Stacking returns
A Random Walk Down Wall Street is a classic investment book written by Burton Gordon Malkiel. It was first written in 1973, but been updated over the last 12 editions. It is a good background book, but probably a bit academic for most beginners. His basic thesis though is one I share: most investment advisors are no better than a monkey at a dart board when it comes to picking stocks. Most of us can do better managing our own money, with a little bit of work. He is a huge fan of index funds and has the stats to support his view.
In his latest addition, he acknowledges that investment returns in the current environment of low interest rates leaves investors with little choice but to look at the stock market as the only game in town (i.e. TINA - there is no alternative). In his more recent editions, he suggests that using leverage is one one way to increase risk, and thus returns, to a portfolio. He suggests that this leverage should be in bond futures - not options which he seems to dismiss as beyond the capability of the average investor. He suggests that investors instead buy futures contracts on U.S. Treasurys - which is a low risk form of leverage. This option is not something most investors have direct access to, although there are funds that mix equities with these futures, like the WisdomTree US Efficient Core Fund (NTSX), and its returns seem to have beaten the market in the three years since it was started. The stacked return principle is sound but for most investors the thought of buying future contracts on U.S. Treasurys probably makes one’s head spin.
I ‘stack’ returns using options directly, either writing calls on stocks already owned or by writing puts on stocks you would like to own. Adding option premiums to the dividends you earn is the best way to earn money to re-invest in the market and compound your returns. Options are, however, risky. You may be called out on a stock that appreciates well beyond your call strike price (which is why you should not write calls too far out into the future). Or you may be put a stock that suddenly falls out of bed because of a bad earnings report, an analyst downgrade or Chinese government intervention. But if you set your call premium at at price that was more than 10% of what you paid for the stock you still make a gain. If you set a put on a solid stock you want to own well below (10-20%) where the stock is currently trading, you get the stock on sale and can start writing calls to recoup the drop. I think adding this type of risk to a portfolio is a sensible way to improve your overall returns. It takes practice to get comfortable with it, start slow and build up your experience base, but you will be pretty happy with the additional cash you can earn.
WARNING: I do not trade options (except a few covered calls) in our retirement accounts. I have a core of assets that have been put aside for retirement and these are kept separate from my trading account. The only time I used put options in a retirement account was when I converted a 401k into an IRA, and had a lump of cash I was looking to put to work. Now that I have a portfolio of stocks and bonds in the retirement accounts - I do not write puts there, unless a bond is called and I find myself with a hunk of cash. Make sure that you wall off your core retirement account from your trading activities. It is depressing to watch the boring, bond equivalent stocks, in your retirement accounts lag behind the overall market returns but very satisfying to see green in those accounts on days when the market is all red. Trading is to earn money, investing is part of saving regime. Remember this.
Market Today: Market was down today due to rising interest rates and poor earnings from tech firms. I closed equal amounts of both calls and puts. I wrote puts on Facebook (FB) which was down again today. It is not a company I really want to own but all the traders on CNBC grudgingly admit they are looking to buy it here, which suggests a trading opportunity. I sold one put in the morning that went quickly very negative, another one later in the day when the stock seemed to have bottomed. I got out of the second put before the market closed. If we are up Monday, I will probably be able to get out of the first one I wrote. Also wrote on Shopify (SHOP) and Square (SQ), but need interest rates to fall back to get out of these quickly. Trades.