Crypto is probably a bad investment!

April 25, 2022

If you remember my April Fools Day post from a few weeks ago, I poked fun at the proliferation of new crypto coins. Most of them are scams. But what about the mainstream crypto coins, like Bitcoin, Ethereum, etc.? Are they a good investment? What’s not to like about a 100%+ annualized return in some of the crypto coins between their inception and their 2021 peak?

Well, those returns are “water under the bridge”. What matters to me today is the outlook for the crypto world going forward. In today’s post, I like to go through some of the reasons why I believe going forward, crypto looks like a sub-par investment. I currently don’t invest in crypto and I don’t think that anything more than a few % of the portfolio seems prudent. Let’s take a look…

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Introducing the ERN-approved Crypto Coin

April 1, 2022

If you’re familiar with my work on Safe Withdrawal Rates, you’ll know that the number one concern for retirees is Sequence of Return Risk. Well, hopefully, this will soon be a thing of the past. I’m now ready to announce the complete “retirement” (pun intended) of my Safe Withdrawal Rate Research because, after years of research and a partnership with some of the most impressive crypto experts, I have finally developed a way to completely(!) hedge against Sequence Risk, once and for all.

Introducing the revolutionary, proprietary, trademarked Sequence-Hedged Investment Token™ Coin. Guaranteed free of Sequence of Return Risk! It’s safe for retirement, it’s safe for accumulating assets. A patented and trademarked revolutionary crypto technology solution to guarantee a risk-free retirement! With tax advantages, too!

Let’s take a look at the details…

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Timing Leverage in Retirement – SWR Series Part 52

March 21, 2022

Last year in Part 49 of the Safe Withdrawal Series, I wrote a post about using leverage in retirement, and in today’s post, I like to explore some additional issues. 

A quick recap, the appeal of using leverage in retirement is that we would borrow against the portfolio instead of liquidating assets. Nice! That might help with Sequence Risk if we avoid liquidating assets at temporarily depressed prices. There could also be a tax advantage in that we keep deferring the realization of taxable capital gains, potentially until we bequeath our assets to our daughter who can then use the “step-up basis” for complete forgiveness of all of our accumulated capital gains. That’s the famous “buy, borrow, die” approach popular with high-net-worth folks.

The gist of the post last year: Not so fast! Leverage could potentially even exacerbate Sequence Risk if you are unlucky and retire right before a bad market event that’s deep enough (like the Great Depression) or long enough (like the 1965-1982 stagflation episode) to compromise the portfolio so badly that the margin loan becomes unsustainable relative to the underwater portfolio.

One solution proposed by several readers: instead of always borrowing against the portfolio, maybe we should carefully time when we use leverage. For example, borrow only when the stock market is down “far enough” and use withdrawals from the portfolio otherwise. And if the market is doing well again, potentially pay back the loan again! Sounds like a reasonable and intuitive plan. But I want to put that to the test with some real simulations. Let’s take a look at the details… 

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Inflation at 7%! Here’s why I’m not running for the hills (yet)!

January 13, 2022

According to the most recent inflation numbers that came out yesterday (1/13), CPI inflation is now running at 7% year-over-year. From September to December we saw a 2.2% increase, which is a 9.1% annualized rate. And it’s not all energy and food inflation. The core CPI is also elevated at 5.5% year-over-year.

What do I make of this? How persistent or transitory is this inflation bump? Should we adjust our portfolio? Or our safe withdrawal rate? Here’s a short note with my thoughts…

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Using Leverage in Retirement – SWR Series Part 49

November 16, 2021

My Safe Withdrawal Series has grown to almost 50 parts. After nearly 5 years of researching this topic and writing and speaking about it, a comprehensive solution to Sequence Risk is still elusive. So today I like to write about another potential “fix” of Sequence Risk headache: Instead of selling assets in retirement, why not simply borrow against your portfolio? And pay back the loan when the market eventually recovers, 30 years down the road! You see, if Sequence Risk is the result of selling assets at depressed values during an extended bear market, then leverage could be the potential solution because you delay the liquidation of assets until you find a more opportune time. And since the market has always gone up over a long enough investing window (e.g., 30+ years), you might be able to avoid running out of money. Sweet!

Using margin loans to fund your cash flow needs certainly sounds scary, but it’s quite common among high-net-worth households. In July, the Wall Street Journal featured this widely-cited article: Buy, Borrow, Die: How Rich Americans Live Off Their Paper Wealth. It details how high-net-worth folks borrow against their highly appreciated assets. This approach has tax and estate-planning benefits; you defer capital gains taxes and potentially even eliminate them altogether by either deferring the tax event indefinitely or by using the step-up basis when your heirs inherit the assets. Sweet!

So, is leverage a panacea then? Using leverage cautiously and sparingly, you may indeed hedge a portion of your Sequence Risk and thus increase your safe withdrawal rate. But too much leverage might backfire and will even exacerbate Sequence Risk. Let’s take a look at the details…

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Passive income through option writing: Part 9 – 2016-2021 backtest: Guest Post by “Spintwig”

November 10, 2021

Welcome to a new post in the Put Option Writing Series. My blogging buddy Spintwig volunteered to perform another backtest simulation. If you remember from Part 5, he simulated selling 5-delta and 10-delta put options going back to 2018. He now added 18 more months of returns to go back to September 2016. In the end, I will also compare my live results with the simulated returns and point out why my live trading achieved even slightly better results.

Mr. Spintwig, please take over…

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Thank you BigERN (can I call you Dr. K?) for another opportunity to collaborate and add to the body of research that supports what is colloquially known as the “BigERN strategy.”

Part 8 of the options trading series is a 2021 update that discusses, among other things, premium capture, annualized return and the idea of lowering leverage while increasing delta.

