Is There Money to be Made Investing in Options? A Historical Perspective

Today, we will review a paper titled Is There Money to be Made Investing in Options? A Historical Perspective. Doran et al*.

The authors use the S&P 100 and the S&P 500 as their benchmarks. The performance of these two benchmarks is nearly identical. Since we refer to the S&P 500 frequently in our blogs, we will do so here.

The paper is scholarly. Monday Morning Millionaire Program members who have the interest, the time and the advanced investing knowledge needed, would find it interesting.

The paper concludes “that including options in the portfolio most often results in underperformance relative to the benchmark portfolio.”

That has been my personal experience over many years. The Monday Morning Millionaire Program now recommends that members write (sell) options in their “fun” portfolio only. It should make up a small percentage of their market holdings but they might find some interesting mispricing which they might then use in their core portfolio.

Note that the paper mentions that underperformance occurs “often” and not “always”.

We have written about writing (selling) derivatives (options) earlier. It would be useful to review the blog. 

Here is another way some Monday Morning Millionaire Program members will find interesting.

  1. Take a meaningful amount of money, say$250,000 and park it in a money market fund such as the TD166 which recently yielded 2%.
  2. This allows you to write (sell) cash-secured puts on a selected security with a strike price 10% below the market price with an expiry date one year away. The Monday Morning Millionaire Program recommends that your security be an exchange-traded fund (ETF) which parallels the S&P 500. 
  3. The money you receive from writing these puts allows you to sell more cash-secured puts on the same security.
  4. Sit tight for a year.

The worst that could happen is that the market drops by more than 10%.  Your chosen ETF would be  put to you (you would be assigned, that is, you would have to buy the ETF at the strike price at which you sold it. ) You like your chosen index so that is fine but you would not be able to buy it at is current bargain price.

Most of the time, you would have earned a very nice return on your investment.

* Doran, James and Fodor, Andy, Is There Money to Be Made Investing in Options? A Historical Perspective (December 8, 2006). Available at SSRN: https://ssrn.com/abstract=873639 or http://dx.doi.org/10.2139/ssrn.873639

Please note that the Monday Morning Millionaire Program contains opinions only. It does not provide any investment advice or endorsements.

Zero return on gold? Really?

On September 27, 2019, from Louis M…. DDS, Louisiana, U.S.

Question:

Your article on gold has me very confused about a zero return on the precious metal of 0% since 1926 at which time the price was less than $21 US. The price today is just above $1500. Is this an error or ??

Monday Morning Millionaire Program Answer:

Thank you for your question Dr. M. I am certain that other Monday Morning Millionaire Program (15.5% annual return since 2012) members would like to see our answer.

The 117-year table below (used with permission) is from Credit Suisse, an authoritative source.

It shows the 117-year real return from gold to be just above half a percent per annum.

Another authoritative paper* states:

“Gold has been described as an inflation hedge, a “golden constant”, with a long-run real return of zero.”*

Gold prices have a history of wide fluctuations as the decade-by-decade table below shows.

For every investor who was able successfully to take advantage of these fluctuations, there was an investor who lost.

However, holding gold for a long time has historically provided inflation protection for savings.

That alone is a major achievement.

*Erb, Claude B. and Harvey, Campbell R., The Golden Dilemma (May 4, 2013). Financial Analysts Journal, vol. 69, no. 4 (July/August 2013) 10-42.. Available at SSRN: https://ssrn.com/abstract=2078535 or http://dx.doi.org/10.2139/ssrn.2078535

Please note that the Monday Morning Millionaire Program contains opinions only. It does not provide any investment advice or endorsements.

Super-inflated market. What to do?

On September 25, 2019, from Bruce W……DDS, ON, Canada

Question:

Talk about this red hot market being at its peak [maybe] and we’re long overdue for a major correction. Do you still invest in ETF’s with prices being so over-bloated?

Monday Morning Millionaire Program Answer:

Thank you for your question, Dr. W. Many have similar concerns.

At market tops, and we might well be near one, as well as at market bottoms, and at all times, it is important to maintain our personal asset allocation.

It is also important to invest in an ETF which mirrors the S&P 500 which itself is an excellent proxy for the entire US economy, the strongest in history. That economy, like all others, will go up and down and take the S&P 500 with it as well as the ETFs that parallel it.

Everyone feels good getting a bargain be it when buying a car or a house or a dining room table or anything else. When the market corrects and becomes a bargain, incompetent investors flee. Competent investors buy the bargains. A bottomed out market will rise with time and allow competent investors to take profits.

This approach does not apply to individual stocks some of which might never rise from their bottoms. (Penn Central Railroad, Enron, Nortel, WorldCom, most penny stocks are examples.)

