Robusta fundamental, leveraged investments

Ves · 20 September 2011

sinner said:
Just wondering now, if you never considered it because you don't like the idea or because you don't understand the options space?

Just as an example:

You would be happy to buy $5000 worth of ANZ at $19, so you write (i.e. sell) the equivalent amount of ANZ Dec 2011 $19 puts into the market. If you reach the option expiry date and the price of ANZ is above your $19 strike, then the options expire worthless to the buyer and you collect the premium. If, on the other hand ANZ falls to $19, you will probably be assigned $5000 worth of ANZ at $19 plus the premium associated with the options you sold.

In my mind, for a trader like yourself who has conviction to step in and buy at specific prices without any qualms, this seems like a far more lucrative strategy. You get to express your view on the market through shorting the puts. Even if the price never goes back there, you can profit from your view. You don't have to sit around waiting for opportunities, you can short the puts all year long collecting premium until you are assigned at the price you actually wanted.

I always ask people who say "if gold ever went back to $700 I'd buy all I could", why aren't you shorting $700 puts then? The answer is because even though they say they would back up the truck, they actually don't have the conviction to be assigned the underlying instrument at their stated price level!

In the ASX there aren't a lot of stocks where you can do such, pretty much restricted to the ASX20. But in other markets, like European, Korean, Hong Kong or American there are plenty of businesses outside the "top 20" which have deep options markets.

Just my thoughts on the matter, certainly not to be considered as advice!

Sinner,

I really like this idea on face value. But I can see a few issues:

1. The depth of the options market is basically limited to the ASX 20 in Australia.
2. You lose control over when you buy. You are entering into a contract in advance. If the stock price falls sharply in the mean time for fundamental reasons (that impact on your valuation) you are at risk at buying at the wrong price. However, you may argue that research should have shown this in the first place, but I refer to events such as COH's recent product re-call.
Whilst, fundamental investors buy for "non-technical or chart reasons" some will also wait for price support.
3. Not having researched or even used this strategy, do mainstream brokers such as Commsec allow access to the type of options that would make this strategy possible for someone who is, as you said, looking to buy smaller positions (ie $5k or less)?

Can you see please share your thoughts on points 2 and 3?

edit: I also forgot to ask how the premiums are calculated? Are these substantial? do they significantly change depending on the price of the underlying share? For instance, what is stopping someone from writing ANZ options at $6 tomorrow? (I suspsect the answer is that no one would take up the other side of the option).

sinner · 20 September 2011

Ves said:
Sinner,

Can you see please share your thoughts on points 2 and 3?

2. How much risk you take is up to you. If you can't handle buying $X amount at $Y price then the trade needs to be structured differently to just selling puts. You could buy some cheap further OTM calls to hedge against catastrophe for example. But this will eat into profit potential, that is of course the tradeoff. The main point is, how much risk you take is up to you. If you can't afford to be assigned $X amount at $Y price then you shouldn't be executing the trade. The example strategy I gave above was specifically to express the view "I would pay $X amount for stock ABC at $Y price before $N date" and nothing else.

3. I just used $5k as an example. You need to work out which brokers and where yourself! But with the recent introduction of better option granularity at the ASX (*100 instead of *1000) it could be worth looking into.

As for your edit, that is options 101 and really even further off topic than I have already derailed poor robustas thread. Worth doing some reading if you are really interested.

Macros · 21 September 2011

Sinner,

Whilst I can see a benefit of that approach, I don't think you are getting something for nothing. If you agree to purchase something at a future date, you have lost your optionality. Therefore the value of selling those options must have greater value than the optional decision to purchase. Factors may change and you may not wish to purchase at the future date - depending on your perception of value.

If I were looking at such an approach, I'd most likely prefer to purchase preference shares (aka Buffett stye) and get the interest without the compulsory purchase.

I see myself as a value investor but I have a completely different take on the banks. I have CBA put options at $44 expiring next year. My view is that CBA could be considerably lower before expiry. For me, I see more value in purchasing options, either put/call, if you have a strong view and there is sufficient volatility - although you need to be right.

Tysonboss1 · 21 September 2011

Macros said:
I see myself as a value investor but I have a completely different take on the banks. I have CBA put options at $44 expiring next year. My view is that CBA could be considerably lower before expiry. For me, I see more value in purchasing options, either put/call, if you have a strong view and there is sufficient volatility - although you need to be right.

