BAC leverage

[Studesy]

its possible the cost advantage will swing back and forth btw calls vs warrants

 

maybe its best to own both to compensate for the switch?

 

The cost advantage may very well move back and forth....so why not just take the cheapest route....then if that route becomes more expensive relative to the other (net of trading fees etc.) sell it and by into the other.

[hyten1]

studesy

 

i hate paying short term capital gains :)

 

hy

[Studesy]

studesy

 

i hate paying short term capital gains :)

 

hy

 

Ya if its not in a tax free account you would definitely have to take that into consideration.  I'm not sure how much spread would be needed to switch between the two alternatives in a taxable account....but I think Eric took this into consideration and found it still worthwhile to make the switch.

[ERICOPOLY]

Despite the short-term taxes, I think the total tax bill from that sale will be recovered by not losing warrant premium when the stock is at $20 in two years.

 

So I look at that as being nearly tax-free -- I was going to lose it anyhow.

 

Of course, that's what I think is likely, not certain.

 

Plus, now as the stock advances I can roll to higher at-the-money strikes.  So it will be a safer strategy as well, locking in the gains from leverage as they come (during each annual roll).

 

[ERICOPOLY]

I got a lot out of this discussion.  First, it was nice to have a sounding board and many people try to tear up my logic.  That helped me clarify my reasoning.

 

Second, I didn't even know about portfolio margin!  That solves some problems for me  :D  Upgraded my IB account a few minutes ago -- pending approval.

 

Next time I won't need to be so darned paranoid about a flash crash.  There is no actual "call" at IB with a margin call -- they just go ahead and liquidate you.  That makes the Reg-T margin account a bit of a potential terror.

 

 

 

[Studesy]

Eric what is your opinion on directly hedging (ie. via put purchases) a portfolio. I understand your explanation of how the embedded put in the LEAPS acts as a leverage hedge....but do you ever find a point in time when it is necessary to protect the common? I guess the rolling of LEAPs at higher strikes generates cash which is essentially a hedge to the common as the price increases (becomes more risky).  I also guess that slowly moving out of the common as it approaches intrinsic value also acts as a hedge to the remaining common.  Do you find it advantageous to exit common stock via selling covered calls?? 

[Studesy]

I got a lot out of this discussion.  First, it was nice to have a sounding board and many people try to tear up my logic.  That helped me clarify my reasoning.

 

Second, I didn't even know about portfolio margin!  That solves some problems for me  :D  Upgraded my IB account a few minutes ago -- pending approval.

 

Next time I won't need to be so darned paranoid about a flash crash.  There is no actual "call" at IB with a margin call -- they just go ahead and liquidate you.  That makes the Reg-T margin account a bit of a potential terror.

 

BTW..If my questions are becoming an annoyance to you just let me know:) But I want to thank you again.....I know you say you got a lot out of this discussion.....but I don't think that compares to what I have gained...you explanations and patience have been nothing short of incredible.  Hats off to you!

[hyten1]

eric this i am sure is a newbie question

 

i assume when you roll to higher at-the-money strikes. you keep the number of contract constant not the dollar value right so as the stock price goes up (assuming that is what happens) you roll to ever higher at-the-money strikes with each subsequent roll you take some money off?

 

 

[Studesy]

eric this i am sure is a newbie question

 

i assume when you roll to higher at-the-money strikes. you keep the number of contract constant not the dollar value right so as the stock price goes up (assuming that is what happens) you roll to ever higher at-the-money strikes with each subsequent roll you take some money off?

 

Hyten...I believe you are correct.....that is how the gains are locked in.

[ERICOPOLY]

eric this i am sure is a newbie question

 

i assume when you roll to higher at-the-money strikes. you keep the number of contract constant not the dollar value right so as the stock price goes up (assuming that is what happens) you roll to ever higher at-the-money strikes with each subsequent roll you take some money off?

 

Hyten...I believe you are correct.....that is how the gains are locked in.

 

That isn't exactly my plan.

 

Okay, suppose you start out with 1.5x leverage -- you initially hedge the 0.5x.

