Conference nyoss1::market_investing

71.0. "Comments on extended index play" by RTPSWS::HERR (These ARE the good ole days) Wed Feb 19 1992 00:19

    

    I had this thought the other day after reading another in a seemingly
    endless series of articles on funds/plans trying to track a particular
    equity index.

    I would be curious as to anyone's comments/critique as to how this might
    actually play.


Assuming that the long term direction of the Stock Market is up we ought to be
able to generate good return from continuously owning Long Future contracts on
the S&P 500 or NYSE Composite.

------

Figure that over a 10 year period the targeted index increases 10 percent 
(including dividends reinvested etc.) per year on average and that our 
initial investment is $50,000.  After 10 years the new total should be 
$129,687 for a before tax net gain of 79,687. 

As an alternative consider that we might purchase a single S&P contract
currently trading at 412.25.  The strategy would require holding a long
position at all times (rolling into a new contract once a quarter). 

In addition, we would buy a PUT contract with matching expiration and strike
price 20 or so points below the current index value.  The monies we use to 
back our position earn interest (about 90+ percent) at a rate slightly less 
than the 1-Yr T-Bill rate.

Some example calculations :

Period End S&P Index           1069.27
Period Start S&P Index          412.25
                              ---------
Gross Point Increase            657.02    

Transaction Loss (1 Pt per)     (40)
PUT Contract Cost (3 Pt per)   (120)

Net Point Increase              497.02

Dollar Yield
-----------------

Point Delta X 500/Contract             248,510
Commissions (35/turn)                   (2,800)
Interest Income (5%)                    31,444

Net Gain before taxes                  277,154


I have ignored at least two factors that work in our favor :

o The Futures Contract goes mark-to-market which ought to yield extra cash 
  available either for reinvestment or interest income building.

o I have assumed that the PUT contact always expires worthless which of course
  would not be the case but I didn't want to try to figure the yearly 
  versus quarterly variances.

    
    re: "a single S&P contract ..."
    
    This sounds like it relates to my other question...  can you explain
    what this is for some of us?
    
       /Jim
    

.0> Assuming that the long term direction of the Stock Market is up we ought to be
.0> able to generate good return from continuously owning Long Future contracts on
.0> the S&P 500 or NYSE Composite.
    
    Sadly, this doesn't work.  The futures contracts are normally priced at
    a premium to the underlying cash index for precisely this reason.  As
    time passes the premium narrows, meaning if the market goes nowhere
    you lose money.  If the market goes up as expected, you break even.
    If the market goes up better than expected you gain.
    
    In order for the scheme in .0 to work you need futures that are priced
    well away from their true value.  This is an infrequent event.
    
      John

    re: .2

    The basis for a particular index FC ought to be equal to only the carry
    costs (up to expiration -- which is OK since we planned to sell a 1/4
    before) minus the lost discounted dividend stream.

    I played with some numbers I have for the two (2) years prior to Apr 91
    and this appears to hold true (r == 0.5% on average).  My other
    observation is that while the basis does fluctuate it typically settles
    over periods greater than six months allowing us to worry only about
    the carry.

    Even playing with numbers from today's WSJ yields numbers for r around
    0.5 -- This actually seems a little high given the expected state of
    S&P 500 dividends.  

    Having thought about it further I think the real flaw in my analysis
    lies in failing to discount my contract percentage growth estimates for 
    both the carry (as you pointed out) and the dividend loss.

    This would seem to reduce the potential by about half, still a little
    better than actually holding the stocks by not nearly as attractive
    given the extra hassle and potential for a single year wipeout.

    -Bob