch what people do in real estate, you'll get a bit of a hint of why I'm doing this -- they call it "negative gearing" in Australia where you have a position that creates a net taxable loss, but the appreciation from the assets (that you never sell) give you a gain that you can borrow from.

 

The puts make the margin loan non-recourse debt.

 

I will probably not sell the BAC shares -- once they get up to mid-twenties, I will just roll the puts up to at-the-money strikes and continue to hold.  Then purchase new investments with the margin borrowing power.  The margin debt at that time will once again be non-recourse (from the at-the-money strikes on BAC).

 

[ERICOPOLY]

I looked up the numbers for BAC, you are paying for the nearest 1-year ATM put 11%. So you are giving up 11% of your return for your security. I can`t see how you can earn more than the risk free rate buying stock+put that way. An OTM put at 10$ costs now 1%, that is probably acceptable.

 

Do you agree that $10/$17 is the same fraction (roughly) as $17/$29?

 

Well, it is roughly the same.  Okay then, you said the $10 strike put costs 1% today.

 

Just wait... the $17 strike put will cost perhaps 1% once the stock hits $29.

 

So in the first years, you don't see the gains from this leverage.

 

However, it's like an adjustable-rate non-recourse loan -- in the later years (stock price is much higher), the cost of the $17 strike put keeps dropping.

 

So it's one of those things where you are rewarded for your patience.

 

The strategy works best when you have an undervalued stock that will not take too many years to rise.  This BAC common was last purchased in March 2013 when I dumped the warrants and moved to the common (purchased at $12) hedged by $12 strike puts (which were at-the-money then).  It cost about 11% at the time (just like now) for at-the-money put. 

 

But how much does it cost for a $12 strike put today?  Not even a year later.  :D :D :D

 

So, adjustable rate non-recourse margin loan -- only the terms get cheaper and cheaper as the stock rises.

 

I chose to lock in much of that gain by hiking the strike up to $15 (rather than continuing at $12).  However, after locking in gain, even the $15 strikes are now cheaper than the $12s were back in March.