#Delta for #Value and #Retirement Investors

Account Showing Beta Weighting to the $SPX

But First, an Explanation

Before I get started speaking about Delta I want to correlate what I’m about to talk about to another aspect of life. Most of us learned to drive when were about 15 or 16 years old. We get the basics, we get formal education, and we learn mainly from our parents how to be good, defensive drivers. Most parents do not teach and do not know how to teach their children to be racecar drivers. However, we can all agree that racecar drivers are probably a cut above the average driver from the standpoint of understanding the dynamics and physics of speed. If a parent is a racecar driver, the child that he’s teaching most likely will have a better understanding of the dynamics that the parent knows. The discussion in this article is really designed to learn the best tactics that a racecar driver will know and apply it to every day driving. Replace that with stocks and options and you’ll understand my goal in explaining this to the average value investor.

What is Delta? A little-known concept know by retirees, those wanting to retire, and value investors is the concept of Delta. Delta is an option Greek that measures the options movement in relation to the price of the stock. Therefore, if an option has a delta of .5, it would move up $0.50 for every one dollar in the stock’s price move.

What is Delta?  Why should I be concerned?

Every stock has a Delta of 1.0 for every share you own. So, if you own 100 shares of Apple you have a Delta of 100 and Apple stock. Generally, people investing in their retirement accounts are usually only long stock. When you are invested in long stock alone your portfolio Delta is always long the number of shares you own.

Unfortunately, most people do not know what Delta is nor do they know why they need to understand Delta. In retirement accounts, it is often hard to hedge against a down market with long stock. Many will balance with value plays like consumer staples, energy, or some other hedge against a down market. With a better understanding of Delta you can have a better understanding of what you need to do to protect against a down market.

What is my delta?

As I explained before, every stock has a Delta value of 1.0.  You may ask, how you reconcile a Google stock ($GOOG) valued at $1100 in relation to a silver index fund ($SLV) valued at $15. This is where the concept of beta weighting comes in.

Beta Weighting

Beta weighting is simply the value of a stock in relation to another stock or index. Using the example above, Google has a beta weighting of 1.36, which means Google will move $1.36 for every one dollar move in the $SPX. $SLV on the other hand has a beta weighting of .176, which means again the stock will only move about $0.17 for every one dollar move in the $SPX. The $SPX, or S&P 500 index is one of the more broad indexes. To gauge the overall market against the $SPX seems the most reasonable, especially for a retirement account.

By the Numbers, How to Hedge Delta Risk

probably the easiest way to create a true hedge of Delta risk is to know exactly what your risk is by the use of beta weighting. Not every platform offers beta weighting. Generally, to get beta weighting information you must have an options trading platform. You can use an options trading platform even if you only trade stocks. Two good trading platforms are TD Ameritrade (please click here, as we get a finders fee and you help us produce good content) and TastyWorks (again, click here to help us out). If TastyWorks does not have beta weighting when you read this, they will shortly.

Many people are limited to the account type in Brokerage of their employer. For example, in my retirement account I cannot use either the brokerages listed above. However, do not fear as you can often approximate Delta risk or more simply use some tech simple technical indicators to hedge off that risk. In my retirement account, I will start buying long stocks that are either reverse ETF’s, or long volatility. As of this writing, I prefer $TZA which is an inverse Russell 2000 stock; $SDS, which is an inverse S&P ETF; and $VXX, which is a long volatility product. Please stay away from ultra short products, 3X products, and products that are cash settled. If you don’t know what these are, perhaps stick to the indexes and products mentioned above. When a stock market goes down $TZA will probably out perform in the short term, followed by $VXX. $VXX will outperform at the market bottom. $SDS will most likely hedge against a long-term down move.  Be aware all these products do lose money if they’re held too long on an up move. Market timing is almost impossible, so the best way to hedge is to actually hedge. By this, I mean you should buy a small amount of shares of these hedging products when you feel the market is topping. If the market continues to be go up, simply by a few more shares over the days, weeks, and months. Please be careful not to buy too much. I’m suggesting the use of these products as a hedge, not as a directional investment. If you must use these products as a directional investment to the short side, consider using an options strategy, if your Brokerage allows.

