Tell me if this setup is stupid

[drm7]

Also this: https://en.wikipedia.org/wiki/Lottery_bond

 

[JSOP]

Had a random thought about a portfolio allocation setup. Say you have $100 in fixed income (we'll just say govt bonds) that pays you 5% per year in interest, $5. You use the interest payments only for pure risk trades with high payoffs, taking large relative risks to the $5 allocation on trades that pretty much always have negative EV, just gambling, like buying options 1-3 days before expiration on stocks that have earnings when the options are trading for a few pennies, every so many you'll make a gigantic percentage return on the $5 risk allocation.

So the thing here is knowing that the risk allocation has negative EV, but building gambler's ruin into the setup by using only the interest payments to fund the risk allocation, and any time there is a big profitable trade wiring the profits out of the risk account not to be touched, so the risk account's capital never grows beyond the amount that gets paid in in interest and to protect any winnings. The idea being to get one or maybe a few big winners before it goes broke every year/semiannual interest payment period and then when it does inevitably go broke, wait for the next coupon payment and rinse and repeat.

I'm not sure if the fact that the risk allocation has negative EV means you'd just be slowly investing into a setup that will lose money over the long run and nothing else matters, or if the potential for huge payouts with the max drawdown being ending the year/coupon payment increment flat makes it something like free (aside from opportunity cost and the interest received, but I'm not concerned about that right now) lotto tickets?

EDIT - I'm assuming trading options like that would have a negative EV, I'm not certain but I'd think it most likely does.

As long as you do UNLEVERAGED trades (that means NO shorting and no buying on margin) with the interest payments ONLY and not 1 cent of the principal no matter how much you lose, then you will be fine. Your principal would at least be preserved. The return would just vary year from year according to your luck. Your setup is fine. That's how many of the market-indexed funds operate anyway.

The only potential loss that you could incur is just like what @kmiklas said is inflation and that is assuming you lose 100% of the interest payments investment every single time.

 

[ajacobson]

The strategy used to be called the 90/10 when interest rates we 10%. There we actually mutual funds that specialized in this. Today it is fairly common in bank issued structured notes and a variant is used in index-linked annuities

 

[kj5159]

The strategy used to be called the 90/10 when interest rates we 10%. There we actually mutual funds that specialized in this. Today it is fairly common in bank issued structured notes and a variant is used in index-linked annuities

Wow, a different era I guess. Could you tell me more about these bank issued structured notes? I thought structured products (besides annuities) were no longer in existence?

 

[ajacobson]

Here's a recent one. Still a very robust market - especially overseas.

 

[tsznecki]

This is Taleb's barbell strategy. Works if you can take the hit from inflation.

 

[kj5159]

Here's a recent one. Still a very robust market - especially overseas.

Thanks for the info! This is a fascinating little gem:

"As a result of such rebalancing, the index may not include any ETFs and may
allocate its entire exposure to the money market position, the return on which will always be less than the sum of the
return on 3-month USD LIBOR plus 0.65% per annum. Historically, a significant portion of the index has been in the
money market position."

There are some very sophisticated-sounding ways for GS to screw you if you buy this thing.

I'm surprised they're able to have this product be a CD, I guess there's some language in the rules for what a CD can be that says something to the effect of: "the issuer can choose how they set up the interest rate" etc.

I've wondered about marketing some kind of structured product to pension funds, pretty much having the result of operating an insurance company that sells giant annuities/annuity-like products to pension funds. Are they the target market for stuff like this?

 

[murray t turtle]

The strategy used to be called the 90/10 when interest rates we 10%. There we actually mutual funds that specialized in this. Today it is fairly common in bank issued structured notes and a variant is used in index-linked annuities

%%
And plenty of money was made, plenty of mortgages was/were bought @10% APR.The bank also made a killing off what they called ''credit life''' A HIGH priced term insurance policy for the amount of the loan LOL-LOL.Some have so much student debt they cant even afford a cheap mortgage @ todays rates.

 

[sle]

There are some very sophisticated-sounding ways for GS to screw you if you buy this thing.

Nah, it's based on an immutable formula which GS can't really influence (this is a standard CPPI . Of course, you are taking GS credit risk and getting shafted on the actual cost of the structure, but that's a given.

I've wondered about marketing some kind of structured product to pension funds, pretty much having the result of operating an insurance company that sells giant annuities/annuity-like products to pension funds. Are they the target market for stuff like this?

Not really. Most structured notes buyers are either retail or family offices. Some of them are pretty sophisticated and have good selection process and some are the proper dumb money. Variable and index annuities are a separate world and there is a whole sub-industry of structured products that is geared towards hedging that risk for insurers.

 

[kj5159]

Nah, it's based on an immutable formula which GS can't really influence (this is a standard CPPI . Of course, you are taking GS credit risk and getting shafted on the actual cost of the structure, but that's a given.


Not really. Most structured notes buyers are either retail or family offices. Some of them are pretty sophisticated and have good selection process and some are the proper dumb money. Variable and index annuities are a separate world and there is a whole sub-industry of structured products that is geared towards hedging that risk for insurers.

Lol @ "the proper dumb money".

So there are structured products that insurers will buy to hedge the structured products that they sell? I would've thought they do that in house.