For people in the US, the best asset class to put in a tax-free or tax-deferred account seems to be closed-end funds (CEF) that invest in REITs. REITs because they pay high dividends, which would usually be taxed as non-qualified dividends, and CEF (instead of ETF or open-end mutual funds) because these funds can use leverage (up to 50%), and it’s otherwise hard or impossible to obtain leverage in a tax-free/deferred account (because they usually don’t allow margin). (The leverage helps maximize the value of tax-freeness or deferral, but if you don’t like the added risk you can compensate by using less leverage or invest in less risky assets in your taxable accounts.)
As an additional bonus, CEFs usually trade at a premium or discount to their net asset value (NAV) and those premiums/discounts show a (EMH-violating) tendency to revert to the mean, so you can obtain alpha by buying CEFs that have higher than historical average discounts and waiting for the mean reversion. There’s a downside in that CEFs also tend to have active management fees, but the leverage, discount, and mean reversion should more than make up for that.
I don’t have a detailed analysis to back it up, but my guess is that CEFs are probably superior because call options don’t pay dividends so you’re not getting as much tax benefit as holding CEFs. It’s also somewhat tricky to obtain good pricing on options (the bid-ask spread tends to be much higher than on regular securities so you get a terrible deal if you just do market orders).
I pretty much never use market orders for options. With a little patience and a limit order, you can usually get the midpoint between bid and ask, or close to it. This would be especially important for LEAPS.
With a little patience and a limit order, you can usually get the midpoint between bid and ask, or close to it.
How do you do this when the market is moving constantly and so you’d have to constantly update your limit price to keep it at the midpoint? I’ve been doing this manually and unless the market is just not moving for some reason, I often end up chasing the market with my limit price, and then quickly get a fill (probably not that close to the midpoint although it’s hard to tell) when the market turns around and moves into my limit order.
Well, it’s obviously not going to be the midpoint when it fills because you can only buy at someone’s ask or sell at someone’s bid. But with a limit order, you can be the best bid or ask.
I don’t usually chase it. If you’re buying a call and the market drops, you get a fill. If it rallies, maybe you wait 15 minutes and adjust, or try again tomorrow. For LEAPS it wouldn’t be unreasonable to try for a few days.
The market is usually calmer in the middle of the trading day, maybe because the big players are eating lunch, although it can get chaotic again near the close.
Except for a very liquid underlying near the money, you’re almost always trading options with a market maker. The market maker will set the bid and ask based on his models. If he gets a fill, and can’t get enough of the opposite side, he’ll buy or sell shares of the underlying to neutralize his delta. He’s not making directional bets, just making money on the spreads. If you offer a trade near the midpoint, but even slightly in the market-maker’s favor, he’ll usually trade with you, when he gets around to it. This could easily take fifteen minutes. He also doesn’t like you narrowing the spread on him, because that means someone might trade with you directly and he doesn’t get his cut, so if he can handle your volume, he’ll just take your order off the book.
Another way to get leverage in a retirement account is with leveraged ETFs. I am using some of those in my IRA currently. You can get up to 3x for some index ETFs.
I’m still interested in these CEFs for diversification though, how do you find these?
Another way to get leverage in a retirement account is with leveraged ETFs.
Yeah, and another way I realized after I wrote my comment is that you can also buy stock index futures contracts in IRA accounts, and I forgot exactly but I think you can get around 5x max leverage that way. Compared to leveraged ETFs this should incur less expense cost and allow you to choose your own rebalancing schedule for a better tradeoff between risk and trading costs. (Of course at the cost of having to do your own rebalancing.)
Also after writing my comment, I realized that with leveraged CEFs there may be a risk that they deleverage quickly on the way down (because they’re forced by law or regulation to not exceed some maximum leverage) and then releverage slowly on the way up (because they’re afraid of being forced to deleverage again) which means they could systematically capture more downside than upside. Should probably research this more before putting a lot of money into leveraged CEFs.
I’m still interested in these CEFs for diversification though, how do you find these?
SeekingAlpha.com has a CEF section if you want to look for other people’s recommendations. CEFAnalyzer.com and CEFConnect.com have screeners you can use to find what you want on your own.
