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General Finance: S&P 500 investment on margin

Discussion in 'TSLA Investor Discussions' started by TD1, Aug 25, 2014.

  1. TD1

    TD1 Member

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    My broker offers a margin rate of 0.66% pa.
    Given that the avg. growth rate of the S&P500 is 5% it looks like good opportunity to make use of the low margin rate and borrow a bit to increase the performance of the portfolio.
    Of course the down side is that in a crash, we lose more, therefore our margin has to be small.
    But how small/big should it be.

    If we have 100k in the S&P500, should it be ok to borrow 20k extra so we work we will have 120k invested in the S&P.
    such things should add up over 10-20 years to significant differences in performance.

    Or am I missing something?
     
  2. Johan

    Johan Took a TSLA bear test. Came back negative.

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    Average growth rate of SP500 may be 5% but fluctuates a lot, but so do interest rates (0.66% is an atypically low interest rate as compared to average interest rates over time). So this makes sense now, but there will be times where interest rates will be higher while at the same time SP500 returns lower, the curves will cross, and you'll be loosing money). For current conditions it seems like a good arbitrage.
     
  3. mershaw2001

    mershaw2001 Member

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    Where are you getting 0.66%? I'm paying 3.75% through fidelity.

    I generally max out my margin and use more than the allowable Reg T (incurring a margin call that i cycle through every week). I am of the opinion that if you use a covered call strategy on the 20% of the portfolio that is up over 100%, you will make high returns. For myself, I don't do it on the index, I do it on specific stocks.

    In general you're strategy will work. To augment your strategy, add during times of distress and remove some during times of calm like now.
     
  4. TD1

    TD1 Member

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    Interactive brokers.
    they changed in the last few months and I didnt notice.
    So now the charge a little bit more.
    but with 7 digits its still around 1% and lower
    Interest and Financing
     
  5. Cosmacelf

    Cosmacelf Active Member

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    Interactive brokers is great if you really know what you are doing. A nightmare if you don't. Once, I bought some Canadian stocks. But I didn't buy Canadian dollars beforehand, so IB dutifully bought the stock for me on margin and charged me interest every month. Took me a while to figure that one out.
     
  6. Johann Koeber

    Johann Koeber Member

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    Remember also that the interest rate changes without notice (well you can look it up any time, but they will not routinely inform you of interest rate changes).

    So one of your risks is that the interest rate goes up at a time when the stocks are going south. This is the normal scenario: interest rates up ---> equity prices down.

    This might get you in trouble.

    So - as Cosmacelf said - it is ok if you know what you are doing and want to take the risk. Just be careful.


    Do not invest long term with short term money.
     
  7. SBenson

    SBenson Active Member

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    I have been thinking of the same exact idea for a while now. I too am an IB client with a 7 figure (no margin) portfolio.

    Yes, mathematically it makes complete sense to go on margin and invest in a broad based fund. But the tricky part is being emotionally capable of holding the position in a downturn. Let me give an example:

    Last year I was holding 2000 shares of Tesla. When it was trading in 150's in June, I went on margin and bought 1000 more shares. The stock ran up to 180 and then came crashing down to 120s, thanks to f*re incidents. At around the bottom all sorts of negative thoughts came to my mind. What if this the beginning of the end. I would have ruined pretty much everything I had. I couldn't take the pain anymore, I panicked and sold the 1000 shares right around the bottom.

    There is a Warren Buffett quote on this: "When you combine ignorance and leverage, you get some pretty interesting results"

    The lesson I learnt was: most people get kicked out of margin during downturns. Either through poor risk management (margin calls), or because they can't emotionally handle the pain. So turns out that's actually the best time to go into margin.

    There is a Warren Buffet quote on this too: "Be fearful when others are greedy and greedy when others are fearful."

    Now I am waiting for a 20% correction on S&P or 30% correction on TSLA to go on margin.
     
  8. mershaw2001

    mershaw2001 Member

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    If you guys want to achieve this sort of leverage, where it is just supplementing your current portfolio, you should just sell puts. Don't add additional shares. The puts are a safer strategy. Plus they expire when the stock goes up and nicely "take care of themselves"- essentially they expire when tesla is doing well and you don't even have to worry about deciding when you should sell your extra margin amount. Depending on your risk tolerance, you can adjust the strike price.

