cheapest way to get leverage with no margin calls?

[muscleman]

What is the cheapest way to do this? I can only think of home equity line of credit, but this depends on the value of my home. Call options seem to be an expansive way to leverage up.

[Uccmal]

What is the cheapest way to do this? I can only think of home equity line of credit, but this depends on the value of my home. Call options seem to be an expansive way to leverage up.

 

Leaps are the cheapest and safest form of leverage you can use, if used right.  You cant borrow against them, so they come out of the cash in your account.  So, the downside is limited to your available cash, providing you dont do something dangerous like borrow from a HELOC to buy them in the first place.

 

When I say used right, I mean used as a proxy for a stock you think is really cheap.  As a tangible example I am no longer buying Leaps on BAC, AIG, JPM at the present prices or higher.  The potential returns are starting to be outweighed by the potential risks.  Of note, I wont buy the common stock of the above examples either - that is how I measure whether a call option is "worthy". 

 

I leave the argument of whether the total markets are overvalued for another thread.  In my humble opinion, you dont want to be borrowing money or buying Leaps on any stocks, into what is now a 5 old bull market.  With each passing day we come closer to a significant correction: 20-30%.  And we are not going to know what precipitates it in advance. 

[ourkid8]

This is a great topic and the same issue I faced in 09 as I used a significant sum from my heloc which helped juice my returns.  I am currently in the process of trying to reduce my risk and exposure as I am 100%+ invested. Slowly but surely, I am paying down my HELOC...

 

During the next panic, I may dip into it again but only when the market is rediciolously cheap.  Otherwise, I'll just use leaps ongoing for the reasons Uccmal mentioned.

 

Tks,

S

 

What is the cheapest way to do this? I can only think of home equity line of credit, but this depends on the value of my home. Call options seem to be an expansive way to leverage up.

[ERICOPOLY]

What is the cheapest way to do this? I can only think of home equity line of credit, but this depends on the value of my home. Call options seem to be an expansive way to leverage up.

 

HELOC might be a cheap interest rate, but it is usually if not always a full recourse loan.

 

Non-recourse leverage is best.

[LC]

Eric's strategy is brilliant...buying with IB margin @ 1.5%, hedged with put options to prevent margin calls (in a "portfolio margin" account). The price of leverage is the margin rate + the put option (insurance) costs.

 

As the stock rises you can sell the puts to book a taxable loss, then re-purchase puts at a higher strike price to "lock in" a tax-free gain between the two strike prices.

 

I always have this technique in the back of my mind now, waiting for an opportunity to use it.

[crastogi]

Eric's strategy is brilliant...buying with IB margin @ 1.5%, hedged with put options to prevent margin calls (in a "portfolio margin" account). The price of leverage is the margin rate + the put option (insurance) costs.

 

As the stock rises you can sell the puts to book a taxable loss, then re-purchase puts at a higher strike price to "lock in" a tax-free gain between the two strike prices.

 

I always have this technique in the back of my mind now, waiting for an opportunity to use it.

 

Hi.  I am new to this.  Can a kind soul explain in more detail?  An historical example with actual costs would be illustrative. 

 

Regards.

[LC]

Eric's strategy is brilliant...buying with IB margin @ 1.5%, hedged with put options to prevent margin calls (in a "portfolio margin" account). The price of leverage is the margin rate + the put option (insurance) costs.

 

As the stock rises you can sell the puts to book a taxable loss, then re-purchase puts at a higher strike price to "lock in" a tax-free gain between the two strike prices.

 

I always have this technique in the back of my mind now, waiting for an opportunity to use it.

 

Hi.  I am new to this.  Can a kind soul explain in more detail?  An historical example with actual costs would be illustrative. 

 

Regards.

 

Your best bet would be to read the BAC leverage thread under the Strategies forum...Eric describes exactly what he did, but I will do my best to illustrate it here with simplified numbers:

 

You open up an account with IB. You qualify for "portfolio margin" (versus Reg-T margin).

You borrow on margin to buy 100 shares of BAC stock at $17 per share.

You pay 1.5% interest on the margin loan.

You buy 1 put option on BAC with a strike price of $15 which expires in 2015.

 

Now, you are fully hedged below $15. The most you can lose (aside from the option cost & margin interest) is $2/share.

 

One year passes. BAC has increased to $19/share giving you a paper gain.

You have paid margin interest.

Your put option expires worthless, leaving you a taxable loss.

 

You purchase a put option with a strike price of $17 which expires in 2016, and repeat the process.

