Tag: Derivatives

Options Trading Series: Part 13 – Year 2024 Review

January 14, 2025 – Happy New Year, everybody! I hope you had a quiet, relaxing Christmas season and a great start to the New Year. As I’ve done in prior years, I want to update you on my options trading strategy: How was the performance in CY 2024? Are there any strategy changes? How did I deal with the volatility in August and December? I also want to share some general thoughts and observations to rationalize the long-term profitability of my options strategy.

Let’s get started…

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Why the Wheel Strategy Doesn’t Work – Options Series Part 12

September 17, 2024 – Welcome to another installment of my Options Trading Series. Please click here for the Options Landing Page for more details about the strategy. People frequently ask me how I deal with losses when I trade my options strategy. My approach is that a loss is water under the bridge, and I run the same strategy going forward, albeit with a slightly smaller account size. I’ve been trading my put options strategy since 2011, and this approach has served me well in several significant equity drawdowns, most recently in the 2022 bear market.

However, some of the options traders who have found my blog over the years must be big fans of the so-called “Wheel Strategy” (or “Options Wheel” or other related terms) and ask me all the time if it wouldn’t be better to take possession of the underlying, and then sell covered calls until I recover the loss. This strategy is often marketed as a great risk management tool and a surefire way to claw back losses.

I’ve previously dismissed this idea and given short and curt answers. But since the issue keeps coming up, I want to publish a more detailed post explaining why I don’t think the Wheel Strategy holds up to all the hype on the internet. Let’s take a look…

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Looking for high-yield CDs? Consider an Option “Box Spread” as a tax-advantaged alternative!

April 17, 2024 – People sometimes ask me for a good and safe place to “park” their money for a short period. CDs, high-yield savings, and money market accounts would be the obvious answers. When looking for safe, short-term investments, options are probably the last thing on your mind. Options have the aura of complicated and highly speculative investments. However, sophisticated investors can structure options trades to make them (almost) as safe as CDs but with more flexibility and higher after-tax income, thanks to a Box Spread trade.

You can implement this trade by hand, and I will go through the mechanics. You can also buy an ETF, though with some small drawbacks. Let’s take a look…

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Trading Options: A Primer (Options Series Part 11)

March 7, 2024 – My claim to fame in the personal finance and early retirement community is my Safe Withdrawal Rate Series, which has now grown to 60 parts. But I also have another passion: trading options to generate extra income in retirement. By popular demand, I like to update everyone on how my strategy has evolved since my last update in early 2023. Before I do that, though, I also want to reemphasize the rationale for my options trading strategy: Why does it work? How does it fit into a portfolio, both during accumulation and now in retirement? How do we dispel some of the common objections and misunderstandings? I think of it as an options trading primer.

Let’s take a look…

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Passive income through option writing: Part 10 – Year 2022 Review

January 9, 2023 – Happy New Year, everyone! I haven’t written any updates on my put-writing strategy in a while, so I thought this is an excellent opportunity to review the year 2022 performance and some of the changes I have made since my last write-up in late 2021.

Let’s take a look…

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Hedging Against Inflation and Monetary Policy Risk

July 5, 2022 – Over the last few decades, we’ve become accustomed to a negative correlation between stocks and U.S. Treasury bonds. Bonds used to serve as a great diversifier against macroeconomic risk. Specifically, the last four downturns in 1991, 2001, 2007-2009, and 2020 were all so-called “demand-side” recessions where the drop in GDP went hand-in-hand with lower inflation because a drop in demand also lowered price pressures. The Federal Reserve then lowered interest rates, which lifted bonds. This helped tremendously with hedging against the sharp declines in your stock portfolio. And in the last two recessions, central banks even deployed asset purchase programs to further bolster the returns of long-duration nominal government bonds. Sweet!

Well, just when people start treating a statistical artifact as the next Law of Thermodynamics, the whole correlation collapses. Bonds got hammered in 2022, right around the time when stocks dropped! At one point, intermediate (10Y) Treasury bonds had a worse drawdown than even the S&P 500 index. So much for diversification!

