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Question about leverage


perig
Posts: 6
Topic starter
(@perig)
Active Member
Joined: 10 months ago

Hi all,

I am trying to figure something out here about leverage and selling 5D puts for 2-3DTE on either the SPY/SPX/XSP or some other index really.

If I sell a 5D on SPX (let's say 5D @ 3500), I think I understand the leverage calculations: 3,500*100/30,000 = 11.7 (if I were to be able to do it on a 30k portfolio, which can't be done due to margin, and which I wouldn't anyway...).

Now, I know stop losses are not optimal and have drawbacks but how can you look at leverage or "risk", if I use, let's say a 3x credit stop loss (i.e. for $2 credit received put a $6 stop loss). Would it be better to look at potential of the percent of account lost per trade as a "better" approach for risk? So here if I took $6 stop loss, a 2x slippage (for gap) the max loss would be $1,000 ($2x$6-$2) or 3.3% of the account.

Or with the overnight gaps are too unpredictable in black swan event and this would not really reflect the worst case scenario? A gap to zero is not realistic but Black Monday was a 20% drop or 700 points at current price, and now that I type this and do the math, with a 200 points buffer at the 5D, that would be a 500 point ITM so a possible loss of more than $50k loss if the stop is not exercised due to the gap. Complete blowout and some.

So would using SPY or XSP or some other instrument give more flexibility for a smaller account like this to bring the margin requirement lower, staying potentially without a stop loss but better sizing to let the probabilities play out, not allow a complete blowout even in case of massive gap?

Thoughts?

12 Replies
earlyretirementnow.com
Posts: 250
(@earlyretirementnowcom)
Member
Joined: 6 years ago

With "only" 30k in equity, you might want to look into doing put spreads. Also called credit spread or vertical spreads. So, sell the 3500 strike and buy the 3400 strike. Maximum loss = 10k  (=100 points times 100 multiplier)

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2 Replies
perig
(@perig)
Joined: 10 months ago

Active Member
Posts: 6

@earlyretirementnowcom Thanks, after quite a bit of research it seems a spread is really the only “simple” strategy, although it’s expensive in how much you spend on that long compared to naked position. Will need to test some when the market opens.

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figuy1
(@figuy1)
Joined: 10 months ago

Eminent Member
Posts: 42

@perig Some alternatives that you can try until you have a bigger portfolio are: sell a couple of XSP puts that only have 10x S&P underlying risk or 1 ES put which has 50x S&P notional underlying compared to SPX which is 100x (~$380,000).  For example, if you wanted to achieve 2.5x leverage, you could sell 2 XSP puts ($38,000*2)/$30,000 = ~2.5x.  The main downside is the fees really add up, if you are paying $1.30/contract in brokerage but only collecting ~$10/contract, it gets expensive. Perhaps you could only sell once a week for more premium instead of 3 times for less premium.

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AP42
Posts: 12
 AP42
(@ap42)
Active Member
Joined: 10 months ago

Sorry but I think writing using SPX options with 30k in equity (ie: effectively 15k cash for margin requirements) is a bit insane. 

If you write a spread you're looking at having to increase your short leg to offset the premium paid on the long leg which will negatively impact you even more. This actually will work against you if there is a noticeable drop.

You won't be able to get good buffers in your regular use. 

If you're absolutely sure about doing this then you should only do this when VIX is very elevated and you can score 10% buffers on your positions. This way your put spreads would at least generate some decent PNL. 

I see a 3450/3350 spread right now is going for $35 Feb 8th. That's about a 10% buffer spread out across almost a week. Even if your position remains strong but IV increases you won't be able to exit the position without a significant loss for it. 

I personally don't think this is a good play with that account size. I considered this as well when my account was this size and I didn't find it worth it then either.

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6 Replies
NavyPack
(@navypack)
Joined: 1 year ago

Estimable Member
Posts: 161

@ap42 I'm surprised a brokerage would even let you do that, since that is massive (>10x) leverage.

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AP42
 AP42
(@ap42)
Joined: 10 months ago

Active Member
Posts: 12

@navypack I don't think you can with 30k equity, since equity is worth half the margin as cash. You can write an SPX (at 3000) put with 30k cash for sure though, at least I know I can on IBKR.

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NavyPack
(@navypack)
Joined: 1 year ago

Estimable Member
Posts: 161

@ap42 makes sense, my guess is folks should work up to at least 50-60k via a Total Market ETF before starting the put selling approach.

Put selling is great (so far), but certainly not the first thing I recommend to folks.  

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perig
(@perig)
Joined: 10 months ago

Active Member
Posts: 6

@navypackrigjt, like I said in my first message I can’t and wouldn’t given the leverage. SPY is an option although coms would be pretty bad.

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NavyPack
(@navypack)
Joined: 1 year ago

Estimable Member
Posts: 161

@perig Agreed, and I didn't read close enough.  All the best!

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earlyretirementnow.com
(@earlyretirementnowcom)
Joined: 6 years ago

Member
Posts: 250

@ap42 3450/3350 is way too far out of the money. That doesn't negate the possibility of the vertical spread. Just raise the strikes a little bit and you get some traction.

Another way would be to use the ES futures options. They have a multiplier of only 50 or the XSP options (as someone already suggested) with a 10x multiplier.

But that said: 30k is a bit thin as a portfolio size...  The 100 point spread, if realized would wipe out 1/3 of the portfolio. I wouldn't take that kind of risk with my portfolio size. But when I started out and my IB portfolio was "play money" I probably took greater risks than that. 🙂

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nobatmanjokes
Posts: 91
(@nobatmanjokes)
Trusted Member
Joined: 1 year ago

I started at 30k writing XSP weekly options for a while at 2x leverage (now would be 38k), but used a higher delta of 10-20 than I do now (2-8ish). The purpose was to understand the process because there’s only so much reading can prepare you for the experience.

Keep doing that until you lose at least one or two trades. The higher delta, small position was good to learn as my returns weren’t all eaten by t-cost and I experienced a couple of losses when the portfolio was insignificant before scaling into a larger portion of my assets. Usually with XSP I just sold at bid and got a $1 price improvement almost every time so the bid/ask wasn’t quite as bad as advertised.

Then as others say scale to futures and SPX. The simplest way to scale is to just buy a total stock ETF and sell it when you have enough to scale up, but elsewhere we had a discussion about a futures approach and some other ways to grow the portfolio.

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1 Reply
perig
(@perig)
Joined: 10 months ago

Active Member
Posts: 6

@nobatmanjokes awesome, thanks for the feedback!

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