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Why Doesn't Anchor Roll The Long Calls?


Recently, an Anchor subscriber asked, “Why don’t we roll the long calls in the Leveraged Anchor portfolio after a large gain and take cash off the table?”  This question has a multi-part answer, from taxation to how the delta on a position works.

First, from a tax standpoint, there are significant advantages to holding the long calls over a year.  These advantages are in the difference between long term and short-term capital gains rates.  In 2018 and 2019, long term capital gains rates are:

 

            Long Term Capital Gains Rate                   Your Income

 

                                    0%                                           $0                    -           $39,375

                                    15%                                         $39,376           -           $434,550

                                    20%                                         $434,551         -           N/A

 

In other words, if you are a low-income retiree, using Anchor to protect your assets with a total income under $39,375, you would not pay any taxes on your gains.  Take the situation where a retiree’s sole source of income is from a stock portfolio of $500,000 with half in Anchor and half in long-term muni-bonds yielding 2.31%.  During the year, Anchor appreciates 10%.

 

The investor would receive $5,775 in interest on the muni-bonds and $25,000 from Anchor, as well as a few thousand dollars in BIL dividends.  This investor is below the $39,375 income threshold, so would owe no taxes on the investments that year.  Whereas if the investor had sold the calls in less than a year, they would owe short-term taxes (12% rate covers $9,701 to $39,475).  The investor, living on the low-income from his portfolio, saved almost $3,000 by simply holding the gains in the long calls for over a year.

 

The difference is no less startling for investors with huge portfolios.  Let’s take Investor #2, who has invested $10,000,000 into Leveraged Anchor (NOTE:  If you have $10m, don’t invest every penny into any single strategy, ever).  The investment made $1m on Anchor and the tax bracket for Investor #2 is 37% -- instead of 20% from long term gains.  They would save over $170,000 in taxes, merely by holding over a year. 

 

(Note: Yes, I am aware of how blended tax rates work, the above numbers are going to be slightly off, as the $10m investor’s blended tax rate is probably closer to 35%).

 

For tax purposes alone, selling to roll makes little sense.

 

However, even if taxes don’t weight into your considerations, the delta of the position should.  When Leveraged Anchor opens its long call position, it does so around a 90 delta (95 is better, but that’s difficult to find right now).  The further in the money and the closer to expiration the position gets, the higher that delta goes. 

 

For those who do not remember what delta represents, delta is the amount an option price moves for a $1 move in the underlying.  So, if our delta is 95 and the price of SPY moves $1, we would expect the price of our option to go up or down by only $0.95 (ninety-five cents).  In other words, we will lag by the delta spread in a bull market (if delta is 95, the delta spread is 5%).  Part of the reason Leveraged Anchor changed to its present format was to try to eliminate the lag in bull markets.  This means a higher delta closer to 1 is better for our strategy. 

 

There is no reason to sell a 98 delta position to switch to a 90 delta position if the position is not near expiration.  Doing so would hurt future performance in bull markets.

 

Is there ever a time to sell the long calls prior to expiration other than the investor needing capital returned?

 

Yes – in the event investors decide to change their risk and leverage profiles.

 

For instance, investors could take on more leverage and increase their risk profiles.  Currently, Leveraged Anchor is in the December 2019 175 Calls, which are trading around $118 and a 91 delta.  These could be sold and reinvested in a strike such as the June 30, 2020 199 calls, currently trading at $94 and also a 91 delta.  This could increase the leverage in the portfolios by just over 20%.  In a bull market, their returns would significantly increase.

 

Similarly, investors could move to the June 30, 2020 calls and invest less money and move some of the gains to BIL.  Doing so would reduce leverage in their portfolios. 

 

Such decisions should be made by investors on a “what can I stand to lose” pain test.  This number shouldn’t change that often and should only change due to life events such as retiring, losing jobs, getting older, paying for a kids college, etc.  Risk should not change because you “feel” differently about the market – that is irrational investing.  Leveraged Anchor is a long-term strategy, it should not be changed dependent on your thoughts, the media’s thoughts, or the like.  It is structured to protect against catastrophic market failure.  Restructuring comes with costs and should only been done for reasons contemplated ahead of time.

 

We will discuss calculating “max loss” on Anchor in a coming post.               

 
Christopher Welsh is a licensed investment advisor and president of LorintineCapital, LP. He provides investment advice to clients all over the United States and around the world. Christopher has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™. Working with a CFP® professional represents the highest standard of financial planning advice. Christopher has a J.D. from the SMU Dedman School of Law, a Bachelor of Science in Computer Science, and a Bachelor of Science in Economics. Christopher is a regular contributor to the Steady Options Anchor Trades and Lorintine CapitalBlog.
 

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