Critique this strategy....

Discussion in 'Strategy Development' started by lindq, Aug 28, 2010.

  1. lindq


    I'm a trader, not an investor. But I have extra cash with which I'd like to create income instead of just sitting idle.

    Here's an idea I've been kicking around. See if you can shoot any holes in it.

    1. 100K account. Buy a 200K basket of dividend yielding 'blue chips' paying an average yield of 5-6%. (IB's margin rates are very low at present.)

    2. Sell 4 ES futures contracts in the account.

    My objective of course is to minimize damage from overall market risk on the downside with the short futures. Individual company risk is protected somewhat by the dividend yield.

    If the market rallies, the short futures will lose, but a diversified basket of stocks will tend to rally equally, making it pretty much a wash. But the dividends will continue the same yield.

    Other than the possibility of a sharp pullback in one of the stocks being held, I don't see too much downside to this strategy, with the possibility of at least some income from the account.

    Intelligent comments?
  2. Buy a 200K basket of dividend yielding 'blue chips' paying an average yield of 5-6%. And "blue-chip" and dividends this high are somewhat mutually exclusive.

    Here is the first problem. Stocks with this kind of dividend are often so because their stock price got hammered. And the dividend often will be soon reduced drastically to adjust. For various reasons.

    If it were this simple, everyone would buy the 5-6% dividend stocks and avoid CDs, bonds, or bank accounts paying 0.5%.
  3. MLP's, preferreds.

    Noone with a brain follows what pikers/general public does. They buy and sell the wrong things at the wrong times.
  4. 1- Your stocks can underperform the S&P by much more than the dividend yield on the stocks. I mean, way more
    2- IB margin will increase over time, as interest rates will. If they dont, it means there is a huge problem in the economy and this could translate into lower dividends.
    3- You will have to roll the futures, and therefore pay the futures roll. (I am not 100% sure about this one)
    4- It's a crowded trade. You ear about buying high yield dividend paying stocks all day long on CNBC. I dont know how that could turn badly but theses stocks may underperform after evebody bough them for the same reason you want in.
  5. LEAPup


    How about building your portfolio with the dividend payers you want, and buy a proportionate amount of leap puts on the spy to hedge you against a 20% drop?
  6. lindq


    These are all good comments.

    However, I would point out that credible academic research has shown that over time a porfolio of conservative dividend stocks has outperformed the S&P by a wide margin.

    The question seems to be the best way to mitigate overall market risk, since so many of these stocks as a porfolio will track the S&P closely.
  7. drcha


    Yes, or hedge with cheap VXX calls out of the money.
  8. drcha


    Excellent point. You can squeeze a bit more out by selling calls against them. Make sure the calls are out of the money, maybe delta around 30-40% is a good spot.
  9. 1. Why would you pay interest to IB when you can pay no interest at all for the same leverage?

    2. Explain how you came up with the hedge value. Dollar for dollar/other/etc?
  10. Could someone cite the papers/references/links/etc?
    #10     Aug 28, 2010