Sanity check for a long-term leveraged investment strategy

Mr.Saver

Malthusian wrote: »

Except this is incorrect, because unlike with unleveraged investment you can't be certain that (barring apocalypse scenarios) you can always ride out the downturn. In a sufficiently prolonged downturn your LEAPS all expire without value and you lose your shirt. In a less prolonged downturn, even one in which you continue to buy LEAPS at the bottom of the market, you could still have enough LEAPS expire that it creates a permanent loss that the leveraged upside cannot recover.

I am talking in vague general terms, but so are you because you haven't done any modelling.

That's why I've added a monthly check and rebalance when necessary to ensure that I don't lose everything in a prolonged or very deep recession.

I don't expect that I can get back to where it was after the market recovers, but since I'll be earning higher return in an average market condition, the long run returns will more likely (but not guaranteed) to be higher than unleveraged investments.

Malthusian wrote: »

What the OP meant by sanity check is that we were meant to tell him that we've checked and he's totally sane.

He is still putting all his mental energy into looking for reasons it will go right rather than ways it could go wrong.

His above statement "As long as the market gradually moves higher in the next decades, the temporary losses are not something that'd concern me" is verging on "la la la I'm not listening" because the fundamental risk of leveraged investment is that the market remains irrational longer than you can remain solvent. There is no way around this and the OP has not found one.

I can remain in the market for as long as it takes, because I always sell the contracts before they expire, regardless of the price, and buy new contracts with the proceeds. I don't see any possibility which I'd hold an option contract to the expiration.

under_western_skies

Mr.Saver wrote: »

My goal isn't to outperform the market, but to have a higher exposure (aiming at 200%). Because I'm optimistic about the general direction of the market movements over the next decades.

In other words: you hope that your strategy will outperform the market over the long term. Your claim of not wanting to outperform is complete sophistry. You have no other motivation.

The big problem is that you can be right about the market going up over the long term, but wrong about your strategy outperforming the market. That has been more than adequately explained in this thread already. You are now just repeating the same preconceptions that have already been debunked. I'm not going to waste time trying to explain it again.

I'm perfectly serious that I now hope you will lose money with this strategy. You are determined to listen only the opinions of somebody who lost huge sums pursuing a comparable strategy (and as a result, now has different opinions). You're asking for it. And it appears that you can afford to lose the money you plan to put into this strategy — otherwise, I might take a different attitude.

MarkCarnage

I am reminded of the following quote from Keynes

The market can stay irrational longer than you can stay solvent.

Except in this case it doesn't even need to be irrational, merely perform in a manner which fatally or more likely seriously impairs your strategy.

As already said, a significant fall followed by a period of flatlining would not be good news. As you are essentially buying derivatives on a capital only index, you will not benefit from dividend income and its reinvestment either as an investor in underlying would.

You are also vulnerable to changes in market vol (as I think you acknowledge to be fair), though less so than an at the money option, however a combination of a sharp market fall at significantly increased vol (highly plausible indeed possibly tautological) would increase that vulnerability in terms of roll pricing,

Your leverage ratio could change very fast in sudden and significant market fall (which most are) and unless you are placed to be on top on this strategy continually this could escalate very adversely for you.

Although you are buying long dated options they still have relatively short expiry dates in the context of a market cycle, and these dates are finite, unlike the underlying stocks where the equity is undated and unless the world goes bust will have some eventual scope for recovery.

You have looked at data on one market during a period which has seen two significant, but relatively short bear markets.You haven't even rigorously backtested it on that, never mind a more onerous stress test like Japan from 1989 or a number of markets in the 30s or 60s/70s.

Apart from all that I'm sure it'll be fine.....

Apodemus

under_western_skies wrote: »

In other words: you hope that your strategy will outperform the market over the long term. Your claim of not wanting to outperform is complete sophistry. You have no other motivation.

Sorry, UWS, I was with you up to this point. The motive for leverage is usually to outperform the unleveraged position. The market will do what the market will do and the choice of investments may over- or underperform. Leverage simply makes the gains or losses bigger!

Malthusian

Apodemus wrote: »

Sorry, UWS, I was with you up to this point. The motive for leverage is usually to outperform the unleveraged position.

I agree with UWS, that's sophistry. The unleveraged position is the market (in this case the S&P 500).

People aren't motivated by making losses bigger, they're motivated by the idea that leveraged investment will deliver higher returns than if they used a conventional strategy.

I was going to say that I disagree with UWS that I hope the OP loses his shirt. But on second thoughts, I actually do hope he loses his shirt. Because the conditions under which he is most likely to lose his shirt - where so many of his options are sold for buttons due to the high probability of expiry without value, that it generates a permanent loss that the leveraged upside cannot compensate for - are a 2008-style hard and heavy market crash in the next couple of years.

As the best possible time for a market crash for someone like me, someone who is currently accumulating into a conventional equity strategy with zero chance of wanting to cash it in, is the next couple of years, that means I benefit if the OP loses his shirt. (Not directly but because the conditions that maximise return for me and cause disaster for the OP are the same.)

And the beautiful thing is that the time at which people are most likely to come up with this kind of strategy is precisely when the market is most likely to crash in the next couple of years and the probability of failure and permanent loss is highest. If you don't sell your stockmarket investments when shoeshine boys start giving you share tips, you should consider selling them when people go on the Internet and say they have a marvellous strategy for making gonzo returns from leveraged investment without the associated risk of permanent loss, although this forum is too narrow to contain it.

The time at which people are most likely to consider strategies like this are at the end of sustained bull markets when market sentiment is at its highest. The time when it is most likely to work is when people are least likely to consider it and least likely to get the necessary credit even if they want to.

The OP probably thinks he is immune to irrational optimism, but everyone thinks they are immune to irrational optimism and 90% of them are wrong, that is why we have market crashes. "Nobody is the villain of their own story" - likewise every investor is The Big Short's Steve Eisman in the movie of their life.

It might be a coincidence that the only well-known thread in which someone published regular updates on the performance of a long-term leveraged strategy was market timer's Bogleheads thread in which it went horribly wrong. But just where are all the people who started threads on their leveraged strategy in 2009 - or even 2012 if it was too difficult to get credit in 2009 - and made a success of it? People usually boast about their success and quietly hide their failures, not the other way around.

Still, if the OP follows through on posting regular updates, and either we don't have a market crash or he do but (despite his lack of modelling) he has guessed correctly that the upside compensates for the downside, and commits to his strategy even it will seem at its most hopeless, he might be the first.

I will reiterate - the problem I have with the strategy is not that I think the OP will lose his shirt. The inherent nature of the strategy is that it has a chance of much higher returns compared to unleveraged investment but also a chance of permanent loss (losses on expiring options in a prolonged crash being so large that the upside cannot recover them). So I would not be at all surprised if he made lots of money from it because that would require me to be surprised that I can't predict stockmarket crashes to the year.

But for this strategy to make sense you need an idea of how likely it is to generate a permanent loss and how rich you are going to be if you don't. Otherwise you might as well take all your money, put it on red or black, then invest your winnings in the stockmarket if you made any. This strategy will also produce much higher potential returns than conventional investment in exchange for a risk of permanent loss, but it is better because at least you know what the odds are. The OP refuses to model the strategy and find out what his odds are.

kangoora

It'll work great...........


Until it doesn't