current trades

[Litodude]

also like a previously mentioned, having a synthetic delta neutral position by owning a stock and writing calls against it month to month or even deep ITM LEAP and selling covered calls that way works to capture that time-decay profit overtime without sacrificing excess capital. i mean..it's just sitting money really. and i don't suppose you think your KO or AAPL or BRB stock is going to move greatly in the span of a month will it??? i mean if you think it will then just make your strike out larger.

there's also synthetic naked puts that you can do via futures even with a small account (sub 2k) to generate a load of income that's relatively safe (but you don't own the underlying like a COVERED (hence the term) option does so it's more dangerous but very very basic and a great way to earn income.)

[Litodude]

now's a good time to be really heavy in liquid capital

[Arch0wl]

we should have an investing forum if it means constant back-and-forth between rubix/litodude, because this shit is a great read.

actually, you know what, screw it: http://www.flashflashrevolution.com/...27#post4276327

[Reincarnate]

Initiate debate mode y/n

[Litodude]

up to you, i love hearing contrasting povs

if it's heavy math though expect delay, i'm not brushed up

[Reach]

Please debate, I love learning about this stuff ;o

[awein999]

Yes please

[choof]

this thread made me open up stepmania

[Reincarnate]

Okay, so I guess I should get into the basics first so everyone knows what everyone's talking about. This is meant to be a primer so everyone can become familiar with the jargon. I'm not getting heavy into any math here. There are certain details I've omitted / simplifications I've made for the sake of keeping this reasonably short.

Disclaimer: I don't consider myself an expert. So take what I say with a grain of salt. If I have said anything majorly inaccurate or misleading, please correct me. I'm writing this in the middle of the night because I can't sleep, lol.



Stocks:

A share of stock can be thought of as a fraction of ownership of a company -- an investment. Some companies issue stocks that pay "dividends," giving shareholders a portion of its earnings on a regular basis. Other companies pay no dividends and reinvest in themselves instead. It depends a lot on the situation. There are also many different flavors of stock, but we can ignore the differences for our purposes.

If the price of the stock increases, you can hold onto it, which improves the value of your portfolio, or you can sell it at a profit. If the price plummets and never recovers, you can only sell at a loss. That's where the risk of a stock comes in -- it can be hard to tell when to buy, hold, or sell a given stock, because you don't necessarily know how the price will move over time going forward.



Options:

Okay, now to the more interesting stuff.

A stock option, instead, is a contract that gives you the right (but not the obligation) to buy or sell some quantity of an asset (the "underlying") for a particular price (the "strike price" or "exercise price") on/before a particular time (the "expiration date"). You can choose to "exercise" these rights when the conditions are met, but if the conditions are not met, then the option "expires worthless."

The contract itself also comes at a price (the "premium") to the person buying it. Buying the contract is cheaper than buying the underlying stock. Also, each contract typically corresponds to 100 underlying shares, as opposed to just one (which relates to a concept called "leverage").

An option is basically a bet on the direction of a stock's price. You don't actually have to own the underlying stock to engage in a contract. More on this later.

There are two main types of options contracts -- the "call" (right to buy) and the "put" (right to sell). I can either buy a contract (taking a "long" position), or sell or "write" a contract (taking a "short" position).


Long Call:


Long call means you purchase a contract giving you the right to buy stock at a fixed strike price at/before expiration. If the stock goes down in value, then clearly you are better off just buying the stock outright rather than paying the higher strike price, so your loss is capped by the amount you spent on the option's premium (the price of the contract). Notice how you need the stock price to increase at least by the amount of the premium in order for you to make your money back.


Long Put:



Long put means you purchase a contract giving you the right to sell stock at a fixed strike price at/before expiration. In this case, you'd like the ability to sell the stock for the higher price in the event that its market price dropped.


Short Call:



When you short a call option, you are selling the counterparty the right to buy stock from you at a fixed strike price at/before expiration. Note that you immediately gain a profit from the premium that the counterparty pays, but then if the stock price skyrockets, you are in deep shit. Now the counterparty will exercise their right to buy stock from you at a bargain.