The screenshots below compare the same portfolio at the same time with no beta weighting (left) and with beta weighting against the $SPX (right). You can see the extreme difference in looking at the same portfolio through a different lens. When you beta weight your deltas and get close to zero from a portfolio standpoint, you are lowering your directional risk to one side or the other. If the market were to go down and you had positions in the hedge products I mentioned above, you would sell these products when the market bottoms, or what you think is the bottom. If you make 15% – 25% I would recommend edging out or selling your hedge entirely. Remember, bulls make money, bears make money and pigs get slaughtered. If you think the market has further to run down then maybe keep a portion on the table but take the rest off. The beauty of the strategy is you now have your hedged money in cash to invest in long positions that pay dividends or you can write calls against (covered calls).

Account Showing Beta Weighting to the $SPX
Account Showing Beta Weighting to the $SPX
Account Showing NO Beta Weighting
Account Showing NO Beta Weighting

 

 

 

 

 

 

 

 

 

 

 

 

If you have any questions, please feel free to comment below and I will answer them best I can. In the meantime please also consider using PocketSmith for your accounting. It is the best product I’ve ever seen and want to support them. By clicking on the banner below you support our blog and the information we provide.

The Unconventional Guide to Retirement Savings

Tastyworks Homepage

Expanding Ideas on Investments

In a world where we’re told to ‘play it safe’, I’m here to suggest something a little more robust.  After all, life involves risk.  I wrote an article about low risk versus high risk and the benefits to taking on a little more risk.  I would also offer that if you’re younger you should take on more risk.  The items below are probably more risky than a bond fund in your 401K, however, they probably also offer more income and dividends.  This article will cover some unconventional investing products.   Regardless of your risk tolerance, you should read up on risk in exchange publications, such as

Unconventional Investment Number One: Closed-End Funds

Closed end funds are very similar to mutual funds, except they trade like stocks. The benefit to the investor is that you can get in and out easily, and benefit from appreciation of a limited number of shares. Mutual funds generally do not limit the number of shares available, but expand as people invest more money and shrink if they invest less. Because closed-end funds have a finite number of shares the stock’s price will go up if demand goes up. This is the same thing that causes stock prices to go up. There is another dynamic with closed-end funds which is net asset value, or NAV.  net asset value is the cost of the underlying stocks or products the closed-end fund invests in. For example, if the closed-end fund invested in a stock that is worth $10 and the price of the closed-end fund is nine dollars in theory you would make one dollar just by buying the closed-end fund versus the underlying stock.

Closed-End Funds

Many closed-end funds offer very high dividend yields. I would caution you to invest only in the highest dividend funds, as many of these actually deplete shareholder value to pay the dividends. I would recommend doing some due diligence and looking at closed-end funds that offer underlying stocks that you may invest in on your own. One way to determine this information is to go to the website CEFconnect.com and look at the fund information. The site will let you look at dividend yields, distribution dates, investment information and the fund’s mission. You can also use their screener function to find fund opportunities. I like to invest in funds we use a covered call strategy, is that is generally how they’re making their money. This is a option trading strategy that I would do on my own, however, is generally not allowed in a company 401(k). This is somewhat of a work around to earn income on covered calls without doing the work yourself.

Unconventional Investment Number Two:  Covered Calls and Naked Puts

Option trading is another somewhat unconventional investing practice.  Although they are becoming more mainstream, there is still a lot of mystery.  Although they can be risky, the covered call and naked put are safer than buying stock outright.  Both offer cost reduction to the purchase, or potential purchase of a stock.  This is not the article where I will get into the nuts and bolts, but if you stick to these two options strategies, you cannot be worse off than buying stock.

A covered call is essentially buying a stock and then selling someone the right to buy at from you at a price higher than you paid.  They will pay you a premium for this.  As an example, if you were to buy Twitter today $TWTR for $24.32 (Price as of Close on 1/5/18), and sell a February 16, 2018 call against your 100 shares for $TWTR at the $26.00 strike for $1.13, two things would happen.  The stock closes on February 16 for less than $26 and you keep the $1.13 (times 100, less commission), or about $110.00.  You can then put on a similar trade for March.  If the stock closes in February above $26.00, you would get the $1.13 plus the $26 sale price for your stock, netting you $2.81 ($26+1.13-24.32=2.81).  Also if the stock went down to $23.19, you could sell it and break even, as the $1.13. collected offers you a 1.13 cost reduction.  Do this 24 months and you own the stock free and clear!  This may seem confusing.  It may seem intriguing.  If it is either to you, please learn more.  I will post more about these trades in future articles.  You can also visit our partner site, www.selltheta.com for more information.