To summarize:

  1. Have and maintain a solid, personal asset allocation position.
  2. Invest in an ETF which parallels the S&P 500.
  3. Maintain a long term view. (Habit number four)

The answer to yesterday’s question is similar to this one in many ways.

Please note that the Monday Morning Millionaire Program contains opinions only. It does not provide any investment advice or endorsements.

Questions about gold, possible market crash

On September 24, 2019, from Cam K…… DDS, BC, Canada

Question:

I did have several questions-

  1. What are your thoughts on gold– especially holding physical gold?
  2. If the stock market bubble was to crash, as many analysts say it will soon, wouldn’t you still be very exposed – with being in an EFT?

Monday Morning Millionaire Program Answer:

Thank you for your questions, Dr. K.

Years ago, the Aden sisters predicted $5,000 per ounce gold. Currently, James Rickards is talking $10,000 per ounce gold. Neither prediction has come close to taking place. What does history tell us?

Over the 93 years since 1926, the S&P500 has returned 11.96% annually. Gold has returned 0%!

On May 7, 2018, we posted a more detailed blog on the subject.

Concerning a market crash, the Monday Morning Millionaire Program (15.5% annual return since 2012) encourages members to hold an ETF which mirrors the S&P 500  and to welcome market drops for the bargain buying opportunities that they are.

To do that, members need to have an appropriate asset allocation in place with enough cash to take advantage of the bargains.

Monday Morning Millionaire Program members take profits when the market rises and buy bargains when it drops. Fluctuations are exciting. Lateral markets are boring.

Please note that the Monday Morning Millionaire Program contains opinions only. It does not provide any investment advice or endorsements.

Negative interest rates

Many are surprised by negative interest rates which have attracted over 15 trillion dollars. CNBC recently published a fine article on the subject.

To control either an overheated or an underperforming economy, policymakers adjust interest rates (among other things).

If you go to a search engine and look for “negative interest rates” you will get over 200 million hits. We have yet to see one which talks about Gerald Loeb’s perspective published over 70 years ago.

“Indeed, should some super-solvent agency agree to preserve the buying power of capital for a substantial length of time at a stated fee per annum, informed people would embrace the plan enthusiastically if they felt there was any real possibility of the agency staying solvent.”

(Loeb, G.M. The Battle for Investment Survival, Classics Edition, p. 18. Kindle Edition.)

In 2011, Greek investors holding government bonds took a 50% writedown on the value of their holdings. Those who had some savings in Swiss bank accounts which actually charged depositors lost nothing but a small service fee.

The inflation rate in Venezuela  was 800% in 2016, over 4,000% in 2017, and 1,698,488% in 2018! Savings were wiped out!

Unless they were in a Swiss bank which charged depositors a small service fee.

During the Civil War, savvy American businessmen held their savings in Swiss bank accounts that charged depositors a fee thereby protecting themselves from the hyperinflation of Confederate currency.  Through inheritances handed down from generation to generation, some of their descendants are benefiting from that wisdom still today.

There are many other examples in history.

American and Canadian investors need not worry about hyperinflation. This blog is intended to highlight Loeb’s view.

Wall Street, Main Street conflict of interest

We just completed the fourth session with a member who is going through the Level 2 process. He has a nice size portfolio which held about 100 securities in it when we started the process.

100 securities!

We compared the performance of SPY, the largest index exchange-traded fund (ETF), to these securities, four at a time, in order. That is, we did no cherry-picking to prove a point.

 

SPY

Over the course of a decade, of the first four securities selected, not a single one equaled the performance of SPY.

Among the other SPY/four-security comparisons, an occasional one did outperform. Microsoft, for example, as you can see in the chart below.

 

SPY

However, if a portfolio has 100 more or less equal-weighted securities, that is, each representing a similar percentage of the portfolio, what possible difference could such a stellar performance by a single security make to the overall portfolio itself?

What possible difference could 100 commissions make to the broker’s income compared to one commission? Follow the link to fiduciary responsibility  and renew your understanding of the way the world of Wall Street works if you have not done so already.

In this and in many similar cases, the broker/advisor did nothing illegal. In fact, one could argue that a large number of stocks is a fine example of diversification. Diversification or diworsification?

In our blogs, we have repeatedly stated that, based on the last decade, a U.S. index Exchange-Traded Fund (ETF) which tracks the S&P 500, held in a tax-advantaged account, has been the investor’s best way for growing savings and is likely to remain so for many years.

We need to be aware of and beware of the Wall Street, Main Street conflict of interest.

Please note that the Monday Morning Millionaire Program contains opinions only. It does not provide any investment advice or endorsements.