Remember how I mentioned that you didn't have to actually own stock to mess around with options? In this case, it's called a "naked call" (as opposed to a "covered call"). Now you have to purchase stock at the higher price and sell it to the counterparty at the lower strike price to honor your contract, and take a massive loss as a result.


Short Put:



When you short a put option, you are selling the counterparty the right to sell stock to you at a fixed strike price at/before expiration. Similar to the short call, you gain some money from the premium paid for the contract. But if the stock price plummets, now you have to buy the stock at the higher price.


Moneyness:

The "moneyness" of an option is defined as the underlying stock's current price relative to the option's strike price (another way of asking "is this thing actually worth something if we were to exercise it?"). There are three states, which differ for puts and calls:

-In The Money (ITM) (For calls, when strike price < stock price. For puts, when strike price > stock price)
-At The Money (ATM) (For both calls and puts, when strike price = stock price)
-Out Of The Money (OTM) (For calls, when strike price > stock price. For puts, when strike price < stock price)

Another important set of definitions:

-Intrinsic Value (For calls, stock price - strike price. For puts, strike price - stock price)
-Extrinsic/Time Value (For calls and puts, option price - intrinsic value)

For example, if a stock is priced at $50 and I have a call option with a strike price of $49, I am in-the-money because I can exercise the contract, buy the stock for $49, and then turn around and sell it for $50. Thus, my option has an "intrinsic value" of $1. If the strike price were $50 or greater, my option would have no intrinsic value.

Note that even if we have a call option that is out-of-the-money (and thus has no intrinsic value), it may still have "extrinsic value" prior to expiration. Extrinsic value is basically the chunk of the option's premium/price that isn't attributable to intrinsic value. Why might an option be worth something over its intrinsic value?

Time Decay:

Time! And as you can guess, as we approach the expiration date, an option's extrinsic value goes to 0 due to "time decay." The further away we are from expiration, the more time an underlying stock has to make favorable movements. All else held equal, time decay is great for option sellers. Not so great for buyers.

Implied Volatility:

The implied volatility is a measure of how much the price of the underlying stock is predicted to fluctuate prior to expiration. Something with low implied volatility won't jump around too much, whereas a highly volatile stock might bounce up and down like crazy. Note that this is not the same as historical volatility, which is derived from past data. Instead, it is a sort of forecast derived from market sentiment, which can, for example, be backed out from the price of the option.

The Greeks:

To aid in risk management, the Greeks refer to a collection of variables that represent various types of sensitivities (rates of change) with respect to the option's price. The big ones are delta (sensitivity to the underlying stock price), theta (time sensitivity / time decay), and vega (sensitivity to volatility), but we also have gamma (second-order price sensitivity), rho (interest-rate sensitivity), etc.

These parameters can be very useful when it comes to making decisions. However, eliminating your exposure to a particular type of risk (especially over a long time period) usually comes at a price, either in the form of buying / selling additional instruments to offset the risk, limiting potential gains, and/or shifting exposure to another risk instead.

For example, maybe your portfolio is sensitive to losing value as a result of a potential shift in an underlying stock's price movement. You could perform a "delta hedge" and make your portfolio "delta neutral" by restructuring it so that all the positive deltas offset the negative deltas. But performing this hedge only provides insensitivity against small movements in price, and it can be costly to hedge repeatedly over time.

[Reincarnate]

Okay, so hopefully that gives everyone some initial context.

Moving onto the question of whether or not we can beat the market over the long term?

There is evidence that some hedge funds can do it. Other market-makers and big banks have institutional advantages, such as lower fees and rebates. They also benefit from much better speeds and execution thanks to colocation and technical expertise. Many hedge funds can pretty much do as they please, whereas everyone else has heavy restrictions on how they can invest. Or they throw a bunch of quants / coders / PhDs at the problem while everyone else is just sucking dust. In short, they may be able to beat the market, but it may not be a fair fight.