It is just a difference of opinion and also different time frames, your purchase of a cba put is really a short term Bet rather than an investment, His sale of a put may also be a Bet against you or it may be part of a long term investment operation.

You believe short term (within the life of your option) that CBA share price will fall far enough below $44 with a set time frame to cover your premium you paid and generate some profit for you.

The guy on the other end may believe that at $44 dollars Cba represents good value, and he decides to take a longer term approach and decides to invest in 1000 shares.

Instead of purchasing the share on market for $44,000 today, He instead sells you a $44 Jan 2012 put for $3100 and keeps the bulk of his $44,000 earning interest at 6%.

If you are right and the put expires in the money, he takes your stock at $44 and holds just as he would if he bought today, except he has another $3500 in the bank from your premimum and interest on his capital, he is happy.

If the stock goes higher, he keeps his money earning 6% and adds your $3100 premimum to his cash pile, he is happy.

Macros · 21 September 2011

All investing is making bets. You are betting that you understand where the future direction is headed. Yes it is a short-term position, but this is a hedge which allows me to accumulate for more long term purchases.

The $44 options are roughly 100% up from my purchase price. I'd sell them now, except that I can still see considerable downside in the banks value. The put seller may have offset some of his loss, but it is still a loss.

Tysonboss1 · 21 September 2011

Macros said:
1, All investing is making bets. You are betting that you understand where the future direction is headed. Yes it is a short-term position, but this is a hedge which allows me to accumulate for more long term purchases.

2, The $44 options are roughly 100% up from my purchase price. I'd sell them now, except that I can still see considerable downside in the banks value. The put seller may have offset some of his loss, but it is still a loss.

1, We have discussed this before, There is a difference between a Bet and an Investment operation.

2, I would say that the investor that sold a put at $44 instead of Buying the stock at $44 has not lost anything. If the option was exercised today he would be infront.

Macros · 21 September 2011

Tysonboss1,

Happy to disagree. I think we could probably disagree about most things

Firstly, we speculate that the world will be the same tomorrow as it is today. Investment is about perceptive speculation about the future. You can call it as you wish.

Secondly, yes if the person selling put options for $44 had to buy them today, they are no worse off. However, the options don't expire today, they expire next year and are American style.

robusta · 22 September 2011

Interesting discussion about options but I am afraid I have nothing to add except to say I agree with the Tysonboss1 point of view.
I have no idea what share prices are going to do in the next 12 months and I am only interested in buying when companies sp reaches a price in my buy zone.
Long dated (5 years +) options may interest me but there does not seem to be much liquidity there.

anyhow

NEW INVESTMENT

BHP- BHP Billiton Limited

Picked up 85 shares @ $35.60

What can I say, good ROE, stuff all debt, great cash flow, solid earning history and a culture of investing with a eye on the future.

Now the portfolio is fully invested

Things have been extremely busy for me lately but I will try to update the portfolio shortly, suffice to say at the moment there is a lot more red ink than green

sinner · 22 September 2011

Macros said:
Sinner,

Whilst I can see a benefit of that approach, I don't think you are getting something for nothing. If you agree to purchase something at a future date, you have lost your optionality. Therefore the value of selling those options must have greater value than the optional decision to purchase. Factors may change and you may not wish to purchase at the future date - depending on your perception of value.

Who said you are getting something for nothing? Not me! But I did say you can receive a premium for expressing your view on the market, even if the current price of the underlying is much more costly than what you would be willing to pay for it.

I agree 100%, factors may change, and that is why I don't normally discuss this strategy anywhere. The key here is someones willingness to step in at a price and buy with conviction. How many times do I have to point that out? For these sort of traders, it is a potentially lucrative strategy. For pretty much everyone else, it is picking up pennies in front of a steamroller.

I think Tysonboss has explained the dynamics of the situation pretty well. I would only add that the option seller, just like the option buyer, has the capability to cancel their view on the market and buy their puts back at the current market rate, whenever they so choose.

If I were looking at such an approach, I'd most likely prefer to purchase preference shares (aka Buffett stye) and get the interest without the compulsory purchase.

Well, why don't you? Oh wait, those sort of deals aren't generally available for retail.

I see myself as a value investor but I have a completely different take on the banks. I have CBA put options at $44 expiring next year. My view is that CBA could be considerably lower before expiry. For me, I see more value in purchasing options, either put/call, if you have a strong view and there is sufficient volatility - although you need to be right.