Let’s throw some data at the idea of trading a higher delta at a lower leverage target and see how metrics like premium capture, CAGR, and max drawdown are impacted. As an added bonus, I’ve obtained SPX data that can facilitate a Sept 2016 start date for this strategy. This gives us an additional 18 months of history vs the SPY data that was used in Part 5.

For the benchmark, we’ll use total return (i.e. dividends reinvested) buy/hold SPY (S&P 500) and IEF (10Y US Treasuries), rebalanced annually, in the following configurations:

  • 100 SPY / 0 IEF
  • 80 SPY / 20 IEF
  • 60 SPY / 40 IEF

Let’s dive in…

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Passive income through option writing: Part 8 – A 2021 Update

October 18, 2021

After three posts in a row about safe withdrawal rates, parts 46, 47, and 48 of the series, let’s make sure we have the right level of diversity here. Welcome to a new installment of the option writing series! I wanted to give a brief update on several different fronts:

  1. A quick YTD performance update.
  2. How does the option selling strategy fit into my overall portfolio? Is this a 100% fixed income strategy because that’s where I hold the margin cash? Or a 100% equity strategy because I trade puts on margin on top of that? Or maybe even a 200+% equity strategy because I use somewhere around 2x to 2.5x leverage?
  3. By popular demand: Big ERN’s “super-secret sauce” for accounting for the intra-day adjustments of the Options Greeks. This is a timely topic because the Interactive Brokers values for the SPX Put Options seem to be wildly off the mark, especially for options close to expiration. So, you have to get your hands dirty and calculate your own options Greeks, especially the Delta estimates.
  4. There’s one slight change in the strategy I recently made: I trade fewer contracts but with a higher Delta thus reducing my leverage and the possibility of extreme tail-risk events.

Let’s dive right in…

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Retirement Bucket Strategies: Cheap Gimmick or the Solution to Sequence Risk? – SWR Series Part 48

September 14, 2021

Welcome to a new installment of the Safe Withdrawal Rate Series, dealing with Bucket Strategies. This is one approach that’s often considered a viable solution to the dreaded Sequence Risk Problem. Simply keep buckets of assets with different risk characteristics designated to cover expenses during different time windows of your retirement. Specifically, keep one or more buckets with low-risk assets to hedge the first few years of retirement. And – poof – Sequence Risk evaporates, just like that! Sounds too good to be true, right? And it likely is. Long story short, while there are certain parts of the bucket strategy that can indeed partially alleviate the risk of retirement bust, bucket strategies are by no means a solution to Sequence Risk. Let’s take a look at the details…

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Passive income through option writing: Part 7 – Careful when shorting long-dated options!

May 3, 2021

Welcome back to a new installment of the options series! In the discussion following the previous post (Part 6), a reader suggested the following: In recent history, the index has never lost more than 50% over the span of one year. Then why not simply write (=short) a put option, about one year out with a strike 50+% below today’s index level? Make it extra-safe and use a strike 60% below today’s index!

12-month rolling S&P 500 index returns (price index only, not total returns!).

So, let’s take a look at the following scenario where we short a put option on the S&P 500 index slightly more than a year out and with a strike about 60% below the current index level:

  • Trading date: 4/30/2021
  • Index level at inception: 4,181.17
  • Expiration: 6/16/2022
  • Strike: 1,700 (=59.2% below the index)
  • Option premium: $11.50
  • Multiplier: 100x  (so, we receive $1,150 per short contract, minus about $1.50 in commission)
  • Initial Margin: $4,400, maintenance margin: $4,000

In other words, as a percentage of the initial margin, we can generate about 26% return over about 13.5 months. Annualized that’s still slightly above 23%! Even if we put down $15,000 instead of the bare minimum initial margin, we’re still looking at about 6.8% annualized return. If that’s a truly bulletproof and 100% safe return that’s nothing to sneeze at. A 6.8% safe return certainly beats the 0.1% safe return in a money market, right? Does that mean we have solved that pesky Sequence Risk problem?

Here are a few reasons to be skeptical about this strategy…

Continue reading “Passive income through option writing: Part 7 – Careful when shorting long-dated options!”

Passive income through option writing: Part 6 – A 2018-2021 backtest with different contract sizes: Guest Post by “Spintwig”

All parts of this series:

* * *

April 21, 2021

Welcome to a new installment about trading options. Alongside my work on Safe Withdrawal Rates, this is my other passion. In fact, on a day-to-day basis, I probably think about shorting S&P 500 put option much more than about Safe Withdrawal Rates. In any case, one of the most frequent questions I’ve been getting related to my options trading strategy is, how do you even get started with this strategy when you have a smaller-size account? Trading CBOE SPX options, with a multiplier of 100x on the underlying S&P index, even one single contract will have a notional exposure of roughly $400,000. I don’t recommend trading that without at least about $100,000 or better $125,000 or more in margin cushion.

How would one implement this without committing such a large chunk of money? 

My options trading buddy Mr. Spintwig who already published another guest post in this series offered to shed some light on this question. He ran some simulations for my strategy using some of the other “option options” (pardon the pun), i.e., implementing my strategy not with the SPX index options but with different vehicles with a smaller multiple than the currently pretty massive 100x SPX contract. For example, the options on S&P 500 E-mini futures are certainly a slightly smaller alternative with a multiplier of only 50. And there are some even smaller-size contract alternatives, but my concern has always been that the transaction costs will likely eat up a good chunk of the strategy’s returns. 

In any case, I’ll stop babbling. Mr. Spintwig has the numbers, so please take over…

Continue reading “Passive income through option writing: Part 6 – A 2018-2021 backtest with different contract sizes: Guest Post by “Spintwig””