What about the average individual investor? Can they beat the market consistently over the long run? Personally, I don't think they should even try. The vast majority of stock-pickers (professionals included) can't do it. Even when we look at the guys who ARE consistently beating the market, it can be hard to attribute their results to skill rather than chance.

http://www.dimensional.com/famafrenc...rformance.aspx

http://www.etf.com/sections/features...a-fallacy.html

https://pressroom.vanguard.com/conte...g_4.9.2014.pdf

So even if it's possible in the long run to consistently beat the market average, I don't think it's all that likely.

One thing I didn't emphasize enough in my previous post was that everything comes with a cost or tradeoff in some form. If you want to experience all kinds of gains, you have to endure all kinds of risks. If you want to hedge your risk, you have to pay for it somehow (and this is going to eat at your upside anyway). And when you factor in things like transaction costs, that stuff adds up. Even if you remain exposed for a few years and make ridiculous profits, all you need is one black swan to turn your leverage against you and completely wipe you out, or lull periods where you underperform by significant margins. There's always a caveat somewhere.

I think most people should just stick to the basics: Invest early and often, diversify, use low-cost index funds, minimize tax, and rebalance occasionally. It's not as glamorous or interesting, but it's simple and it works really well.

[Litodude]

http://papers.ssrn.com/sol3/papers.c...act_id=1149340

tl;dr: anyone in their 20s or younger fully leveraging their portfolio (200%) and investing 100% into stocks (broad based index mind you) yields a significantly higher return on average,without inheriting more risk. they use deep in the money LEAPs to imitate a long stock position; they do this because you can't leverage a normal account without options. an individual investor does not start out with the ability to trade on margin.


trading beyond DITM LEAPs, while only equating yourself with literally MINIMUM added extrinsic risk, writing(selling) covered calls against your DITM LEAP gives you a infinitely generating profit for the duration of the spread, each month.
https://www.youtube.com/watch?v=G-vwdVJzknQ

[Litodude]

You could even trade SSO instead of the SPY/VOO/IVV whatever: SSO is a 2x leveraged ETF that follows the S&P500 99.9999%. You're literally doing the same thing. SSO doesn't have that great of a liquidity compared to other ETFs though, but is essentially the same thing without having to go on margin.

[Litodude]

i just hate having to explain options and greeks and everything else when the question 'why does the derivatives market exist in the first place?' escapes people and they have a misconception of theexistence of the market and purportedly report misinformation of it's entire function. same with futures and swaps

[Reincarnate]

Firstly: Thanks, Lito, for that paper -- I think it's interesting and definitely worth discussing.

Some quick definitions for those following along:

1. A life-cycle fund is a kind of fund where the underlying asset classes might start out with a greater proportion of riskier investments, slowly adjusted over time to become more conservative as you age.

2. Buying something "on margin" (typically) means you are borrowing money from a broker in order to finance a purchase. It's a form of leverage -- which means both positive and negative effects are amplified. To illustrate the concept, ignoring commissions:

Let's say you buy 10 shares of stock worth $100 each using your own money, so $1000 total. The price increases to $130 per share, so now your portfolio is worth $130 * 10 = $1300. Now you've made a return of ($130-$100)*10 / $1000 = 30% on your original investment. You put up $1000 and made an extra $300. Cool!

But let's say you had bought those shares on margin instead. You put up $500 for 5 shares, and your broker lends you $500 for the other 5 shares. Now when the price of the stock jumps to $130, your portfolio is still worth $1300, but now your return is ($130-$100)*10 / $500 = 60% on your original investment. Of course, now you have to pay back your broker, with interest. So $1300 - ($500 + int) = $800 - int. You put up $500 to make an extra $300 minus interest on $500. That's great -- you made nearly the same profit with half as much money. That's leverage working in your favor.

And what if the price had dropped?

