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 pension shuffle
- Where are the weird FIRE folks
- Why your company is not a great place for financial growth
- Hacking the 4% rule
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.
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:
- Write a call AEX dec 21 200
- Buy a call AEX dec 21 800
- Write a put AEX dec 21 800
- 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:
- 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!
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.
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!)