Geeez man, I just used ANZ @ $19 as an example, which robusta provided himself! Next time I will just call it XYZ @ $1.

As for where you see value, sure man, whatever floats your boat. I am not advocating everyone start selling puts on everything! It is just an example!

Tysonboss1 · 22 September 2011

robusta said:
BHP- BHP Billiton Limited

Picked up 85 shares @ $35.60

What can I say, good ROE, stuff all debt, great cash flow, solid earning history and a culture of investing with a eye on the future.

Now the portfolio is fully invested

Things have been extremely busy for me lately but I will try to update the portfolio shortly, suffice to say at the moment there is a lot more red ink than green

Your not really working with enough capital to have a really good go at it, But If I wanted to purchase say 1000 BHP and I was happy to pay $35.60 but I was thinking there was a decent chance of further down side share price movements, rather than buy them today I would have sold a DEC $35.50 Put for $2.20 and pocket $2200 in the mean time while I wait and see where they are in DEC.

Worst thing that can happen is you save yourself $2200 and 3 months interest on the pruchase or you walk away with a clear $2200 profit.

robusta · 22 September 2011

Tysonboss1 said:
Your not really working with enough capital to have a really good go at it, But If I wanted to purchase say 1000 BHP and I was happy to pay $35.60 but I was thinking there was a decent chance of further down side share price movements, rather than buy them today I would have sold a DEC $35.50 Put for $2.20 and pocket $2200 in the mean time while I wait and see where they are in DEC.

Worst thing that can happen is you save yourself $2200 and 3 months interest on the pruchase or you walk away with a clear $2200 profit.

OK but there is also a decent chance the sp could be ~ $42.00 in Dec, where would I be with my put option then?

$3026.00 is all relative isnt it? To some it is not much capital to others...

LifeChoices · 22 September 2011

robusta said:
OK but there is also a decent chance the sp could be ~ $42.00 in Dec, where would I be with my put option then?

$3026.00 is all relative isnt it? To some it is not much capital to others...

I bet you $42 it won't.

But you are right about $3026.00 being relative. In 2011 it could probably buy an old but ok commodore in 2015 it may get you a decent milkshake?

robusta · 22 September 2011

LifeChoices said:
I bet you $42 it won't.

Sorry I am not prepared to take that bet as I said I have no idea where the sp will go in the short term. Volatility goes in both directions remember.

LifeChoices said:
But you are right about $3026.00 being relative. In 2011 it could probably buy an old but ok commodore in 2015 it may get you a decent milkshake?

At the moment to me it is 12.7% of my portfolio, so in my eyes a substantual sum.

ROE · 22 September 2011

There is no perfect scenario, what ever you do involve some degree of risk and give and take ..

Buying stock today at XX price you get all the upside if it goes up and you wear all
down side if it goes down....you get the dividend if the stock pay dividend

Selling put with XX strike, you forgo any upside but guarantee a premium and also wear the risk stock tank below strike price..
you get no dividend but the capital can be parked in the bank getting interest if you have other stocks to put up for margin and collateral

skc · 22 September 2011

Tysonboss1 said:
Your not really working with enough capital to have a really good go at it, But If I wanted to purchase say 1000 BHP and I was happy to pay $35.60 but I was thinking there was a decent chance of further down side share price movements, rather than buy them today I would have sold a DEC $35.50 Put for $2.20 and pocket $2200 in the mean time while I wait and see where they are in DEC.

Worst thing that can happen is you save yourself $2200 and 3 months interest on the pruchase or you walk away with a clear $2200 profit.

He just bought 85 BHP and you are saying he could have sold 1000 puts?

What if BHP goes to $30 in Dec and the puts get exercised... where's he going to find $35.5k to buy those shares?

robusta · 22 September 2011

ROE said:
There is no perfect scenario, what ever you do involve some degree of risk and give and take ..

Buying stock today at XX price you get all the upside if it goes up and you wear all
down side if it goes down....you get the dividend if the stock pay dividend

Selling put with XX strike, you forgo any upside but guarantee a premium and also wear the risk stock tank below strike price..
you get no dividend but the capital can be parked in the bank getting interest if you have other stocks to put up for margin and collateral

I think I prefer the first option, I can wait out the downside and happy to collect dividends.

RandR · 22 September 2011

robusta said:
Sorry I am not prepared to take that bet as I said I have no idea where the sp will go in the short term. Volatility goes in both directions remember.

i must confess ..