Similar to the covered call is a naked put.  With a naked put, you sell someone the right to ‘put’ or sell the stock to you at a certain price.  Let’s use the $TWTR trade at $24.32 on 1/5/18 (today).  If I was bullish on $TWTR, I could sell a put contract for the $24 strike price for February 16, 2018 expiration.  The contract price is $1.55, therefore, someone would pay $155 less commissions to sell me the stock.  On February 16, 2018, two things could happen.  The price of the stock would be over $24, in which case I do not buy the stock and I keep the $155.  Or, the stock is below $24 and the contract owner would put the stock to me, which I was going to buy anyway, right?  My investment in the stock is $24-1.55, or $22.45.  I could then sell a call against the stock I own (See covered call above).  Essentially, you can trade around a stock you like, or choose a different stock each month.

There are more issues you need to be aware of like assignment risk, dividend risk and volatility.  Again, if this is intriguing or confusing, you owe it to yourself to learn more.  If you are interested in a great brokerage account for options and stock trading, visit TastyWorks

Unconventional Investment Number Three:  REITS & MLP’s

REITs are “Real Estate Investment Trusts” and are managed in a special way.  They generally hold real estate or derivatives (Notes, Loans, etc.).  REITs require that 90% of the profits be returned to the investors.  Generally, well managed REITs can pay high dividends.  Please contact a tax advisor or do some research, as they can often times be treated differently under the tax code.

MLP’s or “Master Limited Partnerships” are investments in a specific project(s) and are also treated differently under the tax code.  Many oil wells and natural resource projects are offered as an MLP.  Be careful, as fraud does exist in the MLP and to some degree, REIT market.  Some of these are set up to collect money from investors as the first priority and managing the asset as a secondary task.  This will almost certainly result in a bad deal for the investors.

To find either of these products, I would recommend www.dividend.com or www.finviz.com.  Dividend.com has a premium service with a ranking structure for dividend paying stocks of all sorts.  This might be a good option if you are not sure of what to look for in financial statements.  Remember, Enron looked like a magnificent company on paper, so even “The best” might involve risk.

Unconventional Investment Number Four: Delaware Statutory Trusts (DST’s)

In the early 2000’s, when investments in real estate were hot and there was not a lot of inventory for small investors trying to find single family homes and apartments, there were TIC’s.  A TIC, or Tenants in Common is a type of legal structure to hold real estate.  A TIC investment means that two people (usually not married), could invest in a property equally and if one passed away, their interest would go to the decedent’s heirs.  Whereas many married couples hold their primary homes and other real estate in Joint Tenancy.  The TIC structure became popular in allowing small investors the ability to invest in commercial property or bigger properties with other investors.  When the real estate market tanked, so did many of these investments.  Mainly, the management companies were guaranteeing a certain amount of income for the investor and any improved income would go the management company.  It was a great idea, however, the depth and pain of the downturn in 2007 was unbearable for many of these companies and their investments.  During this market downturn the Securities and Exchange Commission deemed these investments a securities trade and subjected future investments to SEC rules and guidelines.  Needless to say, I would reserve TIC investing for people you know and even then, only with a contract.

Enter the DST or Deleware Statutory Trust.  Another structure for investing in real estate, a DST has a lot of the same features as a TIC, but is still legal.  The investment simply comes down to how good is the underlying property or asset AND how good is the management of that asset.  My concern would be with a DST is you have some of the same problems a TIC has, you are investing with others you probably don’t know; you have little control over your investment; exit strategies for the company may be different than your personal exit strategy, etc.  These types of investment are for savvy, accredited investors and should be utilized with caution.

Unconventional Investment Number Five:  Checkbook IRA

Since were talking about unconventional investing in a retirement account, I would be remiss if I didn’t mention a checkbook IRA.  This type of structure allows you to have retirement funds which are tax deferred in an IRA account where you can write checks to make investments.  The investment and income received go to the IRA account and withdraws for income/living follow the current guidelines of IRA disbursements.  Research this if you are interested in investing in real estate, gold, etc. in your IRA account.  If you are interested in a Checkbook IRA, there are several offering these services.  I will add IRA Accounts offering ‘checkbook’ services below.

Selfdirectedira.org

Conclusion

As I wrote about these investment types, I also cautioned you where I could.  Many of these pitfalls I’ve already gone through myself, some I’ve learned from others, but mostly from my own mistakes.  If you are considering these investments, please seek to understand them better and become an expert.  If you have questions, I’ll try to answer in the comments section.  Understand that just because I brought up an investment does not make it good or bad.  It’s just an attempt to expose you to alternative investments.  Due diligence and starting small are good ways to understand your investment.  As an example, many options trades can be done for a few hundred dollars.  The risk is low compared to the understanding and learning gained.