Increasing fixed income by investing in options

Discussion in 'Options' started by mastah, Sep 3, 2005.

  1. mastah


    Dear traders!

    Let's discuss investing in self-made structured products that replicate index returns with 100% capital protection.

    For example DIA Call Jan 2008 @104 ñosts $12-$12.3

    DIA current price is 104.60. Time cost of this option is 4.68% a year.

    So we invest about 90.5% of total investmet in bond or bank's deposit with YTM about 5% and maturity in Jan 2008.

    Also we invest remaining 9.5% of total investment in YCKAZ options.

    So we have 100% of Dow Jones perfomance (excluding dividends) and 100% capital protection of investments.

    If in 2008 DIA is below current price and options cost 0 we'll still have 100% of initial investments because bond part of investment will return us 9.5% for 2 years.

    Let's modify this strategy:

    We invest 85% of total investmet in mutual fund that invest in floating rate bank loans and yields about 7% and remaining 15% in in YCKAZ options. Floating rate loans or bonds don't deprecate dramatically in price with FED RATE changes.

    So we'll have 150% of Dow Jones perfomance and 100% captial protection!!!!!!!!!

    Historical returns of such investments are more than 15% per annum!!!

    What do you think about this strategy?
  2. MTE


    There's nothing to discuss, it is a classic strategy of getting market exposure while ensuring that 90% or whatever proportion is locked away in a risk-free vehicle.
  3. mastah


    Actually existing exchange traded structured products offer extremly low return rate.

    Self made structures can bring you several times more income by decreasing time periods and choosing optimal calls and bonds\income sources.

    Let's make together the most profitable structured product :cool:
  4. sle


    Theoretically, your structure is not any different from purchasing the index and then buyin AMTF put. In fact, being long index plus puts would have the added tax advantages because of the dividents and long-term gains.
  5. mastah


    It's quite different: index hedged by put is not a 100% risk free - you loose time price of put when index declines.

    I've counted that historical returns based on 1 year risk free index investments were about 16% per annum with 12% standart deviation.

    Also I've counted that historical returns based on 1 month risk free index investments were about 30% per annum with 11% standart deviation.

    To archieve this perfomance you should have dividend yield of your bond part to be equal annualised time cost of 1 month option (current time cost is about 12-16% for major indices).

    Now - while VIX is at very low levels and option annual costs are low: all these gives us great opportunities for options buying to dramatically increase income from high yield securities!

    Dear members!

    Please help me with a historical data on any of index options (DIA or, SPY or ^XEO if it is possible). I'll do more advanced historical research to find optimal timeframe for ideal structured product.

    In my turn I promise to share the results of my research on ideal structured product - high risk free returns for everyone!!!

    If you want to chat about risk free option strategies and trading don't hestiate to sent me a private message! :cool:
  6. 100% protection doesn't exist: option decay with passing of time and even if the underlying moves in your favor, it has to do so in a certain fashion in order for you to make money.

    If the underlying move too slow options can and do expire worthless, although this is usually a characteristic of out of the money options.

    in the case the option is at or in the money like your 104 YM call, you'd find yourself in similar circumstances if the YM drops well below the strike.

    That's because the underlying has to move quicker and more to make your call jump from OTM to ITM, and the movement must be even bigger and quicker if there's little time left to expiry.

    This of course would be the worst case scenario for ITM call options, but nevertheless a possibility.

    And this obviously apply to your put options.
  7. mastah


    Yes, to protect your capital you should invest most part in income securities instead of index to cover 100% of losses if the option becomes worthless.
  8. I don't consider option on indices good value for money.

    Your total exposure to losses from DIA ITM call is more than 10% and purchasing the index with a stop loss, although would expose you to risks associated with catastrophes, would impose more or less the same margin requirements.

    And given where yields are going and the difference in volatility you'd probably be better off investing a large slice of your capital in call options OTM on fixed income securities.

    Of course this would be a much more aggressive strategy.
  9. sle is right. The FI allocation is roughly equivalent to the forward-value, embedded. They are equivalent strategies provided you're using the same risk-free rates. Replicating index returns has been bled to death.

    Better off trading a "free gamma" strategy made popular by Taleb and others. Using Q interest payments to purchase Q puts into the convexity[DOTM] as a distinct portfolio.
    #10     Sep 4, 2005