So, is the worst over now for bonds? Maybe not. The future for nominal bonds looks uncertain. We are supposed to believe that with relatively modest rate hikes, to 3.4% by the end of this year and 3.8% by the end of 2023, as predicted by the median FOMC member at the June 14/15, 2022 meeting, inflation will miraculously come under control. As I wrote in my last post, that doesn’t quite pass the smell test because it violates the Taylor Principle. The Wall Street Journal quipped, “The Cost of Wishful Thinking on Inflation Is Going Up Too”. I’m not saying that it’s impossible for inflation to subside easily, but at least we should be prepared for some significant upside risk on inflation and interest rates. Watch out for the July 13 CPI release, everybody!

So, trying to avoid nominal bonds, how do we accomplish derisking and diversification? Here are ten suggestions…

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Hedging against Sequence Risk through a “Retiree-Saver Investment Pact” – SWR Series Part 53

June 6, 2022 – In this year’s April Fool’s post, I marketed a made-up crypto coin that would completely hedge against Sequence Risk, the dreaded destroyer of retirement dreams. Once and for all! Most readers would have figured out this was a hoax because that complete hedge against Sequence Risk is still elusive after so many posts in my series. Sure, there are a few minor adjustments we can make, like an equity glidepath, either directly, see Part 19 and Part 20, or disguised as a “bucket strategy” (Part 48). We could very cautiously(!) use leverage – see Part 49 (static version) and Part 52 (dynamic/timing leverage), and maybe find a few additional small dials here and there to take the edge off the scary Sequence Risk. But a complete hedge is not so easy.

Well, maybe there is an easy solution. It’s the one I vaguely hinted at when I first wrote about the ins and outs of Sequence Risk back in 2017. You see, there is one type of investor who’s insulated from Sequence Risk: a buy-and-hold investor. If you invest $1 today and make neither contributions nor withdrawal withdrawals, then the final net worth after, say, 30 years is entirely determined by the compounded average growth rate. Not the sequence, because when multiplying the (1+r1) through (1+r30), the order of multiplication is irrelevant. If a retiree could be matched with a saver who contributes the exact same amount as the retiree’s cash flow needs, then the two combined, as a team, are a buy and hold investor – shielded from Sequence Risk. It’s because savers and retirees will always be on “opposite sides” of sequence risk. For example, low returns early on and high returns later will hurt the retiree and benefit the saver. And vice versa. If a retiree and a retirement saver could team up and find a way to compensate each other for their potential good or bad luck we could eliminate Sequence Risk.

I will go through a few scenarios and simulations to showcase the power of this team effort. But there are also a few headaches arising when trying to implement such a scheme. Let’s take a closer look…

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Low-Cost Leverage: The “Box Spread” Trade

December 9, 2021, major revisions on October 2025, 2023 – Last month, I published Part 49 of my Safe Withdrawal Rate Series, dealing with leverage in retirement. In that post, I surmised that the cheapest form of leverage likely comes in the form of a margin loan in an Interactive Brokers (IB) account. If you have the IB Pro account, you can access loan rates tied to the Federal Funds Rate plus a tiered spread ranging from 0.3% to 1.5%. Though, the really low rates don’t start until your loan reaches at least $3,000,000. For more manageable loan amounts that the average retail investor would use, we’re looking at a higher spread: 1.50% spread for the first $100,000 and 1.00% over the Fed Funds Rate for the next $900k. That’s a very competitive rate. Certainly better than a Home Equity Line Of Credit (HELOC), which is usually at around Fed Funds Rate plus 3%.

In the comments section, though, a reader brought up an idea for an even lower-cost method for borrowing against your assets: an exotic options trade called a “box spread”. Since writing this post in 2021, I’ve utilized the box spread loan. So, in today’s post, I would like to go through the basics of the Box Spread, how to implement it, and how this trade could in fact give us a cheaper form of leverage than even the rock-bottom rates from IB. 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…

* * *

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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