Leveraged Theta

Algorithmic & Actively Managed Market-Making Buy-Write is what I call the strategy and it’s my latest way I’m going to harvest money from the capital markets without having to worry too much. It’s more like an experiment in liquidity. My intentions are to test out my hypothesis, prove it works, then open up a fund to friends and family to invest privately.

For starters, to understand what I’m doing, you have to know what a “buy-write” is. If you do, skip this paragraph.  A Buy-Write is a strategy where you go long an asset, and write derivatives against your ownership.  The most common form, is going long the stock and writing calls.  The beauty behind it is you go long an asset you don’t mind holding anyway. Ie, you wouldn’t sell it if it became cheaper but for the right price you’d be happy to sell it (higher).  Well, you choose what price you’d “be happy to sell for” and write that call.  You rake in anywhere between 1/2 % to 2 % a month, hopefully while your stock goes up in value (but not too quickly).  This strategy is arguably less risky than un-hedged ownership because once you write the calls, the asset can fall in value a little, and you’re free to take profit on the calls fall in value.  So, while the upside is capped (while you’re covered), and the downside is a hypothetical -100%, you offset you’re P/L line with the premium of the derivative.

Market making is the act of always trying to sell or buy something, it adds liquidity to the market, and the goal is to capture the bid/ask spread.

My strategy is merging these two ideas to get a Market Making Buy-Write.  I’m going to manage if actively adding compensation for bullishness and bearishness, and I’m working on an algorithm to do it for me.

So, I’ll go long (at least 1000 shares) of a double-long options trading ETF.  The higher the implied volatility, the better, and the more bullish you are on it, the better. I’m going to use HXU.TO, double long the TSX – because I believe Canada is in good shape, compared to other countries. I’m also going to apply the same strategy to SSO.  I’m less bullish on the US, but IV is higher…so it’s a wash.  And I’m also going to do it with one other diversified emerging market ETF.

This is how it mechanically…

1. Go long the ETF (BTW, this will work with regular stock too, but stocks swing more violently and IV is less consistent); Eg. HXU.TO at ~$30, at least 1000 shares = $30K.

2. Send 3 to 5 orders to sell various call options on either the front-one,-two, or -three month option (out of the money). Wait patiently, if the markets move up, raise the ask, if it falls, lower the ask. The options are so illiquid, it might take a week for an order to take.

3. Any that are sold, immediately try to buy them back cheaper, trying to capture the bid/ask spread, patiently waiting at the bid. If the markets move up, good, if they don’t, time is on your side and you’re covered. More patient waiting.

4. Repeat 2 and 3 as much as possible.

There is an active/human based management component, where watching the markets full time, one can incorporate short-term bearish/bullishness into the strategy by picking different strikes and being more or less willing to sell calls (aka raise or lower the ask/bid accordingly). But it’s important to always be ready to sell/buy calls – for the right price.

Downfalls to this strategy are that volatility can blow it apart. Luckily as volatility climbs, so should option premiums. The TSX could shoot up, but in which case, any stock covered will just get called away and return more that capturing the spread would have. Of course, there’s a downside, but it should be offset by the fact that any short calls will fall in price, and in the long-run the market trends up.

Starting out, over the next three months, I’m going to program an algorithm using Interactive Broker’s API to do exactly what I’ll be doing manually to test this out. After I have the algorithm working, I’ll add in some bullish/bearish constants that I can change whenever I feel like and leave it on auto-pilot.

Here we have a strategy, that even if with 1000 shares, if you can sell 5 calls, and buy them back $1 or more cheaper, once a month – you’ll have a machine that’s generating at least $500 / $30K = 1.6% per month = 22% per year (before taxes) while the asset should easily appreciate by at least 15% year.

I’m curious about the scaling of this idea, but as time goes by, liquidity will improve. So, as liquidity improves…I’ll shoot for 15 contracts a month taking $0.3 each time, rather than the 5 contracts taking $1 each time.

This strategy is nothing new, people have been doing it since options started trading, I’m just going to get my slice of the pie.

Thanks, Paul, http://www.newyorkfed.org/mortgagemaps/

…well…it might take a couple days to clear, but the point is – A much higher fraction of my net worth is liquid and approximately only 20% invested.

Do I have plans for the loot? You bet.

I’m going to load up the boat on *HXU.TO. depending on the charts, market timing may vary. Enough to add a tiny bit of liquidity on the Montreal Option Exchange. I’ll be trading calls optimistically, essentially running an actively managed buy-write…which I will be switching over to an algorithmic managed buy-write (as soon as I finish the code and get a dedicated processor for it). I’m expecting +23% returns from this.

