No. of Recommendations: 14
I would have serious doubts that a crude MACD timing signal adds enough value to get the timing right.
And also serious doubts about their estimate of the cost of the leverage. You're getting a loan to buy something, and the interest you pay is not inconsequential.
Remember that when buying SPY calls rather than SPY, you don't get the dividends. So your true cost for the borrow is the visible time premium in the option, PLUS the foregone dividends.
Getting in and out of option positions as frequently as the suggested timing signal implies would eat you alive in trading costs.
So, overall, I would be pretty darned dubious.
However, I can definitely see the potential merits of using deep in the money call options for leverage.
("Leverage: the only way smart people go broke" -- Mr Buffett)
Over the years I have done very well with leverage, most often using deep in the money call options in recent years.
My key rule of thumb is this: FIRST pick the absolutely steadiest, most rock solid, and above all predictable underlying asset. Not necessarily steady in market price, but steady progress of visible value, now and somewhat into the future.
THEN (and only then) consider adding leverage.
Don't worry if the rate of return from the underlying asset isn't that fantastic. Even a little bit of leverage, say 1.5:1, turns a ho-hum rate of return into an excellent one.
Leverage should be used only when the borrowing meets three criteria:
* It's not callable. This rules out broker margin loans. The leverage built into call options is OK--the counterparty can't ask for the strike price, it's YOUR option.
* It's cheap enough. The implied interest rate varies, so there are years it makes sense and years it doesn't. Just don't do it in years it doesn't make sense.
* It's long dated. You want time for your investment thesis to work out, whatever it might be. LEAPS are in the middle: not short term, but not long term. They don't meet this test, but they are pretty close. The risk is that when it comes time to roll your options they might not be available, or might not be cheap enough. It is not a big enough risk to keep me from doing it.
As many know, I make my living primarily by buying long dated deep in the money calls against Berkshire Hathaway. Both the underlying security and the method of leverage were picked using the rules of thumb above. The business is easy to value, and pretty predictable in its value trajectory, and cheap enough often enough that wanting to use leverage makes sense. (not today however--not cheap). For 22.5 years my average profit in a year has been 28% of the average capital I have had at risk on an average day. (The stock has returned 10.3%/year). The returns from year to year are very irregular, but does that really matter?
The advantage comes mostly from the leverage in calls, but also from some buying low and selling high repeatedly. It got REALLY cheap for a while there around 2011-2012, and I really piled in up to my eyeballs. Consequently I made more money in 2013-2014 during the rebound than I did in 2001-2012 combined, pushing up my average return numbers.
Jim