For people in the US, the best asset class to put in a tax-free or tax-deferred account seems to be closed-end funds (CEF) that invest in REITs. REITs because they pay high dividends, which would usually be taxed as non-qualified dividends, and CEF (instead of ETF or open-end mutual funds) because these funds can use leverage (up to 50%), and it’s otherwise hard or impossible to obtain leverage in a tax-free/deferred account (because they usually don’t allow margin). (The leverage helps maximize the value of tax-freeness or deferral, but if you don’t like the added risk you can compensate by using less leverage or invest in less risky assets in your taxable accounts.)
As an additional bonus, CEFs usually trade at a premium or discount to their net asset value (NAV) and those premiums/discounts show a (EMH-violating) tendency to revert to the mean, so you can obtain alpha by buying CEFs that have higher than historical average discounts and waiting for the mean reversion. There’s a downside in that CEFs also tend to have active management fees, but the leverage, discount, and mean reversion should more than make up for that.
Another way to get leverage in an IRA is to buy long-dated call options (as recommended in Lifecycle Investing). Would you expect CEFs to be superior?
I don’t have a detailed analysis to back it up, but my guess is that CEFs are probably superior because call options don’t pay dividends so you’re not getting as much tax benefit as holding CEFs. It’s also somewhat tricky to obtain good pricing on options (the bid-ask spread tends to be much higher than on regular securities so you get a terrible deal if you just do market orders).
I pretty much never use market orders for options. With a little patience and a limit order, you can usually get the midpoint between bid and ask, or close to it. This would be especially important for LEAPS.
How do you do this when the market is moving constantly and so you’d have to constantly update your limit price to keep it at the midpoint? I’ve been doing this manually and unless the market is just not moving for some reason, I often end up chasing the market with my limit price, and then quickly get a fill (probably not that close to the midpoint although it’s hard to tell) when the market turns around and moves into my limit order.
Well, it’s obviously not going to be the midpoint when it fills because you can only buy at someone’s ask or sell at someone’s bid. But with a limit order, you can be the best bid or ask.
I don’t usually chase it. If you’re buying a call and the market drops, you get a fill. If it rallies, maybe you wait 15 minutes and adjust, or try again tomorrow. For LEAPS it wouldn’t be unreasonable to try for a few days.
The market is usually calmer in the middle of the trading day, maybe because the big players are eating lunch, although it can get chaotic again near the close.
Except for a very liquid underlying near the money, you’re almost always trading options with a market maker. The market maker will set the bid and ask based on his models. If he gets a fill, and can’t get enough of the opposite side, he’ll buy or sell shares of the underlying to neutralize his delta. He’s not making directional bets, just making money on the spreads. If you offer a trade near the midpoint, but even slightly in the market-maker’s favor, he’ll usually trade with you, when he gets around to it. This could easily take fifteen minutes. He also doesn’t like you narrowing the spread on him, because that means someone might trade with you directly and he doesn’t get his cut, so if he can handle your volume, he’ll just take your order off the book.
Another way to get leverage in a retirement account is with leveraged ETFs. I am using some of those in my IRA currently. You can get up to 3x for some index ETFs.
I’m still interested in these CEFs for diversification though, how do you find these?
Yeah, and another way I realized after I wrote my comment is that you can also buy stock index futures contracts in IRA accounts, and I forgot exactly but I think you can get around 5x max leverage that way. Compared to leveraged ETFs this should incur less expense cost and allow you to choose your own rebalancing schedule for a better tradeoff between risk and trading costs. (Of course at the cost of having to do your own rebalancing.)
Also after writing my comment, I realized that with leveraged CEFs there may be a risk that they deleverage quickly on the way down (because they’re forced by law or regulation to not exceed some maximum leverage) and then releverage slowly on the way up (because they’re afraid of being forced to deleverage again) which means they could systematically capture more downside than upside. Should probably research this more before putting a lot of money into leveraged CEFs.
SeekingAlpha.com has a CEF section if you want to look for other people’s recommendations. CEFAnalyzer.com and CEFConnect.com have screeners you can use to find what you want on your own.