If you didn't buy on margin, and the price dropped from $100 to $70, your portfolio would be worth $70 * 10 = $700. Now you've made a return of ($70-$100)*10 / $1000 = -30%. You put up $1000, but lost $300. Damn.

And if you did buy on margin going in half-and-half, your portfolio is still worth $700, except now you've made a return of ($70-$100)*10 / $500 = -60%. After paying back your broker, you're left with $700 - ($500 + int) = $200 - int. You put up $500 and lost $300 with interest on the borrowed $500. That's leverage working against your favor.

If your investments drop sufficiently low, you will receive a "margin call," which is when the broker tells you that you need to deposit additional money / securities to your account so that your balance is back up to minimum maintenance margin requirements. This can really suck if you've already sustained heavy losses to begin with.

Had you not gone on margin and used $500 to purchase the losing shares, you would have only lost ($70-$100)*5 / $500 = -30%, meaning you put up $500 and only lost $150. Your loss isn't as profound in this scenario because you aren't leveraged.

As Lito mentions, though, usually there are a lot of limitations in place that prevent young individual investors from trading on margin, especially when it comes to retirement accounts.



To get one other thing out of the way: Ayres and Nalebuff are not claiming that they are beating the market. Their claims are about increasing returns on retirement accounts by changing attitudes towards risk, and doing better than traditional retirement strategies.


I'm compiling this list from a fusion of the pdf, their book, and online interviews.


1. Their method: Use leverage and buy stocks on margin to gain exposure when you're young (deep in-the-money LEAP call-options can be used, or an index ETF that tracks the S&P 500, such as SPY). The authors maintain that traditional retirement strategies are far too conservative.

2. Retirement portfolios become about 50-60% bigger on average. The expected gains beat life-cycle funds by 90%, and 100%-stock funds by 19%.

3. There are risks to their method, but their main thrust here is that it shouldn't matter in the long run because investors would be "diversifying over time" in the following way:

Thus, investors only face the risk of wiping out their current investments when they are still young and will have a chance to rebuild. Present savings might be extinguished, but the present value of future savings will never be. Our simulations account for this possibility and even so, we find that the minimum return under the strategies with initially leveraged positions would be substantially higher compared to the minimum under traditional investment strategies.

Nalebuff: Theory tells us that diversification reduces risk. You know you should buy mutual funds to have lots of different stocks, to not put all your eggs in one basket. Stocks are not perfectly correlated, and so you get lower risk by having a large basket. Well, returns across time are even less correlated than returns across stocks. So if you think of each year as a different asset, you would like to spread your investment out across multiple years. You expose the same amount of money to stocks, but you reduce risk because you spread that stock exposure more evenly across more years.

If you're using leverage, how can risk go down?

Nalebuff: The increased market exposure when young allows you to have less exposure later on. And while the total market exposure is the same, it's better spread out. Therefore, it has less risk.

5. Their recommendations: You should not use this strategy if you have credit card debt, have less than $4000 to invest, or need the money to pay for your kids' college education(s), or if your employer matches contributions to your 401k, or if your salary is correlated with the market, or if you are averse to the possibility of losing money. In particular, I'd like to quote this part:

You can't buy on margin in a 401(k). Is it worth giving up the tax shelter and company match to do this in another sort of account?

Nalebuff: Absolutely not. We want to be 2-to-1. If a company match is going to give you the 1 right away, then you get 2-to-1 risk-free. That beats having to borrow for it. Even 50% matching is a better deal.

I have to step out for now but I'll give my own thoughts on all this when I get back -- there's a lot to say.

[Arch0wl]

Originally Posted by Reincarnate

If you want to experience all kinds of gains

also, I think this is why an investing forum would be useful -- stickies that cover the preliminaries so that people who don't need to know the preliminaries can just refer to the stickies, instead of the more knowledgeable posters having to repeat themselves

[Litodude]

Originally Posted by Litodude

Before you ask me basic questions, look at this:




AMA

literally from the op of my ama

this thread assumes you have all that shit covered already and have more to play w/

[Reincarnate]

Whoops, forgot about this thread (looks like everyone else did too, though).