 

So essentially, you now have protected your paper gains and created taxable losses.

But you don't have to pay capital gains tax, in fact you can keep rolling the gains forward year after year by rolling the put option strike price forward every year.

[matts]

What is the cheapest way to do this? I can only think of home equity line of credit, but this depends on the value of my home. Call options seem to be an expansive way to leverage up.

 

I think I remember you making comments in the past that were pretty firm against using leverage. Now you have started multiple threads looking for ways to leverage.

 

Has your opinion on leverage change? If so, why? 

[infinitee00]

Eric's strategy is brilliant...buying with IB margin @ 1.5%, hedged with put options to prevent margin calls (in a "portfolio margin" account). The price of leverage is the margin rate + the put option (insurance) costs.

 

As the stock rises you can sell the puts to book a taxable loss, then re-purchase puts at a higher strike price to "lock in" a tax-free gain between the two strike prices.

 

I always have this technique in the back of my mind now, waiting for an opportunity to use it.

 

Hi.  I am new to this.  Can a kind soul explain in more detail?  An historical example with actual costs would be illustrative. 

 

Regards.

 

The strategy that Eric popularized in this forum ( that LC refers to in his comment) is a variation of the 'Protective Put' option strategy ( The examples in the link assumes you use cash to buy the stock, but you can also use portfolio margin to get the most benefit). Here is another link explaining the option strategy. Eric has done a great job explaining the details in the BAC leverage thread so you may want to take a look at it also.

[mankap]

Do you know what kind of leverage you can get in IB. Is it 100% or 200%?

[watsa_is_a_randian_hero]

Do you know what kind of leverage you can get in IB. Is it 100% or 200%?

 

566%  ((1-.15)/.15) with portfolio margin.  Most mid/large cap stocks you have to have about 15% equity down, below that you'll get called. 

 

They will also give credit for short hedges sometimes.  IE, they will look at your net exposure vs your gross.

 

The portfolio margin is more risk based than rules based, but still has its drawbacks.  For instance, how does it make any sense that if I buy FRFHF I get 0% margin ability but if I buy FFH.To I get 566%?  It seems like for mid/large caps they give you more leverage then you could ever need, but for small caps or anything listed OTC (even if it is a large cap or even if it is a duplicate listing) they will give 0 credit for.

[crastogi]

Eric's strategy is brilliant...buying with IB margin @ 1.5%, hedged with put options to prevent margin calls (in a "portfolio margin" account). The price of leverage is the margin rate + the put option (insurance) costs.

 

As the stock rises you can sell the puts to book a taxable loss, then re-purchase puts at a higher strike price to "lock in" a tax-free gain between the two strike prices.

 

I always have this technique in the back of my mind now, waiting for an opportunity to use it.

 

Thanks LC and infinitee00.  Great strategy by Eric. 

 

Hi.  I am new to this.  Can a kind soul explain in more detail?  An historical example with actual costs would be illustrative. 

 

Regards.

 

Your best bet would be to read the BAC leverage thread under the Strategies forum...Eric describes exactly what he did, but I will do my best to illustrate it here with simplified numbers:

 

You open up an account with IB. You qualify for "portfolio margin" (versus Reg-T margin).

You borrow on margin to buy 100 shares of BAC stock at $17 per share.

You pay 1.5% interest on the margin loan.

You buy 1 put option on BAC with a strike price of $15 which expires in 2015.

 

Now, you are fully hedged below $15. The most you can lose (aside from the option cost & margin interest) is $2/share.

 

One year passes. BAC has increased to $19/share giving you a paper gain.

You have paid margin interest.

Your put option expires worthless, leaving you a taxable loss.

 

You purchase a put option with a strike price of $17 which expires in 2016, and repeat the process.

 

So essentially, you now have protected your paper gains and created taxable losses.

But you don't have to pay capital gains tax, in fact you can keep rolling the gains forward year after year by rolling the put option strike price forward every year.

[Daytripper]

I hold BAC-A warrants, on margin.  The warrants are at $8.15.  Would I be incorrect to assume that I could use this strategy to secure the warrants? Why wouldn't 1 BAC put @ $16 would cover 200 BAC+A warrants?

 

If this could work, I could really increase my position in the warrants with a loan against my 401K.

 

Any thoughts on this?  Thank you.

[tradevestor]

"But you don't have to pay capital gains tax, in fact you can keep rolling the gains forward year after year ".

 

Wouldn't this trigger a constructive sale ?