I’ll also be buying a much smaller position in SSO, planning on selling nearly at the money calls, or maybe i’ll scale in by writing puts-to-own. I’d like to steal +19% per year from this – should be doable if I stick to my policy of at the money front months and don’t get optimistic on the US.

The other list of stocks I’ll be buying include:

VCP (multiplier expanding returns, around the corner), MFC (15% + whatever calls I can scalp), XRAY (18%), and maybe a little TNH (no ceiling on expectations). Also want to take a second look at NTDOY, now that the fit is out.

I’ll be continuing to hold JCI (expecting 18% + multiplier expansion from 15 to 18 + whatever calls I can scalp), CCJ (no ceiling on expectations), CPA (no ceiling on expectations), AAPL (26%), GOOG (22%), and SVC.TO (I’d like to get out of the red before 2009).

I want to save a little cash for adding the right “green” play that comes along or “rice equilibrium” play, or maybe something else – on the cheap.

I may skip on TNH and instead just buy that agriculture ETF, I forget the symbol right now…it just launched…I realize I’m late to this party.

I’d also like to add some exposure to South Africa or Latin America…likely it’ll be through an ETF.

I’m curious what you would do if you suddenly had a bunch of spare cash you had to put to work.

I’ll also be investing in things to improve my productivity: 40″ 1080p LCD HDTV + 2 x19″ Monitors all driven by an Intel Quad Core, 2 TB raid array hard drive with 8 GB of RAM + blue ray and 8 channel sound.

*Note, in original post I wrote HXD.TO – that was a mistake, it’s fixed now.

According to an informed mortgage department rep, at PC Financial, all 5 major banks were sued almost two years ago for accepting “pre-payment” payments not on the discrete mortgage re-balancing dates, as per the standardized contract.  Because of that lawsuit, two years ago, I lost $400, today.  Read on to not let it happen to you. If I had known sooner, I could have saved the minor fee.

Picture this scene.  A home owner wants to use some of the penalty free pre-payment, to increase equity in their home, and reduce the mortgage payments before their 5 year term is up.  Before the lawsuit, the bank would say “Sure, we can take that cash, today, and on the 1st of next month, your new payment will be lowered to $XXX”.  That’s how I figured it would work, but the lawsuit slapped the banks hands for being flexible, and now they choose to only accept payments on the dates when mortgage payments are also collected.

See, the banks used to take pre-payment money any given day of the month and applied the same flat calculations.  The legal document (the one with all the fine print, borrowers sign when they get the mortgage) gave them the right to not bother to account for the (negligible) difference in present value of paying down your mortgage on say the 10th vs the 20th of the month.  Ie, if you paid down $25K worth of mortgage on the 10th, by the banks flat calculations (which they were legally allowed to do) it had the same effect as paying down your mortgage on the 20th.  Somebody got mad about this, and sued, and won.  So, Banks said “Fine, we’ll stop (being flexibly) and accepting payments except for recalculation days (days when we regularly just collect a mortgage payment)”.

Now, since I’ve sold my house on the 15th of April, with a close of the 30th of April, I don’t have a mortgage payment date in between.  So there is no recalculation day where PC Financial will collect my ~$25K of pre-payment. Since there is a penalty, which is a function of the outstanding debt, due when the mortgage is broken I’m forced to pay the penalty on my entire outstanding mortgage, rather than paying down my pre-payment and paying just a penalty on the remaining 4/5ths of the debt.  The penalty for breaking the mortgage early, on 1/5th of debt is approximately $400.  The conclusion is, if I would have closed the sale of the property on the 1st of May, I could have used my pre-payment privileged and sent them a check for the ~$25K on the first of May, but since the deal closes on the 30th of April, I’m screwed out of $400.

Thanks big banks…keep up the good work *rolls eyes*

Tycooonville – That’s where I’m headed.  It’s a place where high degrees of wit, extreme capitalistic tendencies, uber conservatism, and intelligent policy both fiscal and monetary are expected, no - demanded.  In Tycoonville, absolute gains are expected, present value is assumed, and markets are effecient as they all obey causality. To get there, you’ll need hard work, a brain, and likely some form of leverage – plus an invite, from the mayor. 

I’m up at 4 in the morning planning my next 3 months.  This is a green sign with white text, on the way to Tycoonville.

Seriously,  I feel like I have to let everybody know, but likely no one cares, so hence this asynchronous message to the internet. I’ll call it the gameplan from here on out.  Oh, and i’m not being narcassistic anybody who reads me – likely has a vested interesting in some of these points.