Anyways, thoughts on the retirement strategy listed by Lito:

It's fine for some, perhaps, but I feel like it has lots of practical limitations which makes it unsuitable for most people. You'd basically have to be someone who is young, has some money sitting around, is finance/options-savvy, has no debt, has a high tolerance for risk, and yet is somehow incapable of finding a job with an employer who matches 401k contributions? Why assume all the risk that comes from buying stock on margin instead of allowing an employer (who is undoubtedly in a much stronger position) to pick up the slack?

Okay, fine, I'm being a little unfair. Let's assume you have 401k matching. While the strategy is now less attractive, it's still viable. Now you could try buying on margin through a broker, but then you're dealing with taxable gains, which will be inferior to simply going straight to the tax-advantaged IRA as per the usual personal-finance hierarchy.

Unfortunately, there are several restrictions with IRAs, namely the one that prohibits leverage using margin. You can trade options and leveraged ETFs in your IRA instead, but a lot of places will require you to sign stuff / establish qualifications first in order to get approved. There are also differences between all these different methods (leveraged ETFs vs. margin accounts vs. DITM LEAP call options) but I'm too lazy to get into them. They're all viable if you know the pros and cons and structure accordingly.

If you'd rather use a taxable brokerage account instead, you should probably fill in the rest of the 401k first due to the tax advantage... but by this point you're investing a ton into your retirement between your 401k and IRA as it is so you can pretty much do whatever you want with your surplus money.

Anyways, is any of this worth it? Maybe -- if you know what you're doing, and if you have the right risk tolerance, which I don't think most do. Leverage is one of those things that you definitely don't want to botch up. It's great when you're applying it during an upward-trending market, but it's absolutely terrible otherwise, and not everyone has the iron stomach necessary to weather the storm.

Behaviorally speaking, people do all sorts of rash things when leverage bites them in the ass. Most panic. Nobody wants to lose their entire account that they've spent a few years building. However, this is precisely what the authors of the paper tell you to just suck up and deal with. Basically "Yeah, you might lose your entire retirement account, but you're young and have plenty of time to rebuild it." While I don't deny that it's a mathematically defensible claim here, I feel like retirement is one of those things where it's best not to take on too much risk.

The authors say typical strategies are too conservative. I disagree. Starting early and saving often will augment your accounts like fuc in the long run without the need for anything too fancy.

Another example:

If you start early, the effects of compounding can be huge. For example, suppose you start setting aside $1,000 a year (about $19 a week) when you're 25. You put it in a retirement account earning 8% a year. Even if you stop investing completely when you turn 35 - that is, you've invested for only 10 years - your total investment will have grown to nearly $169,000 by the time you turn 65 and are ready to retire. That's right: A $10,000 investment turns into $169,000.

OK, here's where it gets really interesting. Let's say you do the same exact thing, but you don't start investing the $1,000 a year until you turn 35. And you keep on investing that much every single year until you turn 65. That is, you invest $1,000 a year for 30 years, rather than for 10 years as in the previous example. How much do you wind up with when you're 65? Only about $125,000. That's right: Even though you invest three times as much money, you wind up with less.

Another example:

http://thesimplemoneyblog.com/wp-con...825-132806.jpg

To me, this is the most important intuition to have about retirement investing.

[qqwref]

Who are these people getting 11% annual return without risk?

(e: Also, is putting ~$15k a year in a good strategy even if I can't get an insane interest rate?)

[Reincarnate]

(Used a better picture. The rate doesn't matter so much in the proof-of-concepts. The general idea is that starting early has significant impacts later and allows you to maintain a lower overall savings rate. Starting late means you have to save even more money and still be unlikely to close the gap)

[Reincarnate]

Lito: Out of curiosity, what is your risk tolerance / preferred ratios with respect to stocks (large, mid, and small-cap, international vs. domestic, etc) and bonds?