Risk free strategy that yields 5.46% per annum.

Chuck Krug

Chuck Krug

Buy DIA yield 2.28%
Leverage x4
Total yield: 11,4%
-Margin interest 5.94% *

Yield: 5.46%

Hedge by shorting YM



* Interest on 400k example
 
Chuck Krug said:
Buy DIA yield 2.28%
Leverage x4
Total yield: 11,4%
-Margin interest 5.94% *

Yield: 5.46%

Hedge by shorting YM



* Interest on 400k example
More...

Are you serious, or is this just christmas click bait?

Assuming you are:

The cost of the hedge will be the yield minus the effective funding cost implicit in the future. Yield will be the same; but effective interest will be much lower (in theory it will be what institutions would pay as their marginal cost of borrowing to do the same trade). So this is a way to guarantee losing money...

GAT
 
Hi GAT,
I agree, the title was a bit click-baity. I was afraid that I wouldn't get any responses, what with christmas eve coming up and all. I have to say that I don't really understand your response, but I'll re-read it a few times.
Let me give the example in broad strokes. I'll do the more detailed calculations after my christmas shopping.
Amount Dividend Yield Cost
100k 2.28k 0
400k 9.12 5.92

Total 2.28+9.12-5.92 = 5.48
Please note that I didn't use the full 6.6 portfolio margin, because there is margin needed for the YM.
Please correct me when wrong.
 
Chuck Krug said:
Hi GAT,
I agree, the title was a bit click-baity. I was afraid that I wouldn't get any responses, what with christmas eve coming up and all. I have to say that I don't really understand your response, but I'll re-read it a few times.
Let me give the example in broad strokes. I'll do the more detailed calculations after my christmas shopping.
Amount Dividend Yield Cost
100k 2.28k 0
400k 9.12 5.92

Total 2.28+9.12-5.92 = 5.48
Please note that I didn't use the full 6.6 portfolio margin, because there is margin needed for the YM.
Please correct me when wrong.
More...

The futures trade under the cash market:
Cash market is 17602
March futures are 17465

At march expiration the two will equal each other. So you have earn 135 points in (dividends-interest) to break even. This is 77bps or about 2.5%/year (what you think you can earn).

This is basic no-arbitrage put call parity.
 
Newwurld,
This will probably sound like a stupid question. Are you saying the futures will drift upwards? I've never held futures overnight
Ok,
This will probably work better with a basket of high dividend paying stocks, but then the hedge isn't as good
 
Chuck Krug said:
Newwurld,
This will probably sound like a stupid question. Are you saying the futures will drift upwards? I've never held futures overnight
Ok,
This will probably work better with a basket of high dividend paying stocks, but then the hedge isn't as good
More...

Yes the futures will drift upwards.

Buying stocks for dividend yield and then hedging out with options won't yield a positive expectation because the options (and futures/forwards) will price it in.

The basket of stocks isn't the issue. It's the derivatives hedge to remove price risk that is in this strategy.
 
Chuck Krug said:
Newwurld,
This will probably sound like a stupid question. Are you saying the futures will drift upwards? I've never held futures overnight
Ok,
This will probably work better with a basket of high dividend paying stocks, but then the hedge isn't as good
More...

Yes if you hold high dividend payers hedged with the index then you're effectively running something like an equity neutral hedge fund (though before embarking on this you probably need to do some more reading. At a minimum you should understand the difference between cash neutral and beta neutral). It isn't a 'free money machine' like your OP, but it should earn a positive return over time.

This is a reasonable thing to do*. But you're overpaying for your financing costs because interest margin is so much higher than what you get back in the futures hedge. So it's going to be tough to get positive carry without going for relatively high yielders (roughly speaking you need to earn at least 5.94% - LIBOR, or about 5.5% in dividends to break even).

* I do this myself, albeit without leverage.

GAT
 
I know some guys who have run 100M with a somewhat similar strategy leveraged x5 and hedged wirh futures. And they averaged 13.2% p.a. (after their 2 and 20) since 2008
 
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