 

Buying a protective put can trigger a constructive sale of your stock if the purchased put is either at or in the money.

https://www.fidelity.com/viewpoints/active-trader/Protect-your-profits

[LC]

That's why you purchase an OOM put! :D

[tradevestor]

Aha ! Sorry about that.. I misunderstood what "in the money" puts mean. :-[

[CorpRaider]

I'm sort of thinking maybe to buy BRK or MKL might be the best way, of course you have to cede authority over management of the portfolio...

[ukvalueinvestment]

Surely Fairfax would be the one, given the amount of downside protection he has bought?

[ageofsocrates]

Hi guys,

 

Have a question about hedging and wanted to ask if my assumptions are correct.

 

I read through several of the previous posts and believe there's a flaw in the concept of hedging.

 

Assume one buys 100K worth of BRK stock using portfolio margin. This would allow one to buy 800 shares of BRK@125

 

Now for hedging.  To hedge the position, one would need to consider the delta value of the option (assuming it's a Jan 2016 put @125). As of today, the delta for this option is about -0.3925 (based on CBOE data)

 

To delta hedge correctly, one would need to use the following formula

 

no. of options for hedging = no. of shares/delta value = 2038

no. of option contracts =2038/100 =20 put contracts (approx)

 

Based on the previous threads, it seems that to hedge the position, one would need to buy equal number of options based on the no. of shares owned. For example, one owns 800 shares. So to hedge, one would need to buy 800 put options (8 put contracts) 

 

However, to accurately hedge this, one would need to consider the delta value and buy 20 put contracts instead to hedge this exposure.  Would this be correct?

 

 

 

[PatientCheetah]

Hi guys,

 

Have a question about hedging and wanted to ask if my assumptions are correct.

 

I read through several of the previous posts and believe there's a flaw in the concept of hedging.

 

Assume one buys 100K worth of BRK stock using portfolio margin. This would allow one to buy 800 shares of BRK@125

 

Now for hedging.  To hedge the position, one would need to consider the delta value of the option (assuming it's a Jan 2016 put @125). As of today, the delta for this option is about -0.3925 (based on CBOE data)

 

To delta hedge correctly, one would need to use the following formula

 

no. of options for hedging = no. of shares/delta value = 2038

no. of option contracts =2038/100 =20 put contracts (approx)

 

Based on the previous threads, it seems that to hedge the position, one would need to buy equal number of options based on the no. of shares owned. For example, one owns 800 shares. So to hedge, one would need to buy 800 put options (8 put contracts) 

 

However, to accurately hedge this, one would need to consider the delta value and buy 20 put contracts instead to hedge this exposure.  Would this be correct?

 

delta moves with price, eventually goes to 1 if the stock price is well below the put strike price. In your example, 20 puts fully cover your exposure in the worst case scenario.

[Ham Hockers]

Gotta keep rolling the hedges as prices moves + option decays.

[dpetrescu]

Buying 20 puts to be fully hedged and regularly adjusting put contracts to match the delta of the shares as you describe below means that you take directional risk completely out and are only betting on speed of price movement, future volatility. This means that if BAC moves up 1% and you gain $1,000 from your shares, your equal delta puts will also lose $1,000.

 

As value investors, I imagine one would actually want to take on the directional risk because shares are perceived to be undervalued and one might not care so much about volatility or speed of of price movement. If that's true, you never want to be fully hedged. The original setup had lower delta puts which made sense. All the puts did was limit the losses.

 

Hi guys,

 

Have a question about hedging and wanted to ask if my assumptions are correct.

 

I read through several of the previous posts and believe there's a flaw in the concept of hedging.

 

Assume one buys 100K worth of BRK stock using portfolio margin. This would allow one to buy 800 shares of BRK@125

 

Now for hedging.  To hedge the position, one would need to consider the delta value of the option (assuming it's a Jan 2016 put @125). As of today, the delta for this option is about -0.3925 (based on CBOE data)

 

To delta hedge correctly, one would need to use the following formula

 

no. of options for hedging = no. of shares/delta value = 2038

no. of option contracts =2038/100 =20 put contracts (approx)

 

Based on the previous threads, it seems that to hedge the position, one would need to buy equal number of options based on the no. of shares owned. For example, one owns 800 shares. So to hedge, one would need to buy 800 put options (8 put contracts) 

 

However, to accurately hedge this, one would need to consider the delta value and buy 20 put contracts instead to hedge this exposure.  Would this be correct?