The trick to get rich by using other people’s money

Sander’s guest post about how to get rich by using other people’s money was a big success! Heck, I’ve been getting emails and even calls asking how he does it. That bloody cliffhanger?! 😉 Despite being FIRE, Sander is a busy man (I’m starting to see a pattern here…)! Fortunately he found a couple of spare hours and wrote the follow-up post: The trick to get rich by using other people’s money. Enjoy & Happy Investing!

In case you have some time, here are a few other interesting guest posts we featured:

The trick to get rich by using other people’s money

It’s nice to see the reactions on this blog about my first post, and I heard there have been a lot of page views. So I wanted to write the sequel, but I’ve been really busy lately. It’s amazing how you can be busy without doing paid work. Painting a house, working on selling an apartment, going to the gym, spending time with my 4 year old daughter, and of course managing my investments.

Speaking of which… Some of the remarks were that my strategy is not for the faint hearted. That is true for sure. I’m writing this in the midst of Theresa May struggling with her Brexit deal, Donald Trump making half-baked agreements with Xi, while at the same time arresting a Huawei board member, the Italians submitting fiscal plans which are somewhat over-optimistic (to say the least), and people using the word ‘recession’ more and more.

The trick to get rich by using other people's money
The trick to get rich by using other people’s money

So, markets respond. And going down is always more violent than going up, so that hurts. And with leverage, you increase the hurt. So, people who are not certain they can stand “losing money” should for sure not use this strategy.

Sleeping Well at Night

The reason my strategy doesn’t make me lose sleep at night is simple: I don’t look at the current value of a stock, but I look at the income stream it provides. This means I’m not so interested if the price of Eurocommercial Properties is currently €30 or €28. However, I am interested in the dividend of €2,15; and the sustainability of that dividend. This is the same way a business owner or a real estate owner looks at his investments…

Last time I said I would shed some light on creating cheap leverage. It’s clear that the FIRE community doesn’t like cliff-hangers, so without further ado: the trick!

Creating cheap leverage with an option box

The basics of this option box are to create a construction in which you know for sure how much you will have to pay at a certain moment in time. This construction makes use of buying and writing options, which generate an option premium. Make sure to use European style options, like the AEX index options. This is important because they have cash settlement, and no early exercise. This is paramount because at exercise you would have to repay the money you borrowed and you want to know exactly when that is. You don’t want your carefully created option box to be “splinched”…(hello Harry Potter fans!)

So the premium you receive is basically the loan you take out, and at expiration of the options you repay the loan. It may sound a bit confusing, but I will use an example.

Let’s say we want to take out a loan of €60.000, for three years.

What we need to do is the following:

  1. Write a call AEX dec 21 200
  2. Buy a call AEX dec 21 800
  3. Write a put AEX dec 21 800
  4. Buy a put AEX dec 21 200

So what does it mean to have this specific combination? I will use the table to explain. In this tablet he end result of each option in 2021 is shown:

The trick to get rich by using other people's money - options
The trick to get rich by using other people’s money – options table
  • First, the written call 200 gives the buyer the right to buy AEX at settlement for 200 from us. So, if AEX is 200, the option expires worthless. But if the AEX is 700, the option is worth 500 and we pay him 500.
  • Second, we wrote a call 800. This means we will expire worthless if the AEX is below 800. If the AEX is 700 for example, the option is worthless
  • Third, the written put 800 will cost us money if the AEX is below 800 at expiry date. So, with an AEX at 700, this option will cost us 100.
  • Fourth, the put 200 we bought will only generate money if the AEX is below 200. When AEX is 700, this option expires worthless.

The interesting part of this construction is in the ‘total’ line. It shows that, whatever the AEX settlement is, we always have to pay 600!

Practical example

By creating this option construction we know we will have to pay 600 in 2021. The premium we receive is the loan we take out, and the difference can be seen as the interest we pay. So, let’s see what we would receive as premium. I’m looking at today’s prices (11 December 2018):

  • Call AEX dec 21 200          bid €254,55 / ask €258,50
  • Call AEX dec 21 800          bid €0,16 / ask €0,25
  • Put AEX dec 21 800          bid €347,45 / ask €351,4
  • Put AEX dec 21 200          bid €1,60 / ask €2,10

So the minimum premium we receive is €254,55-€0,25+€347,45-€2,10= €599,65. Since the tick size of AEX is 100, we would receive 100*€599,65=€59.965.

