Three Methods to take advantage of Portfolio Margin for Insane Gains

 Karen the Supertrader turned $100k into $41 million during the 2007-2011 stock market while overall market declined quite a bit. How did she do it? She traded very safe options (deep out of the money) using portfolio margin. Each bet had 95% chance of winning. She used math in her favor by placing high probability bets but making a very small amount with each bet. She was able to use 50% of her capital for options trading.

 

Why can’t regular investors do what she did?

In a cash only account, to make $500 you sell a put on SPY with 95% win probability. Not bad, right? You make that $500 fee regardless plus if you lose the bet you would simply buy 100 shares of SPY at a price you like anyway. HOWEVER you’ll need to lock up $45000 in case the trade doesn’t go in your favor and you are forced to buy the shares. It would be locked up for 2 months. Depending on how much money you have, you wouldn’t be able to do too much of this. The returns, while reliable, are not better than simply buying the stock. Enter portfolio margin account. The margin rate is only 9%, so instead of locking up $45000, you only lock up $3300. Now you can do 11x more of these safe $500 trades. In other words, if you can use $1 million to sell $11 million worth of options at any given time. This ends up being over 50% annual returns.

Karen the Supertrader used The Wheel strategy, mostly just selling puts. Typically, she would sell calls on up moves. She would sell puts on down moves. We can potentially get better returns than Karen the Super Trader in such a good market as we won’t need to sell as deeply out of the money. The Wheel is the most $$$ per amount of risk (best Sharpe Ratio).

 

Method 1: Spam “The Wheel” selling naked puts

Buy safe options that eat up very little margin cost, like SPY at 9% margin ratio. If you lose the bet, sell a call option to get rid of it. Or just keep it since it eats up only 9% of however much you are holding.

You can spam huge numbers of safe bets. You’re scaling up sure bets, small profits individually, but a huge amount of them. This can be modified for even better returns by selling at-the-money, which is what back-testing research has proven. For short duration options, you should hold till expiration. For longer duration options, close early at 40-50% gains.

This consistent 50% annual returns can only be done in a portfolio margin account. The reason we pick SPY (or VOO) is the very low margin requirement. Most stocks require 15-20% margin.

 

What happened to Karen the Supertrader?

Unfortunately Karen the Supertrader later switched onto more exotic trading strategies (Iron Condors) and lost a lot of money in 2014. She organized a sophisticated options roll at the end of each month to hide losses, which the SEC considered to be fraud. She shows us what to do and what not to do. Should have just stuck with the newbie method of selling puts. 

Her early results were real. Despite her later losses, not one of her clients lost money or complained. Even the worst year ever with the big loss, investors still made 14% that year, but the better years were 50%+. There was a "look" of fraud but her actions could also be explained by desire for tax optimization (she's an accountant). She decided to settle with the SEC and pay a fine rather than deal with the headache, and unfortunately that damaged her reputation so people don't hear about the great investor anymore. They'd rather convince themselves that her results are not possible rather than try to replicate it themselves.

 

Do you have to be good at technical analysis to use this strategy?

Nope, you don’t need to learn technical analysis. Backtesting research has shown it to be useless as a predictor. That said, momentum does matter a lot. Anyone can tell positive vs negative momentum in a chart. A stock with a lot of recent bad news but intact fundamentals, that has been recently beat up, if it looks like from the chart that the sell-off has stopped, that would be a great time to sell a put on it.

 

How I use it

Most of my portfolio is still based on owning the actual stock. However, there is a lot of volatility in owning high growth stocks. People are afraid of owning 3x leveraged ETFs like TQQQ, but it does not even compare to individual stocks, which can suddenly drop 50% in one day. Furthermore, the margin in a portfolio margin account itself is unstable. Therefore, I sell put options which are more stable. It adds more balance to my portfolio without hurting my returns.

 

Method 2: Dividends with Effective Dividend Yield of 52%

The dividend yield for SPY/VOO is 1.5%. But in a portfolio margin account, it only uses 9% margin, so the effective dividend yield is 16.7%. This dividend slowly pays off your margin. Neat! And of course, most of the gains would be in the appreciation of the ETF.

Another good option is OHI, which is a REIT with a sustainable dividend yield of 7.8%. It uses 15% margin, for an effective dividend yield of 52%! The dividend will pay off your margin very effectively.

 

Method 3: Allows you to increase your hedging to take greater risks

Generally speaking, being 150% invested is about as risky as most experienced investors are comfortable with. However, you can buy more long term treasury bonds (TLT, TMF is 3x leveraged version) as a hedge. Portfolio Margin will increase your buying power when it detects your portfolio is more hedged. This allows you to simply buy more stocks (using more leverage). It’s hard to say how much is safe. If you use half the available margin, you can weather a 30% stock market crash (accounting for the increased margin requirements in a crash). With higher leverage, you really have to bet on yourself to time the market. If there’s a huge market bubble or a global pandemic, it’s common sense to de-leverage. If government has easy money policies for the next 2-3 years, and you know there is a lot of cash on the sidelines to buy any dip, then it makes sense to leverage higher. Compared to Reg T margin, Portfolio margin decreases risk of margin calls in a crash since it allows more margin that is available in general. Plus any margin call would hurt you less as you would still have a ton of purchasing power.

 

For my philosophy on investing, see Why "safe" investing is actually more risky and Article Review: Leverage for the Long Run which backtests the long term leveraging strategy.