Hello again everyone! I’ve heard it said that the space between Heaven and hell is the distance from our head to our hearts. Somewhere between that chasm is our soul and it’s being pulled one way or another literally every second of the day. I hope today, we recognize that battle and don’t try to fight it alone. Instead, let’s ask Jesus to anchor us to His call. That way, no matter how strong the pull against His truth we avoid a stumble or fall.
Now, I had to write another post this week because I’ve been seeing so many Youtube videos about using margin to invest into high yielding assets. In theory it makes perfect sense. We borrow money from our broker, invest into high-yield assets, and pay off the loan with the income. Then keep the shares to create even more income. Too easy!
However, almost every video I’ve seen suggests using Yieldmax or Defiance style funds to accomplish that task. Namely, because several of their funds offer such an incredibly high yield. The problem is, those funds cannot grow (at least very much) because the upside will always be capped by the options strategy. Meaning (at least to me), it’s a race against the clock and the market.
Big Problems With this Strategy
Here are the three biggest problems as I see them.
- The market and these investments could crash.
- Less than expected or irregular levels of income.
- The margin must be paid back, with interest.
Now, these problems are currently just hypothetical. In fact, many of the funds being suggested for this strategy have shown some stability with regards to income.
Still, if the market were to crash and my $1,000 dollar investment was now worth $500, that 100% distribution wouldn’t look quite as attractive or nearly as beneficial. Similarly, if I expected $100 per month but only received $50, now I’m on the hook to find the difference to pay down my margin. I realize it doesn’t work that way but you get my point, the dividend month to month is unknowable because the options premiums change. Lastly, the margin must be paid back with the agreed upon interest. The broker doesn’t care if you’re strategy worked or if it didn’t. They provided you the loan and now it’s time to make good on the agreement.
All that to simply say, they’re problems that scare me a little bit too much to enter the arena myself. But it did get me to thinking about how I could create some leverage to invest into safer high yield assets without using margin.
Here’s what I found…
Using Options to Generate Interest Free Margin, is it Possible?
I need to start by saying, this strategy may not be possible in the way I’m going to describe it. It’s very likely that to perform this strategy of using options to generate interest free margin we’d still need the required capital. Moreover, it may vary from broker to broker so I’d have to do more research to know.
The strategy I’m pondering is selling a deep ITM put to create a rather large credit. With that cash inflow, I would buy shares of a higher yielding asset. Which asset to sell puts on or to purchase would be up to each investor. Ideally though, as I see it, I’d want to be bullish on the assets. Additionally, it doesn’t have to be two different assets. It’s fully possible that the high yielding asset also has options available.
If this we’re to work as I’ve described it I could essentially bring in more money than I currently have available to then invest. Again, it may not be possible because the broker may “lock” up the funds as collateral for the cash secured put. Still, it’s worth a look and below I’ll lay out how I’m entertaining the idea of such a strategy.
How I’m Considering Using Options to Generate Interest Free Margin
I’m considering a trial run of this strategy using two assets I’ve held before. They are Ford (F) and Alliance Resource Partners (ARLP). I’m not overly bullish on either of them given the current market environment but I’m not scared to hold them either. Here’s my thinking about the strategy.
Selling the Cash Secured Put Deep ITM
I’d start by selling the deep ITM cash secured put on Ford (F). If I go out to the December 17 2027 contracts I can sell the $17 strike put for about $740 dollars of premium. Not a lot I know but remember I’m trying this out. If it works as I’m hoping I’ll up the ante in the future. Here is the short put on Ford but take a look at the buying power requirement.
By selling this put I’m using ($211.65) of buying power to generate a $740 premium. That’s an additional $528.35 of available capital! If everything fell apart, the worst case scenario is I hold Ford shares at $17 per share minus this $7.40 credit. Making my effective cost basis $9.60 which is still less than Ford’s current price of $10.43. Not the worst deal in the world and I have 950 days for Ford to increase in price. If it did, I could easily just unwind this entire strategy for a profit on the short put.
