Strategy

Index Lever

Type of Strategy

investing

sentiment

Long-Term Bullish

implied volatility

Low IV Preferred, but Flexible

description

The Index Lever is a specific application of a DITM LEAP call option strategy.  Index Levers offer investors the ability to acquire long equity exposure to an equity index using leverage outside of the traditional brokerage margin format.

SOI only recommends Index Levers for investors with advanced knowledge of equity and derivative markets.  Index Lever strategies should only be employed by investors with long-term time horizons greater than ten years, and who are willing to commit to employing the requisite capital for that time frame.

Index Levers are only recommended for young investors who will not require the capital funds for at least twenty years.  SOI recommends greater equity exposure for young investors than more mature investors, as lower volatility assets provide safer alternatives for those approaching retirement.

SOI only recommends Index Levers within an Index Canal Lock strategy.

Finally, 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

SPX current price is $3,975

An Index Lever is a DITM LEAP call option on an equity index, generally the S&P 500 Index.

An investor wishing to execute an Index Lever on the S&P 500 Index decides to use SPX rather than SPY.

In assessing alternatives, the investor considers purchasing the 995 DTE, 99.5 delta SPX LEAP call option with a strike price of $2,400 for a cost of $1,576.60.  This option has a time premium of $1.60, which the investor considers negligible in relation to the overall transaction.

Note that the investor could choose XSP rather than SPX to obtain 1/10th sized contracts.

Index Lever – SPX

example – SPX

Index Lever – SPX – @ $3,975

   – 995 DTE     IV = 16

   – Long Call at $2,400

1) In an offensive (tax-free) account, the investor purchases the SPX 995 DTE, $2400 Strike Call Option for $1,576.60 (or $157.77 in XSP)

2) Consider that in a tax-free account, the investor could choose shorter duration options (~365 DTE) or SPY vs. SPX vs. XSP as best benefits the investor’s situation and expected performance profile

3) Notional Consideration: Even though cash investment is only $1577, this equity should be considered as full notional exposure of $3,975.

4) Cash savings from Index Lever = $3,975 – $1,577 = $2,398

5) Investor may consider at this point how much, if any, leverage to employ in relation to investing the cash savings in an Index Mat.

  A. SOI only recommends substantial leverage for young investors with long time horizons

  B. SOI only recommends employing leverage when utilized in an Index Canal Lock strategy

6) The 45-year-old investor decides to use 25% of the cash savings as leverage and 75% in an Index Mat

7) Account holder invests $1,800 in a defensive account.

  A. Sell an SPX 360 DTE put vertical at 30% below current SPX market value.  This spread has an annual yield of 9.4% along with preferential tax treatment.

  B. Account holder must roll SPX put verticals at ~180 for continued returns

  C. After-tax financial return on SPX spreads is approximately $128

8) $128/$3,975 = 3.2% which is approximately 2x the S&P 500 dividend yield or an incremental 1.6%

9) The remaining $598 in cash savings will be used for further investment in the S&P 500, targeted by the investor for the Index Canal Lock strategy