ToDo:

0. Finish Taxes (Due in 5 days, will be done in 1 or 2) Clean house for the last time, before tenants move in on May 1st. April is done.

1. BlogTalkRadio – Andy, Ross, & Howard – as I warned I had zero time for this in April, now it’s May – let’s get on it.  If any of you read this, I’m dedicating 18 hours starting May 1st at 1 pm and to be use up on or before May 4th + whenever a scheduled show.  We’ll see how the first show goes.

2. Cuba – You only live once, but Cuba, one can do twice. My girlfriend + plus best bud want me to go…so I’m in. May 5th ish - May 15th ish

3. Chicago – Have to still arrange with Andrea, at Ariel, what week I can volunteer.  1 week, likely late May.

4. Los Angeles & San Francisco – Got some weekend trips to make here.  Assigning two weekends in June.

5. Florida/Hawaii – Both these markets require some attention, may not be able to squeeze them in, crossing my fingers I can.  2 weeks, one per state, likely July.

6. Philly – I regret not calling Scott sooner, I hope I can still get involved with Ashoka, time permitting.

7. Point Pelee – I have to squeeze in a few days with my folks.

In between all those shananigans I have to find a place in Toronto (and move there), finish stoxbox, launch a separate get rich quick scheme I’ve been brewing, manage my growing portfolio, and i’d like to assign a little time and capital to an algorithmic buy-write strategy using Interactive Brokers.  PLUS I should redo jeffreymclarty.com and bluemoat.com.  Oh, and it’d be a shame if i didn’t read a book or two – right?

9. Dallas – The gameplan all wraps up with a week here, starting July 28th.

PS – there is no 8 in Tycoonville, we work on a scale from 0 – 10.  People expect, no – demand, 9’s and 10’s so there is no use for 8’s.  We kept the numbers 0 – 7 to measure hours of sleep per night.

I want a tool where I can quickly look at, show, and share cash flows, graphically.  I want to be able to manipulate them, create annuities, both growing, shrinking, positive and negative, show better than expected, worse than expected, add risk and possibility of outliers events, etc. etc. I think if North Americans better understood cash flows and more specifically, the present value of money – they could be all more well off.  That’s the only trick to getting rich.  Folks, a dollar today IS NOT the same as a dollar tomorrow.

I want to be able to quickly draw up and down arrows for projects, ideas, opportunities, investments, budgeting, etc.

I’m going to add this to the long list of things I want to program for myself.  Maybe I’ll make a website out of it.  Maybe I’ll create a website to help entrepreneurs pitch ideas.  Maybe families could use it, or investors could network and share experiences as well as invest in each others projects.  Maybe discount brokerage firms pick this up to help clients manage more than just their security holdings.

Maybe nothing will come of this idea, and it will end here and now – then again, maybe it won’t.

I owe some thanks, and shout-outs, to the people closest to me that helped me over the last 5 years.   My sister, was probably the most priceless asset to have - she was essentially risk free income, who helped me out in many intangible and unquantifiable ways through-out the entire last 4 years.  She also brought her friends as customers, that worked out really well.  Big thanks to her.  Followed by an “almost-tie-for-first-place” ranking of my amazing girlfriend who helped me out, especially over the last 3 years, with PRICELESS cleaning hours as well also becoming a source of revenue over the last 8 months.  Many many thanks are due.  I’ve also had good friends, I want to thank, as customers for on & off 4 months stretches. Customers who in hind-sight, I should have trusted more and not worried so much over getting deposits as early as I made them.  With the exception of minute little ”best-timez-of-our-livez” dart board holes, holes I almost wish I could take with me when I move out, they never really caused any damage and have been top-notch tenants to deal with.  I don’t know how to put a value on a repeat, good, customer…But want to say thanks for everything guys, and for being so cool.  I owe an even huger (yes I said huger)…maybe even the hugest (yes I said hugest)…thanks to my folks, they helped me in SO many quantifiable AND unquantifiable ways.

My Reflections (Read ‘em if you want, and at your own risk, just my thoughts out-loud):

Hindsight, I think it worked out well for me as well as everybody involved.  I mean, because I put up capital and hours of work I was able to provided a service – a service they all needed, and were happy (I think) to pay for.   I *think* they received a fair price and a good product, in their dealings with me.  Of course, there were minor hick-ups, but compared to the limitless, no-upper bound, of things that could have gone wrong (for either me or them)…everything generally worked out.  Hindsight – I’m glad.

I don’t know the entire impact, I likely never will, of having to balance friends, my girlfriend, and sister (and sister’s friends) as customers.  I’ll never know how many times they likely kept thoughts quiet just to be polite.  I had a few myself, but it’s water under the bridge now.  There are other impacts, I don’t want anybody to think, that I’m not thinking about it.

