https://docs.google.com/spreadsheets/d/ ... sp=sharing
Ok, I also have a leveraged portfolio going, similar to George the original one. I share George's sentiment about interest rates being low. I should note, rates are at an ALL TIME LOW, so I want to be able to say that I did more than just say "gee, rates are really low..." I think it is more than just a shame to not take advantage. I think this may be a once in a lifetime event to take advantage of super low borrowing costs.
I have always like the concept of interest rate arbitrage, although this is not that, as interest rate arb deals with capturing a risk free profit, I think this is worth the risk and I can hedge/reduce a good bit of the risk involved. In essence I will be borrowing low at a short term rate and reinvesting at a higher rate.
Portfolio margin for more flexibility/leverage
A couple things I did differently with respect to George, I have a Portfolio margin account vs a reg T. Portfolio margin is different in many ways as you have MUCH more flexibility and initial margin = maintenance margin. You can also go as high as 6-1, but I would never, ever go that high. (You can also drive a car with your feet, but that doesn't make it a good idea.) I am at 4-1 right now and plan to decline.
That said, margin calls are the #1 most significant risk to this strategy, as with Interactive you don't really get much notice, and they will just start selling stuff if you get into an adverse position, so don't get into an adverse position margin wise.
ETF/CEF's over stocks for diversification
Now, the other key difference is that I am investing in closed end funds and ETF's as opposed to individual stocks. I only have 3 individual stocks, and set a limit of 5, although I haven't come across anything I would really get into. The stocks are 1% positions. One risk I see is individual stock specific events that can't be hedged against and can't be anticipated. Individual stocks can also be much, much more volatile over the short run, so to avoid all that unnecessary drama, I just avoided individual stocks for the most part.
Next, while I like CEF's and ETF's, CEF's are nice because many trade at a discount to NAV, which is just bonkers and according to EMH (which I disagree with) should never happen. Discounts 5-10% are not unusual at all. Conversely, some trade at a premium, and even significant double digit premiums, which is just bananas crazy. I am a value/income investor, and despite not being anywhere close to the typical retirement age, I don't believe in paying through the nose for growth or paying a $1.50 for a dollar.
Buy at a discount and collect the dividends
More importantly, I believe buying a high dividend paying CEF at a significant discount to NAV generates a measurable alpha, which is excess return on a risk adjusted basis. I'd rather lock in a fairly certain alpha, as opposed to trying to be a superior stock picker. Although I think I am a long term decent stock picker, in the short term, Mr. Market doesn't always agree...
Next the other key element of this is that dividends, not capital gains are the primary driver and element for success. I just want my dividends to pay down the margin debt and I am set. Consider it the difference in buying a rented apartment building vs a fix/flip. If I can have someone pay off a loan for me over time, which has value. I do not need for the securities to go "to the moon" to be successful, nor do I have any interest in showing my forecasting abilities or how I am the smartest guy in the room. The only thing I can forecast about the market is that it will be different tomorrow than it is today and it will go up, down, or sideways although over time there is a positive trend.
That said, I'll take capital gains just the same and would rather be up 10% vs down 10%, BUT I don't need cap gains for success and will be just fine and dandy if the market is where it is today in 3 years.
There are 3 key elements: The portfolio, the hedge, and the PUT.
The portfolio is made of several diversified closed end funds, almost 40 in total that invest in several asset classes/industries from real estate to option-income to MLP to high yield debt to health care to Preferreds. The portfolio's 2 year beta is .77 and 1 year is .74. The yield is 7.86% This provides a steady stream of income each month. Some pay monthly, some pay quarterly. No position is over 6% of the portfolio.
I look for yields over 5%, discounts of 5% or more, and try to spread the risk across multiple sectors: MLP, REITs, Option income, high yield and debt, convertible/preferred securities, etc... I am ok with the fund using leverage, but I am ok with them not using leverage too. I haven't run the percentages on the sector weightings, but I think I spread it all around well, probably 10-15% in each segment and I run a bit higher on option income funds as I think they are a bit more defensive and steadier in their income sources. They are also a bit more tax efficient, although taxes aren't a huge concern.
I try to buy CEF's that are at a greater than normal discount, so if a CEF historically traded at say a 7% discount, but is now at a 9% discount, that is a compelling trade, vs buying the same CEF at a 4% discount.
NAV growth is very important as well. I need to see that the underlying is moving up by some reasonable amount each year 7-9% is fine.
Total return is important as well. You can't just look at a yield and go all in, and like I said, I will definitely take capital gains, but speculating on price movements isn't the point of this exercise.
I should get market type returns without market type risk and outperform in all markets but a straight vertical, raging bull market.
The hedge is for 100% continuous downside protection 365 days a year. I have shorted SPY about 80% of the portfolio's value and created a "synthetic put" by combining a long call LEAP position to cover my downside. Until I can build up a few months of dividends as a cushion, my biggest concern is and will always be a sharp downward move in the portfolio.
Now, this is a significant cost to the portfolio (5%), specifically the call position to hedge the upside, which cost about 26k, BUT if I can sell puts weekly for $520 or more (26k/50 weeks), I can recoup the premium paid for the calls and get a 100% hedge for free. That's the idea, and it sounds goods on paper, but being able to consistently execute this for 50+ weeks is the challenge. So far, so good on recovering the premium, as I have almost 5k that I have made from selling options.
I am currently looking to buy some LEAP puts as I am going to increase my cash position fairly significantly (about 40% increase) and therefore increase the portfolio, in about a month, so I want to get ahead of that while PUTS are cheap with VIX at 13 at the time of writing. The time to buy puts is not when there is an Ebola scare, taper tantrum, flash crash or whatever the next "thing" is that spooks the market and VIX jumps through the roof to 35 overnight. Similarly, say it is 3 months out from expiration, and the vix drops under 15 again, I am probably going to step in and roll my VIX LEAP puts out.
The PUT index is one of the most interesting things I've read about in finance. Notionally, it is an index created by the CBOE for selling puts 2% OTM on the SPY. The results are compelling to me, which suggest slightly better than market returns and about 30% LESS volatility. The PUT index beat the pants off SPY over the past 10 years, beating it 7/10 years and losing by less than 1% in 2 out of the 3 years where it failed to. Most notably, during the 2008 meltdown, it beat SPY by more than 9%, and down years are the most painful element about investing, as you have to make more than the loss on the upside to recover your losses. If you lose 30% in a bear market, you have to make 44% to get back even.
I replicate this selling puts on IWM about 2% OTM each week. If I get assigned, I will flip to selling covered calls with the target of getting back to even. I went through that recent 10% market correction swoon, and although I wasn't hedged anywhere close to what I am now, I got assigned on my puts, and life was painful, but ok. I could also roll the puts out with the target of breaking even and ride out more volatile swings.
At the rate I am selling puts right now on both SPY and IWM, it should take about 12-15 weeks to recover the premium paid for the calls. Figuring an 80% chance of success, selling puts is getting me 2k/week, I should be at about 20k in premium received in 12 weeks. That said, I have almost a year to recover the call premium, so there is no rush and no point in taking undue risks. If I can profit on the trades that go well and roll/break even on the trades where it doesn't, I should be ok over time.
Statistics: Posted by bad_LNIP — Fri Nov 14, 2014 8:13 pm