Buying the High Yield Asset
If all goes to plan, I would now have $740 to put into Alliance Resource Partners (ARLP) to earn the current 11.21% yield. The worst case here is ARLP falls in value or the dividend gets cut. I could of course choose a much higher yielding asset but ARLP is my “safer” pick, at least as I try using options to generate interest free margin.
If this plan doesn’t work as I’m laying it out the buying power I would personally need is $211.65 for the Ford put and $364.56 for the ARLP shares. A total buying power of $576.21. Again, the worst possible case here is I end up with 28 shares of ARLP and a long term put on Ford. I’ve certainly made worse trades.
Lastly, based on the current dividend, I could expect to collect $0.70 per share, per quarter. Totaling $78.40 per year. If I only held it for the duration of the Ford put I’m “more than likely” to receive at least $196 in dividends over that time. If ARLP goes up in value I could always sell the shares for a profit.
Possible Outcomes
I’ve already mentioned what could happen for both assets but I wanted to provide it separately for clarity. As I consider using options to generate interest free margin here are the likely outcomes for each position.
- Ford falls in price – I end up holding 100 shares at a cost of $9.60 per share.
- Ford rises in price – I close the short put early for a profit.
- ARLP falls in price – I hold to collect the dividend.
- ARLP rises in price – I hold until the profit is greater than the total dividend of $196.
I don’t see any immediate reason why I’d ever need to terminate this position for a loss. As mentioned, the most capital I’d need to deploy this strategy $576.21. Again however, that number may be considerably different depending on how my broker allocates everything.
Profit Considerations
Profit isn’t the primary reason I’m looking to deploy this strategy. The primary reason is to see what’s possible in terms of using capital I don’t have to invest for income. As I discussed in the opening paragraph, a great number of people are borrowing on margin to invest in income producing assets. A concept I like but am not overly comfortable with their method. I don’t like paying interest for starters, and I’m not in love with the high risk assets. However, as a secondary priority, profit is certainly a goal.
As I see it tonight, the profit potential is really unlimited. ARLP or Ford could appreciate in value and there is no limit to what I could make on the shares of ARLP. Of course, I’m limited to $740 of profit on Ford. That said, I’m really doing this to try creating income with money I don’t currently have. In that light, the max profit would be the $740 premium plus the $196 in dividends for a total of $936.
If I take that $936 and divide it by the buying power used I get a percentage return of 162.44% over the next 2 1/2 years. If I calculate the 100 shares of Ford at $960 and I include the $729.12 for ARLP I get a total cost of $1,689.12. The $960 already includes the premium received from the short put. Therefore, realistically my profit potential would be whatever happens with ARLP or Fords price and the dividend. If I assume no price appreciation, the ROI would be $196/$1,689.12, or 11.6%. I’ll spare you from making any price appreciation assumptions.
Final Thoughts
First, I’ve never attempted this before so using options to generate interest free margin may not truly be possible as I see it tonight. The hope is I can generate the $740 in premium and then turn right around and invest it into shares of ARLP but we’ll see soon enough. If everything works, this would just be the start. I would eventually be leveraging even larger assets to complete the same goal.
For quick example, I could currently open a short put on Apple at the $300 strike price for $4,058 in buying power. That unlocks $9,990 in credit from selling that put. A difference of $5,932 dollars in capital that I don’t currently have. If I invested the entire $9,990 into ARLP I could generate $1,119.87 in dividends each year. If I only used the $5,932 of capital I don’t have, that would be $664.97 in dividends each year.
Lastly, and just for fun, what if I put that $9,990 into a crazy yielder like MSTY? If I did, that would generate an eye watering $12,087 (theoretically) in dividends each year. Just using the $5,932 that I don’t have, the dividend each year would be $7,177.72. Simply ridiculous what’s possible!
If you enjoyed learning about this strategy but didn’t love the longer time horizon, have a look at this post titled, Options Day Trading Strategy Using ThinkorSwim’s 1st Trgs OCO. It’s way faster!
Until the next post.
God bless,
Jeff