 

Later the stock doubles and the account is now leveraged 1.25x.

 

When I roll, I plan to hedge only .25x.

 

So I'm only interested in hedging the amount "borrowed". 

 

Over time, the amount "borrowed" becomes a smaller percentage of the pie -- but nonetheless, I always hedge the absolute dollar amount initially "borrowed" at ever roll.

 

As long as the stock is rising, this means fewer and fewer contracts on successive rolls.

[hyten1]

eric another newbie stupid question

 

when you say leverage 1.5x, what does that excatly mean

 

are you saying whatever amount you want to spend on an investment you put 2/3 into the common and 1/3 into the leaps (dollar value)?

 

so lets say you want to spend $99k, that means 66k you will buy the common and 33k you will buy the leaps?

[ERICOPOLY]

Eric what is your opinion on directly hedging (ie. via put purchases) a portfolio. I understand your explanation of how the embedded put in the LEAPS acts as a leverage hedge....but do you ever find a point in time when it is necessary to protect the common? I guess the rolling of LEAPs at higher strikes generates cash which is essentially a hedge to the common as the price increases (becomes more risky).  I also guess that slowly moving out of the common as it approaches intrinsic value also acts as a hedge to the remaining common.  Do you find it advantageous to exit common stock via selling covered calls??

 

Learning about portfolio margin helps me enormously for managing my taxable account.

 

Now I can be 100% BAC common stock on the upside  but 10% on the downside.  Under Reg-T, this would blow up my margin limits in a crash and so I couldn't do it to my full satisfaction.  So if I'd known about portfolio margin in the past, things would have been a lot less worrisome for me.

 

Here is what you do.

 

1)  Go put 100% of your portfolio in BAC common stock.

2)  Purchase at-the-money puts to protect 90% of the BAC position

3)  Write puts on other securities such that you now have 90% downside in those other names

 

Reg-T rules treated this as 1.9x downside I believe, even though it's really only 1x downside.

 

The cash from writing puts on a diversified basket of names finances the puts that protect the concentrated BAC position.

 

 

 

[ERICOPOLY]

eric another newbie stupid question

 

when you say leverage 1.5x, what does that excatly mean

 

are you saying whatever amount you want to spend on an investment you put 2/3 into the common and 1/3 into the leaps (dollar value)?

 

so lets say you want to spend $99k, that means 66k you will buy the common and 33k you will buy the leaps?

 

1.5x leverage means if I can only afford 10 shares of BAC with my cash, I buy 15 shares.  The extra 5 shares is hedged at-the-money, so the "loan" is non-recourse. 

 

The "loan" might be money synthetically borrowed via a LEAPS call contract.

 

 

[ERICOPOLY]

I got a lot out of this discussion.  First, it was nice to have a sounding board and many people try to tear up my logic.  That helped me clarify my reasoning.

 

Second, I didn't even know about portfolio margin!  That solves some problems for me  :D  Upgraded my IB account a few minutes ago -- pending approval.

 

Next time I won't need to be so darned paranoid about a flash crash.  There is no actual "call" at IB with a margin call -- they just go ahead and liquidate you.  That makes the Reg-T margin account a bit of a potential terror.

 

BTW..If my questions are becoming an annoyance to you just let me know:) But I want to thank you again.....I know you say you got a lot out of this discussion.....but I don't think that compares to what I have gained...you explanations and patience have been nothing short of incredible.  Hats off to you!

 

I benefit because if I tell you something incorrect, and another poster spots it, I learn too.

[Studesy]

Eric what is your opinion on directly hedging (ie. via put purchases) a portfolio. I understand your explanation of how the embedded put in the LEAPS acts as a leverage hedge....but do you ever find a point in time when it is necessary to protect the common? I guess the rolling of LEAPs at higher strikes generates cash which is essentially a hedge to the common as the price increases (becomes more risky).  I also guess that slowly moving out of the common as it approaches intrinsic value also acts as a hedge to the remaining common.  Do you find it advantageous to exit common stock via selling covered calls??