This means our interest for three years is €35. This is negligible, a mere 0,02% per year for a loan of €60.000. And to be exact, you don’t have to settle for only the bid price. My best guess would be that I can set up this construction for 603. This would mean that I’m actually being paid 0,17% yearly for taking out a loan!

Too good to be true?

This construction is beautiful and opens opportunities for very cheap funding. However, there is a setback: this construction requires margin. Basically this means the broker needs security to know you will be able to pay back the loan.

Depending on your broker, this margin could be around €70.000. So this means you need to have a portfolio in order to take out this loan. Of course you can also use the €59.965 of premium for this, but you need a starting capital.

Conclusion

This blog was a bit technical, and I apologize for that. On the other hand, this stuff is better not used by people who don’t fully understand what they are doing.

So it is some kind of acid test: if you understand this blog, this strategy might be interesting for you. If you don’t understand, please don’t try this at home! If you are somewhere in between, and you feel attracted by this strategy, please contact me through this website, perhaps I can help you in person.

Please let me know your thoughts!

 

Haarlem 2019 – BENL FIRE Meetup

In case you are curious to meet Sander and discuss his options box and investment strategies, you can! He will be joining us in Haarlem on Saturday January 26, 2019. Actually, he will be presenting his investment strategy that day too! If you have not signed up yet, here is your chance: Click here to buy you tickets (€15pp – includes drinks & sandwich lunch!)

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24 Comments

  1. Hi Sander and Mr. CF,

    Like SamP i’m also quite new to the world of investing and loaning.
    Defitnetly not ready for strategies like these yet, but it is fasinating to read how a construction like thise can lead in such cheap loeans.

    @Sander: would it be possible that you can send me a direct email. I have some more private questions which I rather not ask in the commentsection. Thank you in advance:)

    Thank you both for the blog and this post.

    Keep up the good work! Inspiring;)

    Leander

  2. Hi Sander,
    very interesting set-up indeed. I noticed that the current interest rate for the loan of 60.000 you proposed is 0.0367. A bit higher than at the moment you wrote the article, still quite low. Can you give any advise on what is a good moment for such a set-up? Bear or bull market?
    Can you give a bit more explanation on your last comment: ” As a matter of fact, the value of the box is determined by the current interest curve.”

    1. Hi Julietta,
      Beautiful name you have, reminds me of an awful but beautiful Alfa!
      The interest rate depends on the term you take, for 1 and 2 year, it is actually below zero, and longer terms have a low positive interest.
      The construction works best when the interest rate is low, like now.
      Of course, you need to invest the proceeds, so a bull market would be easier. But you can also use this construction for risk avoiding strategies, like savings account.

  3. What can I do with this?

    Can I leverage my stock portfolio to finance a car with super-low financing cost?

    Could I create a finance bridge (deposit) for a real estate investment?

    What is the risk(s)? I’d have to be able to keep refinancing (rolling out to new positions) or I’ll get a margin call?

    1. I would never finance a car. But maybe I’ve been reading too much of MMM’s blog…
      But of course you could use this for investments outside your broker account. I’ve used it for financing an apartment at an effective rate of 0.22%.
      The drawback is you need a lot of assets in your account for this purpose. Since you take the money out of your account, the only cover value that remains is your original investment.

      Refinancing is no problem, the margin is the main problem to worry about.

      1. Thanks.

        By margin, do you mean upkeep of the value of the capital that you’ve secured the “box” against?

        ie. If it’s you’re all-in on an S&P500 index ETF and it takes a tumble, you could eventually have inadequate margin?

  4. Impressive, but scary. Ofcourse if you just sit on the 59.5k, you’ll have the 60k payoff ready in 2021. But if you somehow manage to lose (part of) the 59.5k, you might be in troubles!