I love BHP.

But you know full well where BHP is going in the short term. Its a commodity play, its profits are fixed for it. The appetite to pay premiums for those products will quickly diminish based upon current sentiment.

But if you take a 10yr+ timeframe, no matter what happens in the next month or two. its hard to imagine BHP wont be banking bigger $$$ profits.

Tysonboss1 · 22 September 2011

skc said:
He just bought 85 BHP and you are saying he could have sold 1000 puts?

What if BHP goes to $30 in Dec and the puts get exercised... where's he going to find $35.5k to buy those shares?

If you read my post you will see I said he had a small capital so there wasn't much he could do, but I was giving an example of what I would do

robusta · 22 September 2011

This thread was started to track the journey of my portfolio and while the options discussion has been interesting here is my random point of view in no particular order:

* I have no interest in trading anything short term - options included

* If you can tell me where the market or a particular sp is going short term, good luck to you but I have no idea

* The portfolio is focused mainly on small to mid cap ASX companies (not many opportunities to trade options there)

* I have not researched any companies listed on other exchanges and would not be prepared to take on fx risk and higher brokerage to find liquidity

* Using leverage is enough of a risk for me, writing naked put options would make me loose sleep

robusta · 22 September 2011

Sorry I have been away most of this week and missed your post

nomore4s said:
Hi Robusta,

While I commend you on putting forward your portfolio in a public forum there is imo a few areas you need to look at.

1. Market conditions
Your strategy is best suited to a bull market, the current conditions do not suit this strategy imo. Using a $30k loan to buy long term stocks with a buy & hold strategy during a flat/bear phase in the market is opening yourself to unwarranted risks, especially when starting the portfolio up, without even considering hold costs (interest payments, missed opportunity costs etc etc).

You need to have some way to gauge and evaluate market conditions and the effect those conditions have on you portfolio. Like SKC said sometimes it is more profitable to miss the first part of a move.

There will be a time when true bargains are available and this sort of strategy will bring in a very good return but imo we are nowhere near that stage.

The strategy is to concentrate in the main on high ROE growth companies and while this may underperform in a bear market who knows when a bear market ends? It is often difficult to tell until after the fact.

I do however take your point patience needs to be learnt.

nomore4s said:
2. Risk
You need to understand and control risk, and again imo this aspect is very lacking in this portfolio. While I don't mind investing long-term in the right conditions without stops I would never do it in the current conditions with leverage and I would never be fully invested under current conditions with leverage and no stops.
When starting a portfolio up like yours it is probably better to drip feed your capital into the market to help counter some serious portfolio heat should we encounter a serious drop in the market and with the current risks surrounding Europe and the US this is not out of the realms of probability.
If the market does tank tomorrow and your portfolio halves you are left carrying a debt or a number of stocks that could take years to get back to breakeven and either way you are left paying interest on your loan till repaid or the market recovers.

Wow you were reading todays news two days ago

I understand your point but I think the cycle is moving faster now. If you bought a quality growth portfolio just before Lehman Bros went down it would have hurt but would not have been terminal.

The quality of my portfolio will have to stand the test of time.

nomore4s said:
3. Return
Investing is all about generating a return and one of the big problems for you with this sort of strategy is you need to return around 8%pa to end up in front, now during a raging bull market this is probably going to be no problem but during current market conditions you will be lucky not to lose 8%pa.
It is going to be very very hard to get in front with the way the markets are atm and paying 7.5%pa in interest makes it harder, especially with a buy & hold type strategy.
IMO you would be well worth having a good look at SKC's fundamental strategy & have some long discussions with SKC about how best to pull returns from the market using a fundamental approach as his method is one of the best I have seen.
IMO you need to be more active to generate returns using leverage the way you are.

I respect the way SKC operates but I do not have his focus to find short term opportunities.

The companies I hold have IMO rising profits and dividends into the future and with that capital gains should take care of themselves. I look forward to the day the portfolio becomes cashflow positive.

nomore4s said:
Good luck and I hope you continue to look at ways to improve your trading/investing.

Thankyou I will

Robusta fundamental, leveraged investments

Ves

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sinner

Macros

Tysonboss1

Macros

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Macros

robusta

sinner

Tysonboss1

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LifeChoices

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ROE

skc

Goldmember

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RandR

Tysonboss1

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