Well, the deal last week fell through.  The bank ended up needing more time, so we extended the deal until Friday at 3pm.  It fell through at 8:30 AM on Thursday, in the form of an e-mail from the wannabe buyers; ”The bank was going to force us to sign an affidavid (I can’t spell), that no students would ever live there”.  I said, let’s see what ANOTHER bank says.  “They said I doubt it will work”.  The buyers were extremly apologetic for not coming in with financing.  In a heartfelt conversation, the wife said to me “Thank-you so much, for allowing us to work with verbal terms, for what it’s worth – we had nothing but 100% pure solid intentions of delivering every bit of our verbal portion.”

There terms were such, that they were going to pay me 3% higher than my ask (due to multi-bidding), and a close of June 15th. On Thursday, hours after the property began to have showings again, the first bidder ended up coming back with his bid which was ~2.4% higher than my original ask – but a close of september 1st – less desirable terms for me.

Due to the market action, I decided to raise my ask.

Well, the same Thursday, a private buyer came out to play, and bent over backwards to work with me.  He gave me my ask, and a close of April 30th, and since it was a private buyer I only had to pay my agent 3% instead of the terms I signed originally at 5%.

To conclude, I held out and was optimistic several times during negotiations through 3 different bidders, and ended up that the third bidder would end up giving me the best deal.  Having faith in people, would have paid off, even though the bank squashed the first deal.  This new deal inked today, is still pending financing, but for reasons I shouldn’t blog – it’s much more likely to come through. It should be a done deal by Wednesday.  Fingers crossed, and developing.

I’m in the middle of a Real-Estate deal, the conditions get waived tonight by 9pm.  Part of the deal, had to be verbal – I chose to allow it.  I could get screwed, but I wanted the rest of terms of the deal.

The buyers didn’t want my tenants, and asked for “vacant possession”, because they wouldn’t get financing with student tenants.  They verbally told me they actually wanted the tenants ie they were going to lie to the bank. Heir go,  the bank has told them, they can get financing if they rent to a family.  Apparently, students are poor tenents – go figure.

I leaned back in my chair, and decided to have faith in human beings and accept the written offer as well as the verbal terms.  Since, they did give me 3% higher than my ask after an awesome multi-bid evening, I figure – I’ve been lucky thus far.  I’m being optimistic that their verbal declaration of a willingness to accept my tenents will come to fruition.  I could get screwed, and sued if the buyers end up being ass hats.  But, for now, in my youth – I’m choosing to have faith in people, and be optimistic, that it will all work out (and that they were being honest)

I’m taking a page for a smart dude I know, “To the optimist go the spoils” …time will tell if it was smart or not.

It can’t be an efficient business model.  Cold calling people must suck.  Trying to sell insurance, exercise equipment, internet service, long distance…blah blah blah….awful.

Here’s the scary thing -  they keep doing it.  Therefore, some people must actually bite.

I’ve had an idea on how to bring them down – if we all banned together, we could end the telemarketers FOREVER.

Here it is:

Waste their time, make it inefficient for them, make it so bad they hang up on YOU.

Here’s how:

Ask long winded questions, and sound interested in buying.  Try this sentence: “Wow what a coincidence, I’ve really been meaning to BUY product XYZ, can you give me every reason you can why I should buy through you?”  Then set down the phone, and pick it back up 10 minutes later.  If you have time to kill, like while you’re stirring dinner, it usually works best.  All it takes is “Oh, wow, keep going, tell me more” and they will keep wasting their time.  Once you get bored, start asking them dumb questions about their product.  “Well, if I take your product apart, and use it on my cat, will you take it back if it brakes?”.

I don’t even have a cat.

One story:

One time, in the most indian voice ever, I hear on the other end of the phone “Hello, I’m Ronald Smith, I’m calling from Rogers…we’re trying to promote blah blah blah”  ME: “WAIT – what’s you’re middle name, and how do you spell it?”  He shit. Ronald Smith, clearly born in the middle east clearly must have changed his name when he picked up the phone.  He didn’t have a middle name.  And then, he couldn’t spell Smith.  But what’s funny, is he could spell Ronald.  He didn’t get it, so I kept asking him questions while I stirred my mac-and-cheese.  He eventually got pissed and threatened to “Tell his boss on me”  HAHAHAHAHA.  I HAVE NO idea what his boss was going to do, but I said “Put him on, I’d like to tell on YOU, and then waste some of his time, that’d be fun – don’t you think?”  He hung up.  I won.