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Watsa interview - Part 2


omagh
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Yea the situation is that the people with the capital need an incentive to invest.  In the 50's the gov paid nothing on bonds and we had 5-6% inflation..this puts a lot of capital into companies that earn good returns on capital where it freaking should be! 

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Yea the situation is that the people with the capital need an incentive to invest.  In the 50's the gov paid nothing on bonds and we had 5-6% inflation..this puts a lot of capital into companies that earn good returns on capital where it freaking should be! 

 

Or into TIPS.

 

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Taxable treatment of Tips: Semiannual interest payments and inflation adjustments that increase the principal are subject to federal tax in the year that they occur, but are exempt from state and local income taxes.

 

So unless your marginal tax rate is 0 or you hold all your assets in a Roth you still don't keep up with inflation.   

 

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Taxable treatment of Tips: Semiannual interest payments and inflation adjustments that increase the principal are subject to federal tax in the year that they occur, but are exempt from state and local income taxes.

 

So unless your marginal tax rate is 0 or you hold all your assets in a Roth you still don't keep up with inflation.    

 

 

The interactive brokers IRA accounts are rather interesting -- they let you use margin.  You can write deep-in-the-money index puts covered by TIPS.  I think that ought to beat inflation!

 

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Taxable treatment of Tips: Semiannual interest payments and inflation adjustments that increase the principal are subject to federal tax in the year that they occur, but are exempt from state and local income taxes.

 

So unless your marginal tax rate is 0 or you hold all your assets in a Roth you still don't keep up with inflation.    

 

 

The interactive brokers IRA accounts are rather interesting -- they let you use margin.  You can write deep-in-the-money index puts covered by TIPS.  I think that ought to beat inflation!

 

 

Eric-  Can you elaborate?  You're writing in the money puts on TIPs?  Are you covered by shorting?  I've been writing calls on the 30 year treasury bond futures (betting rates don't go back below 3.85%).  The code in IB is ZB.  If the contract goes above 122 or 123 I would write out of the money calls.

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Taxable treatment of Tips: Semiannual interest payments and inflation adjustments that increase the principal are subject to federal tax in the year that they occur, but are exempt from state and local income taxes.

 

So unless your marginal tax rate is 0 or you hold all your assets in a Roth you still don't keep up with inflation.    

 

 

The interactive brokers IRA accounts are rather interesting -- they let you use margin.  You can write deep-in-the-money index puts covered by TIPS.  I think that ought to beat inflation!

 

 

Eric-  Can you elaborate?  You're writing in the money puts on TIPs?  Are you covered by shorting?  I've been writing calls on the 30 year treasury bond futures (betting rates don't go back below 3.85%).  The code in IB is ZB.  If the contract goes above 122 or 123 I would write out of the money calls.

 

I have been mulling over a strategy for an IRA that would provide "real" capital gains (without dilution from the nominal kind).

 

Say you have $50k in the account

1)  Write very deep in the money puts on an equity that you deem safe (maybe on an ETF like SPY, or maybe KO,PG,JNJ... whatever) with $50k of shares underlying

2)  Buy $50k worth of 10 yr TIPS

 

There are no borrowing costs.  Deflation can only knock the value of TIPS down to their original issue principle value, but that principle value rises with CPI measured inflation.

 

So you earn:

1)  volatility decay  (even deep-in-the-money puts have some volatility)

2)  interest on TIPS

3)  capital gains from rise in shares underlying the puts

4)  rises in the CPI from TIPS adjustments

 

Another advantage of writing deep-in-the-money puts is that you get a huge amount of cash that can be used to raise your margin equity percentage.  TIPS require very little margin equity.

 

Rising inflation expectations shouldn't kill TIPS bonds the way normal 10yr Treasuries would get killed.  They ought to rise but maybe I don't understand it properly.

 

 

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Unless they gave you different privileges on your IRA than mine, I don't think you will be able to actually trade on margin.