    You could make some money with a deposito ladder or some obligations though. If you manage to get 1% per year on the principal you’ll earn €1200 to 1800. That could be some nice free money right there.

    1. I agree! That is a way to use this construction as well.
      I believe the risk of putting this money in Rabo Ledencertificaten is also quite low. There is of course quite a bit of interest risk, but the interest rate of 6.5% on the principal (effective 6%) is enough of a reward for this risk.

  5. What is the advantage above using the margin on the 70K stocks directly, apart from the fact it seems about 20% more (0.7 * 70K = 49K vs 60K) you’ll receive for the option combination.

      1. By buying this option combination, you receive 60K. But you mentioned you also need to keep about 70K woth of stocks in you account as security.

        If you have 70K of stocks anyway, you can also “get” on margin about 50K directly to buy other stocks/assets?

        What is the main advantage to go through the option route?

      2. In addition to 7.41: any other advantages apart from the low(er) “interest” and you will get it in cash?

      3. In response to Rube:
        I would say the main advantages are a far lower interest (my two brokers charge eonia +1,25-4%) and the fact you can actually choose how long you want the interest to be fixed, instead of a variable interest.

  6. About my previous reaction: Where i said ‘real estate report’ i meant ‘dividend update’ – stop the clock;-) –

  7. HeeyCheesy,

    Off topic, sorry about that. I use Bloglovin to read my favourite blogs. Your Posts aren’t showing up anymore it seems, since your real estate report of November. Did you change anything in the way you post? If not I will have to look at Bloglovin. I came here via the latest post from Geldnerd, so that’s working fine…
    Have a nice day anyway
    (and Sander, very interesting, but too complicated for me ;-))

    1. Hey Anna, I had noticed a problem with the RSS link, but I didn’t change any settings. Still investigating what’s going on. The RSS feed at Geldnerd was updated this week and is now working again. Not sure what I can do about the blogloving. Any experts???

      1. An addition to Anna’s comment, I haven’t seen a new post notification signup option in your blog. I strongly recommend adding that. If it already exists, I’m sorry, my fault.

        Besides that, I am a new follower and really learned a lot from your blog. Thank you very much for the effort you put.

      2. You are on to something, I have not focussed on an email list (don’t even have one). Was planning to add one this year, but have not had the time yet. Working in progress!
        P.s. glad you like the blog and find it useful!

    1. I haven’t done a full fledge research into brokers. If a broker offers the option to use PBM (portfolio based margin), they offer more margin. For example, Binck offers this opportunity.
      But be aware: margin is very tricky, so do not stretch it too much.

  8. Hi Sander,

    Thanks for sharing your knowledge.

    I have no experience with options, only buying simple ETFs that follow a broad index. So I am a beginner, trying to grasp this construction (don’t worry, I am not going to try this for now!)

    If I understood it well, it means if you have 70k in broker account, you can lend another 60k with this construction? If this 70k is in cash on my account, I presume I don’t run any risk. But also do not make any profit with it. If the 70k is in stocks, and the value drops, then the broker has not sufficient assurance and they will ask me to either pay back my loan or I have to increase my portfolio value in order to back my loan?

    1. Hi SamP,
      For the construction, you would need a cover value of around 70k. Of course, a cash euro counts for 1. But a euro invested in stocks normally also counts for around 0.70. So this means if you have 70, lend 60 and invest in stocks, the cover value is 0.7 times (60+70) which is 91k.
      That gives a cushion of 21 k.
      You can even complicate more by using an advanced way of margin calculation, but let’s kerp it a bit simple here.

  9. Very interesting. How to determine the margin that the broker needs? I think you cannot terminate this construction earlier than the end date of the options right?

    Ralf

    1. Hi Ralf,
      The best way to determine the margin is to key in an order, but keep the limit too high. The broker then responds by giving the needed margin.
      Make sure to use a ‘combination’ order and first order the two most expensive options. They make up most part of the margin.
      About ending it: sure you can. Just reverse the orders. Since the value of this box is stable, you can always reverse.
      As a matter of fact, the value of the box is determined by the current interest curve.

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