    For instance, let's say the price of tesla was 140 and it was going down to 122 ultimately (after the F*res). So the stock is at 140 and you don't know how much further it will go down. If you have little risk tolerance but want some exposure, you sell the 100 strike puts. If you want a lot of exposure, sell the 160 strike puts.
     
  9. SBenson

    SBenson Active Member

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    mershaw2001, Appreciate your comment again.

    We were talking about selling (covered) calls in the newbie options thread. I gave up on that idea after discussing with you guys because I fundamentally never wanted to let go of my existing shares, incase the options get exercised on a spike. So I started thinking about the whole premise deeply.

    Selling calls is essentially a bearish move, or at least it's a non-bullish move. That's probably not the position I want to be in with TSLA in any case.

    So, if the goal is to make money by selling accelerated time decay of options, we can still do that by taking a bullish stance. That would be selling puts.

    The risk here is, what if there is a sudden crash. In this case I can let the options get exercised and end up owning the shares bought at a drop. I want to buy more shares (by going on margin) when there is a crash anyway. It all makes sense.

    Tomorrow I will start combing through the put options to sell some. Thanks for all the info/input you have given.
     
  10. MikeC

    MikeC Active Member

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    If you sell a put that is backed by margin, do you pay interest on the margin? Like if I sell a 200 put, I need to have $20,000 in case it gets in the money. If I use margin to cover that, I'm not technically borrowing the $20,000 yet, so is interest charged?
     
  11. mershaw2001

    mershaw2001 Member

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    If you sell a put, you actually get money, so since you aren't borrowing any money you don't have to pay interest. Furthermore, since you get money from the put, you can then spend that money on something else. However, if you do so, you increase your leverage even further. For instance, some people sell puts and use the proceeds to buy calls in a "synthetic stock" play.

    When you sell a put, the brokerage sets aside some of your cash as collateral to cover the purchase of the stock, because after all a put is an obligation to buy. If you are in a non-margin account, the cash is set aside and you cannot use it to purchase. If you are in a margin account, virtual cash is set aside. In a margin account, you are allowed to borrow a margin balance up to the amount that you own, according to reg T rules. The amount you can borrow is your special memorandum account, or SMA. (And, to be honest, i'm really simplifying this here). Selling a put reduces the amount you can buy on margin because the brokerage then withholds some virtual money that is part of your SMA.

    Assume you have 1000 dollars and there is a $1000/share stock. Strategy one: You buy 1000 dollars of this stock, and you could go on margin to buy up to 1000 more dollars of it. You will pay margin interest.

    Instead, strategy 2 in a margin account: you buy 1000 shares of the stock, you then sell a put with a premium of 300 dollars with a strike price 2 years in the future of 1000 dollars. You will now have 700 (1000-300) dollars invested, and 300 dollars that can still be invested. However, you will need to make a mental note that you are 2x leveraged in that stock. Furthermore, your SMA is reduced by 1000 dollars (the amount that you could have bought on margin) because the put requires 1000 dollars set aside as it has a strike price of 1000. Since you took in 300 dollars from the premium, your SMA ends up being 1000-1000+300=300. In this situation you pay no margin interest.

    So that all sounds complicated. If you have an abundance of cash and don't want to leverage yourself over 1.5x, you will never have to be concerned about the above. Your SMA will just naturally recalculate and you will never check the number. The only time this starts to matter is when you get close to that 2x leverage point and start to run the risk of being in a margin call.

    One final thought, Sbenson- don't leverage (margin) yourself in the same direction unless you are ABSOLUTELY sure of the move in the short term. Your own example of margin is that- leveraged in the same direction. Instead, use leverage (margin) to pick up positions that hedge each other. I never sell weekly puts because my account is long tesla. I only use a weekly strategy that is opposite to my main holding. That way, the few times that I royally mess up, the worst that happens is that all my tesla is sold, not that i go bankrupt.
     

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