 

They offer the IRA in "margin" vs. "cash" but it is not true margin (or at least mine isn't).  It is margin in the sense that If you sell a security on day T, you don't have to wait until T+3 for actual settlement to use the cash.  In other words, you can sell a security and IB will "lend" you the money to buy another one prior to actual settlement. 

 

However, this is not true margin, and is normal business for other brokers.  I actually made the mistake of signing up for a cash IRA first, and thats how I know this, because I had to change it to margin so I could sell a security and use the funds the same day in order to buy another.

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Unless they gave you different privileges on your IRA than mine, I don't think you will be able to actually trade on margin.

 

They offer the IRA in "margin" vs. "cash" but it is not true margin (or at least mine isn't). 

 

I am in tears hearing this.  Dammit, those bastards!  I don't have an IRA account yet, but I was planning on doing it soon.  This puts the brakes on that idea.

 

But anyone it seems could start a hedge fund that beats the S&P500 employing this strategy.  Hah hah... beating the S&P500 is such a f**king joke it seems, yet people try so hard and can't do it.

 

 

 

 

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I have been mulling over a strategy for an IRA that would provide "real" capital gains (without dilution from the nominal kind).

 

Say you have $50k in the account

1)  Write very deep in the money puts on an equity that you deem safe (maybe on an ETF like SPY, or maybe KO,PG,JNJ... whatever) with $50k of shares underlying

2)  Buy $50k worth of 10 yr TIPS

 

There are no borrowing costs.  Deflation can only knock the value of TIPS down to their original issue principle value, but that principle value rises with CPI measured inflation.

 

So you earn:

1)  volatility decay  (even deep-in-the-money puts have some volatility)

2)  interest on TIPS

3)  capital gains from rise in shares underlying the puts

4)  rises in the CPI from TIPS adjustments

 

Another advantage of writing deep-in-the-money puts is that you get a huge amount of cash that can be used to raise your margin equity percentage.  TIPS require very little margin equity.

 

Rising inflation expectations shouldn't kill TIPS bonds the way normal 10yr Treasuries would get killed.  They ought to rise but maybe I don't understand it properly.

 

 

 

a few questions.

1. why only an IRA?  why not do this in a taxable account?  Is it just because of the taxable events associated with TIPS?

2.  I don't quite understand how low risk this is..  How far in the money would you go?  The further you go, the larger the spreads, so there's slippage, plus the higher the likelihood that you get assigned the shares.. which comes to my next point..

3.  Say there's another crash and your stocks drop 50%. You're on the hook for 50K worth of stocks right?  So what you're saying is that in that case you'd either use margin or sell half your TIPS and buy the stock?  Is that right?

4. What about your comment regarding beating the S&P?  I'm trying to wrap my head around that.  How would this beat the S&P?  Maybe my brain just isn't working right, but can you walk me through it...

 

Thanks.

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I have been mulling over a strategy for an IRA that would provide "real" capital gains (without dilution from the nominal kind).

 

Say you have $50k in the account

1)  Write very deep in the money puts on an equity that you deem safe (maybe on an ETF like SPY, or maybe KO,PG,JNJ... whatever) with $50k of shares underlying

2)  Buy $50k worth of 10 yr TIPS

 

There are no borrowing costs.  Deflation can only knock the value of TIPS down to their original issue principle value, but that principle value rises with CPI measured inflation.

 

So you earn:

1)  volatility decay  (even deep-in-the-money puts have some volatility)

2)  interest on TIPS

3)  capital gains from rise in shares underlying the puts

4)  rises in the CPI from TIPS adjustments

 

Another advantage of writing deep-in-the-money puts is that you get a huge amount of cash that can be used to raise your margin equity percentage.  TIPS require very little margin equity.

 

Rising inflation expectations shouldn't kill TIPS bonds the way normal 10yr Treasuries would get killed.  They ought to rise but maybe I don't understand it properly.

 

 

 

a few questions.

1. why only an IRA?  why not do this in a taxable account?  Is it just because of the taxable events associated with TIPS?

2.  I don't quite understand how low risk this is..   How far in the money would you go?  The further you go, the larger the spreads, so there's slippage, plus the higher the likelihood that you get assigned the shares.. which comes to my next point..

