The previous two posts Pay a 30-Year Loan On a 15-Year Schedule and Borrow 30-Year and Invest The Difference showed how you can save money if you are committed to making higher monthly payments on your mortgage. This fits into a general theme: pay a lower price if you commit to something and you make that commitment known to the other party.
Buying in bulk also fits into this theme. When you buy detergent in a gigantic size container from Costco, you are saying to the manufacturer you are committed to their brand. As a result, they give you a break on the per-ounce price. When you buy a season pass to a ski resort, you are saying you are committed to skiing there, and they give you a deal versus buying single tickets.
In each case, just making the commitment in your own mind isn’t enough. You have to make your commitment known to the other party. If you are committed to paying off your 30-year mortgage in 15 years but you don’t let the lender know, you are not going to get the lower rate. If you are committed to a detergent brand but you buy one small bottle at a time, you don’t get the price break. If you always ski at the same place but you buy a day ticket every time you go, they just treat you like a one-timer.
Now, when it comes to rebalancing your portfolio, are you committed to buy when prices get low or sell when prices get high? Maybe you are absolutely committed in your own mind but does anybody else know? If you let somebody know, you can get paid for your commitment.
How? Through the options market.
An option is the right to buy or sell by a date in the future at a predetermined price. To someone looking for a buyer (or seller), knowing that you are committed to buy (or sell) at a set price is very valuable to them, so much so that they are willing to pay you for your commitment.
Here comes the test: are you truly committed to rebalance at a set price point? So much so that you are willing to put your commitment down in writing? If yes, you are a candidate for getting paid for your commitment.
There are always divergent opinions among market participants. As I’m writing this, SPDR S&P 500 ETF (ticker SPY) is worth about $131 a share (corresponding to S&P 500 at 1,310). A call option — the right to buy — at $140 a share in the next six months is worth about $3.00 per share. Someone paying $3 for a right to buy at $140 is thinking S&P 500 will go above 1,430 in six months. Meanwhile a put option — the right to sell — at $120 a share in the next six months is worth about $4.60 per share. Someone paying $4.60 for a right to sell at $120 is thinking S&P 500 will go below 1,154 in the next six months.
If you are close to a rebalance such that S&P 500 falling to 1,200 will make you buy to rebalance anyway, why not let others know you are out there and get paid for it? You can sell a put option on SPY expiring in six months at $120 per share for $4.60 per share. For each $12,000 you are committing to buy, you earn $460. That’s a 3.8% return in six months, 7.7% annualized, which is much higher than you expect to earn from a bond fund if you just make the commitment to yourself without telling anybody.
Is it speculating? No because you are not betting that the prices will go one way or the other. It’s all about formalizing your commitment to rebalance at a set price point and letting others know about it. If when S&P 500 drops to 1,200 you want to say "Hmm it looks like it will go lower. I will wait for the bottom before I rebalance." selling options isn’t for you because you are not truly committed to rebalance at a set price point.
Is it risky? Yes in a sense a 15-year mortgage is riskier than a 30-year mortgage but you get compensated for it. There’s a cost for the rebalancing flexibility insurance just as there’s a cost for the payment flexibility insurance embedded in a 30-year mortgage.
I trust that you won’t go out and start selling options like crazy just because someone on the Internet said so. Think about it. Maybe you are not as committed as you thought. If you decide to try it, only sell as much as you are willing to rebalance anyway.
Some pointers on logistics if you want to explore this. To be able to sell ("write") options, you need a brokerage account; just mutual funds with Vanguard isn’t enough. Then you need to apply for options trading. Selling "cash-secured puts" and "covered calls" are 100% collateralized; you have cash ready to buy or shares ready to sell. You don’t need a margin account. Because of taxes, it’s best if you do it in an IRA.
The options market in Vanguard ETFs isn’t as active as that in some other ETFs such as SPDR S&P 500 ETF (SPY), iShares Russell 2000 ETF (IWM), iShares EAFE ETF (EFA), or iShares Emerging Markets ETF (EEM). If you end up with SPY ("assigned") but you prefer a Vanguard ETF, just swap to what you really want. The online trading commissions are very low.
Refinance Your Mortgage
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