Strategy

Index Canal Lock

Type of Strategy

investing

sentiment

Long-Term bullish

implied volatility

low iv preferred, but flexible

description

The Index Canal Lock strategy is a series of Index Lever investments made over an extended time horizon.  The strategy may be considered a combination of approximating dollar cost averaging applied to levered index investments.

The Index Canal Lock should only be employed by investors with an advanced knowledge of capital markets and derivative securities.  The strategy requires a long-term horizon (10-year minimum).  The Index Canal Lock may be an effective strategy for young investors with 30+ year horizons and a greater risk tolerance.  Research supports investors utilizing higher risk/reward assets in the early stages of their investing progression.

Investors utilizing an Index Canal Lock strategy should have a strong understanding of the advantages and disadvantages of leverage.

SOI recommends that a significant portion of cash saved from individual Index Levers should be invested in very low risk assets.  The amount of leverage utilized for additional investment in an Index Lever or Index Canal Lock should be considered extensively before further investment.

SOI recommends that all strategies should be managed on a notional base, and any leveraged positions should be explicitly understood and documented.

SOI recommends that any investor looking at Index Levers or an Index Canal Lock discuss the advantages, disadvantages, and contingencies with a professional investment advisor.

Set-Up

A young investor with a 30-year time horizon and strong knowledge of capital markets has talked about investments with a professional advisor.  The investor commits to a disciplined investing plan for the next ten years inside of a Roth IRA account.

Between current funds and future contributions, the investor confirms the ability to purchase a DITM XSP LEAP contract each quarter for the next ten years, along with investing a portion of the cash savings in low-risk assets.

1) The investor commits to a quarterly purchase on the first business day of each calendar quarter, buying one 3-Year XSP 99.5 delta LEAP call option

2) The investor breaks the difference between the notional value and the cash outlay into two equal buckets (determination of a 50/50 split based on risk profile, performance expectations, financial goals, and simulations of market returns)

  A. Half is invested in a low-risk municipal bond (tax-free) with a 4.5% yield

  B. Half is committed to the next quarter’s Index Lever investment

3) As the Index Levers accumulate in layers, the investor may roll out LEAPS with nearer term expirations to keep the investments actively compounding

4) The investor may need to re-allocate the low-risk investments as they mature

Management

In general, there is little management available beyond rolling out LEAP options.

In an instance of significant pressure, a short call option could be sold against the long call option to reduce overall risk profile, while capping upside potential.  In a significant market downfall, the LEAP option will become closer to a 50-delta option (ATM), increasing the extrinsic value of the option in a high implied volatility environment.  The investor could decide to roll down the LEAP option to sell the increased extrinsic value (time premium) and reduce losses below a 1:1 ratio.

Canal Lock System

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Index Canal Lock – Tiered Leverage

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