 

Learning about portfolio margin helps me enormously for managing my taxable account.

 

Now I can be 100% BAC common stock on the upside  but 10% on the downside.  Under Reg-T, this would blow up my margin limits in a crash and so I couldn't do it to my full satisfaction.  So if I'd known about portfolio margin in the past, things would have been a lot less worrisome for me.

 

Here is what you do.

 

1)  Go put 100% of your portfolio in BAC common stock.

2)  Purchase at-the-money puts to protect 90% of the BAC position

3)  Write puts on other securities such that you now have 90% downside in those other names

 

Reg-T rules treated this as 1.9x downside I believe, even though it's really only 1x downside.

 

The cash from writing puts on a diversified basket of names finances the puts that protect the concentrated BAC position.

 

So for #3...do you mean write way out of the money puts?? Just enough to pay for the BAC puts??

[LC]

Eric what is your opinion on directly hedging (ie. via put purchases) a portfolio. I understand your explanation of how the embedded put in the LEAPS acts as a leverage hedge....but do you ever find a point in time when it is necessary to protect the common? I guess the rolling of LEAPs at higher strikes generates cash which is essentially a hedge to the common as the price increases (becomes more risky).  I also guess that slowly moving out of the common as it approaches intrinsic value also acts as a hedge to the remaining common.  Do you find it advantageous to exit common stock via selling covered calls??

 

Learning about portfolio margin helps me enormously for managing my taxable account.

 

Now I can be 100% BAC common stock on the upside  but 10% on the downside.  Under Reg-T, this would blow up my margin limits in a crash and so I couldn't do it to my full satisfaction.  So if I'd known about portfolio margin in the past, things would have been a lot less worrisome for me.

 

Here is what you do.

 

1)  Go put 100% of your portfolio in BAC common stock.

2)  Purchase at-the-money puts to protect 90% of the BAC position

3)  Write puts on other securities such that you now have 90% downside in those other names

 

Reg-T rules treated this as 1.9x downside I believe, even though it's really only 1x downside.

 

The cash from writing puts on a diversified basket of names finances the puts that protect the concentrated BAC position.

I forget who wrote about this months ago...it may have been you, Eric. This is essentially transferring the downside risk of BAC to the market as a whole.

[hyten1]

LC

 

what do you mean by "This is essentially transferring the downside risk of BAC to the market as a whole."

 

if you write puts on other securities (how many, which ones you have to figure out) aren't you running the risk of getting put these securities? if you write way out of money puts, you would need to write a entire bunch of them since the premium are usually small?

 

hy

 

EDIT: i guess for example lets say you bought BAC common and bought at the money puts for BAC as well

 

you can write BRK.B 2015 $75 strike puts for a premium of $2.05, and use this to pay for your above at the money puts for BAC.

now if BRK.B crashes for some reason you could be put the stock. i guess worest case scenario everything  crashes, your BAC would be ok since you have the put to protect you. however if brk.b hits $75 you can be put te stock i guess in that case you would sell the at the money puts for BAC to buy the BRK.B?

 

or i guess you can write puts on SPY lets say jan 2015 at $90, premium of $1.5 per share.

 

 

[hyten1]

i guess you write puts for another securities is to transfer the downside to something else

 

which you believe has a lower probability of going down is that why you do it?

 

EDIT: another example is you can buy Jan 2015 $10 puts for BAC which is $1 a share to protect you from BAC going below $10

you can use the proceed from writing Jan 2015 $80  puts for SPY for $0.93 a share. last time spy went that low ($80) was during 2008 and 2009, the odds of that happening is low (some people would disagree with this statement).

 

 

[LC]

The difficult part for me to comprehend is what exactly you are trying to accomplish by transferring the downside. Are you trying to protect from a systematic pullback? Are you trying to continue speculating? Are you playing off the implied vols of different options whose underlying should behave differently?

 

And in what proportions? I assume the premiums received from writing puts on a basket will not match for premiums paid for the BAC puts.