3.  Say there's another crash and your stocks drop 50%. You're on the hook for 50K worth of stocks right?  So what you're saying is that in that case you'd either use margin or sell half your TIPS and buy the stock?  Is that right?

4. What about your comment regarding beating the S&P?  I'm trying to wrap my head around that.  How would this beat the S&P?  Maybe my brain just isn't working right, but can you walk me through it...

 

Thanks.

 

 

Let's use the example of your goal being to beat the S&P500 over a 10 yr period.

 

Okay, assume you do this today when the SPY is at 109.61.

Step 0)  Start with 100% cash in the account

Step 1)  Use 100% of the cash to buy TIPS  (Fidelity allow me to margin 10:1 for TIPS, so margin risk is minimal)

Step 2)  Leverage the account by writing the 180 strike SPY put for 72.40, enough contracts where taking the underlying would tie up your cash 100% if you were to have just gone 100% SPY back in "Step 0"

 

Forget about margin calls.  You can margin spy at like 4:1 before getting called and you can margin TIPS 10:1.  So no margin call risk to speak of.  Even if you did get called in some bizarre scenario, it's not like TIPS are an illiquid security, just sell them.

 

Amd who cares anyway if you get assigned?  Just sell the assigned SPY shares and write more puts.

 

The point isn't to make money.  The point is merely to beat the S&P500.  Isn't that how most money managers think?  Do they care if they make you money?  Some do of course, but most just brag about how much they beat the S&P500.

 

And this strategy is guaranteed (I think) to beat the S&P500 on a going forward basis if the CPI rises as some predict it will.  Should the CPI not go up at all.... well, you still get income from the TIPS and you still get a little bit of volatility decay.  The S&P500 isn't yielding much anyhow.

 

 

 

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1. why only an IRA?  why not do this in a taxable account? 

 

I already do it in my taxable account, I use TIPS to back up the 2012 $40 strike WFC puts that I wrote.  You see, right now the "would be" dividend is accruing to book value at WFC.  But I get 5.5% annualized "dividend" from WFC puts in the form of volatility decay and TIPS yield.  Maybe more if I get CPI increases from the tips.  So far I'm gaining intrinsic value at an 11% annualized clip just from that alone!  But that's not all, it's also a floor wax... I mean, it also has capital gains up to $40.  Now, I leveraged myself with this and bought SPY puts Dec 2011 to hedge.  The SPY puts cost me 8% per annum against the notional amount they hedge.  So I feel clever but we'll see how it actually turns out.

 

A tax-free account would be gravy.

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Interesting.  Do you just buy the ETF TIP or do you actually buy TIPS directly?  I'll have to look into how to do this through IB.  But don't you end up paying any margin interest?  I guess you would only do so if the value of the TIP and the value of the underlying stock went down right?

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Interesting.  Do you just buy the ETF TIP or do you actually buy TIPS directly?  I'll have to look into how to do this through IB.  But don't you end up paying any margin interest?  I guess you would only do so if the value of the TIP and the value of the underlying stock went down right?

 

Nope, no margin interest.  You never borrow any money.  The reason why I said to sell the ETF shares and write more puts if you get assigned is that... otherwise you are paying interest.

 

I think of deep-in-the-money puts as float (after all, puts are just insurance on equities).  And float can hurt you if you investments go down.  However, that's why it's not safe to be levered... but levering into TIPS I don't think is too naughty.

 

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Interesting.  Do you just buy the ETF TIP or do you actually buy TIPS directly? 

 

I hold the TIPS directly -- I wanted to make sure that I didn't buy TIPS with CPI adjusted gains already priced in (deflation could knock out those gains) -- I'm all about upside without downside. 

 

The ones I hold are 10yr TIPS that were issued in July 2009.  CUSIP:  912828LA6.  They appreciated 2.32% thus far -- I bought them on Sept 28th.  They do have some downside... but over 10 yrs the yield will easily make them whole even in the very unlikely event of zero CPI gains over 10 yrs (in a pig's ass).

 

 

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