 

Forecasts: the best way to benefit from them

 

Who but a weather forecaster could be wrong most of the time and still keep the job?

Investment gurus, that’s who.

Recently, renowned economist, James Rickards  published Aftermath: Seven Secrets of Wealth Preservation in the Coming Chaos (Penguin Books Limited, Jul. 23, 2019). Daunting title, prominent author, plausible gloomy forecasts, difficult reading – only street bums with no assets could ignore it!

However, the record shows that renowned guru forecasts are worse than a coin flip. Well-known gurus predicting the stock market, economic growth, currencies or interest rates make weather forecasters look good.

Making forecasts costs nothing. Attractively packaged in a book put out  by an established publisher, such forecasts can make money for their authors.  Investing based on these forecasts is, at best, less than optimal and at worst, a money-losing activity much of the time.

The best way for Monday Morning Millionaire Program members to benefit from  “expert” forecasts is to practice the habits of Monday morning Millionaires and to ignore the forecasts. We should read them for amusement only.

Members who want to spend time studying well-documented economic forecasting history can read Larry Swedroe’s May 20, 2019 article.


Whom can we trust? Part 2.

A space photo such as the one of China above is a convincing view of the level of industrial activity. Areas of industrial activity and the related energy use are lit up. The dark areas show a complete lack of industrial activity.

This is a continuation of yesterday’s blog in which Beijing claimed that in the second quarter of this year, China had a 6.2% annualized growth. Reviewing data much of which was officially unreported, a Sunday Wall Street Journal article said: “…there is a growing belief among economists, companies and investors around the world that the real picture is worse than the official data.”

Bluntly stated, the Chinese government is lying about its economic growth. Belongs to the same club as President Trump.

Observations certified by  Space photos like the one above show a contraction of industrial activity, not growth. Then there is a web-search index which shows the number of workers who return to work after a major holiday. These numbers are down sharply.

Some Monday Morning Millionaire Program members want to know why the program does not recommend markets other than the American one.

It comes down to the third habit of the six habits of Monday Morning Millionaires, which is, buy the US economy as a whole. (That is, don’t pick stocks, don’t pick countries other than the USA.)

History shows that investors could not do much better than holding shares of the largest 500 companies in the most diversified economy in the world. Further, for investors looking for Chinese exposure, the majority of these companies have a market presence and most countries, including China. That eliminates the risk of being victimized by a culture of twisting facts.

If you are interested in details, see in the Wall Street Journal article.

Please note that the Monday Morning Millionaire Program contains opinions only. It does not provide any investment advice or endorsements.

Whom can we trust?

A space photo such as the one of China above is a convincing view of the level of industrial activity. Areas of industrial activity and the related energy use are lit up. The dark areas show a complete lack of industrial activity.

The Bottom Line

From the Wall Street Journal, September 8, 2019:

“…there is a growing belief among economists, companies, and investors around the world that the real picture is worse than the official data.”

Simply put, the Chinese government is lying.

It is well known that dictatorships show the world how and what these dictatorships want the world to see. They want investors so they entice them with rosy portrayals of economic reality.

Beneath China’s stable headline numbers, there is a growing belief that the real picture is much worse.

We wrote about that previously.

We will expand on the subject in tomorrow’s blog.

Please note that the Monday Morning Millionaire Program contains opinions only. It does not provide any investment advice or endorsements.

Why the difference in performance of exchange-traded funds (ETFs) which mirror the S&P 500?

On September 4, 2019, from John G….. Ontario, Canada

Question:

The three Canadian ETF’s which follow, mirror the S&P 500:

  1. BMO S&P 500 INDEX CAD UNT ETF Symbol ZSP (not currency-hedged)
  2. VANGUARD S&P 500 Index ETF, Symbol VSP (currency-hedged)
  3. iShares Core S&P 500 Index ETF, Symbol XSP (currency-hedged)

Over the last decade, as expected, XSP and VSP have appreciated as much as the S&P 500 has — a little over 100%. ZSP has appreciated about 180%.

Please explain the difference.

Thank you.

Monday Morning Millionaire Program Answer:

Currency hedging removes the effect of foreign exchange fluctuations.

For instance, if your ETF was CAD-hedged and the CAD weakened relative to the US dollar by 5% over a certain period during which the S&P500 rose 15%, then your return would be 10% for that period. If the CAD appreciates relative to USD, then the opposite is true, of course.

Non-hedged means you will get the return of the S&P500 in USD terms and you benefit if USD gains strength over the CAD.

Over the last decade, USD has strengthened relative to the CAD, which is why ZSP (non-hedged) has outperformed.