[compoundinglife]

I believe what he is saying is that with portfolio margin (vs reg-t) the BAC puts/hedge prevent 90% of your BAC long position from impacting you with regards to meeting your margin requirements.

 

As a result that means you can sell puts on other solid names on margin (WFC etc...) to help pay for your BAC hedge. The idea being that if BAC crashed independently your hedge covers you and its paid for by premiums on the WFC puts which you wrote on margin and hence did not cost you assuming you never get put the stock.

 

So know you only lose if your basket of written puts (the overall market) get creamed. Hence transferring 90 percent the downside. The 90 percent is because that is the most they will allow a hedge the cover on your margin requirements. So if you were long the SP500 and short equivalent of the Dow only %10 of your long position applies to meeting margin requirements. 

 

Basically portfolio margin determines your requirements based on the risk they calculate for your portfolio. Its kind of like the stress tests on banks but for your portfolio. It can allow you to borrow much more on margin than a reg-t account.

 

 

[ERICOPOLY]

Example:

 

The $10 BAC puts (2015) are bid at nearly 10% of strike.

 

The $25 SHLD puts (2015) are bid at nearly 10% of strike.

 

So at those strikes they both cost the same for insuring a dollar of risk.

 

So I can swap $10 BAC downside risk for $25 SHLD downside risk.

 

So, worst case, I might get put SHLD after a 50% decline from it's current price.

 

But I get protection from a 20% decline in BAC.

 

 

EDIT:  I guess it's obvious, but I meant to say the worst I can suffer from BAC is a 20% decline.  It no longer matter how far it drops beyond that point.

 

 

[ERICOPOLY]

The difficult part for me to comprehend is what exactly you are trying to accomplish by transferring the downside. Are you trying to protect from a systematic pullback? Are you trying to continue speculating? Are you playing off the implied vols of different options whose underlying should behave differently?

 

And in what proportions? I assume the premiums received from writing puts on a basket will not match for premiums paid for the BAC puts.

 

 

Some people diversify their portfolio to reduce risk.  But they miss out on concentrated upside from what they know is their single best idea.

 

Remember the comments from people about how it "takes guts" to focus all the money into a single stock?  Well, that's total bullshit, actually.  It assumes the downside risk is also 100%.  But it doesn't have to be.

 

You can have 100% upside in one name, but you can have 100 different names where each one represents 1% of downside.

 

This is like a Frankenfund.  Concentrated upside, diversified downside.

 

[ERICOPOLY]

And swapping risk is what these things are designed to be used for in the first place.

 

So I'm hardly stating anything original here.

[gokou3]

Example:

 

The $10 BAC puts (2015) are bid at nearly 10% of strike.

 

The $25 SHLD puts (2015) are bid at nearly 10% of strike.

 

So at those strikes they both cost the same for insuring a dollar of risk.

 

So I can swap $10 BAC downside risk for $25 SHLD downside risk.

 

So, worst case, I might get put SHLD after a 50% decline from it's current price.

 

But I get protection from a 20% decline in BAC.

 

This is a brilliant example.  Just curious, in the above example do you pick out SHLD randomly?  My guess is no.. I think you found it because it has a relatively high time value.  If so, I wonder if you use a particular website to filter these high time value names.

 

I have been following the entire thread.  Thanks for the great knowledge dispensed.  An elegant and rational way to think about options and leverage.

 

 

[Palantir]

 

 

Here is what you do.

 

1)  Go put 100% of your portfolio in BAC common stock.

2)  Purchase at-the-money puts to protect 90% of the BAC position

3)  Write puts on other securities such that you now have 90% downside in those other names

 

Reg-T rules treated this as 1.9x downside I believe, even though it's really only 1x downside.

 

The cash from writing puts on a diversified basket of names finances the puts that protect the concentrated BAC position.

 

Fascinating discussion.

 

I understand that you're essentially converting your downside in BAC into downside in a diversified position (say an index) , but what if the market does go down substantially, wouldn't the short index put be exposed? If I am not mistaken, the long put hedges the underlying, but you end up with a large unhedged long position on the index?