Deconstructing Autocallables

Earlier this week, I spent some time trying to dig in more to autocallable ETFs with the help of Copilot. The basic idea is that autocallables have been around for a while as structured notes, an investment product, that tend to have high yields and last year, they started to become available via the ETF wrapper thus democratizing the product. 

We've looked a few times at the Calamos US Equity Autocallable Income ETF (CAIE). The very basic idea is that it pays 14% annually (it's a monthly pay) so long as the reference index does not decline 40%. If the decline is that big then payments are suspended until the underlying index recovers back above point where it breached 40% down. I remember from the presentation when CAIE first listed that there was only one instance where the index went down such that payments would have been suspended. 

CAIE owns 52 autocallables with one coming due and getting replaced in the fund every week which can reduce volatility some. 

It's not even a year yet but you can decide for yourself what you think about it. My hang up has been that I don't think I really understand the risk here. A 14% yield in a 4% world has risk. It's not that no one should take the risk but I don't believe in taking risks that I don't understand. I may have made progress with Copilot. It was kind of a long back and forth but it was productive and hopefully I can convey what I think I've learned. 

I'll include tables from Copilot but the TLDR is that although they continue to pay out as long as there is not a 40% decline, the price will be sensitive to price swings in the reference index which is a derivative of the S&P 500. 

This next one makes them seem very complex.

The prompt for me to do this was that GraniteShares launched autocallable ETFs for two stocks, one tracking Tesla with symbol TLV and the other tracking Nvidia with symbol ANV. I made the obvious observation awhile ago that this sort of thing would be coming and that it is something we should try to learn about. 

Copilot said the "structural mechanics" of TLV and ANV were the same as CAIE other than using individual names for the reference securities. It said the yield on TLV and ANV wouldn't be higher than CAIE. I pushed back on that because by definition there is more risk in a stock than an index so the compensation for the autocallable tracking stocks should more. 

First it agreed that you'd expect higher yields but...

What it really meant was that the yield will be a little higher with TLA and ANV but not enough to compensate for the volatility and risk of the underlyings.

Copilot thinks that TLA and ANV will "carry 2-4x the risk of CAIE but only offer 1.2x the yield of CAIE."

Hoo boy. So I asked if the GraniteShares concept would make more sense with less volatile names like maybe Microsoft and Alphabet. 

Using lower‑volatility stocks like Microsoft or Alphabet would make the GraniteShares autocallable concept materially better — but not for the reason most people assume.
It’s not just “lower vol = safer.”
It’s that autocallables behave non‑linearly with volatility, and MSFT/GOOGL sit in the sweet spot where the structure actually works as intended.

That's really quite an indictment of TLA and ANV. It goes on to say "bad tradeoff" describing TLA and ANV. Using MSFT and GOOG has volatility characteristics that would make the autocallable behave more like it's supposed to behave, it said. 

Alright, I guess Copilot is not a fan. We're going with the idea that Copilot is correct.

While I still am not so intrigued that I want to step into CAIE, knowing there is downside sensitivity helps me understand a little better. I am not saying Calamos said there would be no downside but I don't recall it being discussed.

The reality is that CAIE will "work" the vast majority of time but not feeling like you fully understand what can go wrong makes it a difficult hold even if we understand a little more than we did before. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Looking Around Corners

This morning's email from Bespoke led off with the following quote from author William S. Burroughs.

“The best way to keep something bad from happening is to see it ahead of time... and you can't see it if you refuse to face the possibility.”

It ties in with a lot of what we talk about here not just for portfolio management but also lifestyle. 

First, portfolio management. I talked about "looking around the corner" for trouble or problems. A simple example is that with tech's weighting in the S&P 500 being so high at 45% (that's actually tech 34%, communications 11%), realizing that history has not been kind to sectors that grow larger than 30% of the index, being underweight tech and/or communications however you think about those two is a way to minimize the impact of something bad happening to the index. 

I'm not saying no tech exposure, that doesn't make sense, but if the software stock panic of this week turns out to be a canary in the tech coal mine, then being underweight should probably spare the portfolio some number of basis points of the full decline of the broad market if that's what happens. 

Try to look around a corner accounts for our perpetual exploration of how to use liquid alternatives to try to smooth out the ride which takes us to a webcast put on by WisdomTree with Shana Sissel from Banrion as the guest. Shana is working with WisdomTree to build model portfolios that rely heavily on alts as well as capital efficiency (leverage) using WisdomTree's core efficient funds like NTSX which leverages up such that a 67% allocation to that fund equals 100% allocated to a 60/40 balanced fund like VBAIX from Vanguard. Brad Krom from WisdomTree who was also on the webcast said that if the leftover 33% can go into something that earns more than T-bills, that you'd be adding alpha versus VBAIX which is a point we've looked at here before. 

The Banrion/WisdomTree portfolio is available at the WisdomTree website if you register. It's probably not ok to share all the names and percentages but we can keep it high level. It allocates 42% to "allocation" which includes NTSX and another core efficient (leveraged) fund, 17% to alts including client/personal holding BTAL, long/short (Shana is big on long/short), crypto, managed futures, a little bit to emerging markets, 10% to simpler fixed income beyond the fixed income exposure in the core efficient funds and the rest in simpler equities but included in that equity sleeve is a little gold from GDE. 

The backtest is short because some of the funds are pretty new but that's ok, Shana didn't start working with WisdomTree since last August or September (I think, apologies if it was more recent than that). Also, the portfolio is not static. She talked about dialing up or dialing down exposures but there was no indication of how frequently she does that.

Here's how I replicated it, it's about half the funds but it admittedly is a loose replication. For one thing, she included long biased long/short but I did not.

Everything there except AQMIX and SHRIX are in my ownership universe.

I wouldn't take too much from the raw performance for being such a short time frame but I think you can get a sense of the volatility added by the crypto and gold as both have gone down a lot in the last few days. 

The gold exposure is nowhere close to the 20-25% that some pundits argue for, it is much closer to the low-single digit starting point I use. It's not like she has a ton in crypto but it's not nothing and I am not a fan of Bitcoin or the others as a diversifier, to me it is all about asymmetric opportunity. Based on how volatile it used to be (the current event maybe approaches that?) and then the compressed volatility of the last few years, I don't believe it can be modeled in as a diversifier. 

Shana said something that is almost word for word what I have said here. She said that BTAL and managed futures are the two most important holdings because of the diversification they provide. I'm not claiming she got that from me, I am saying it is two different people drawing what I think is an obvious conclusion. BTAL and managed futures are the two most important diversifiers. Of course the 77% of the time that markets are going up makes them tough to hold but, also echoing our conversation, since there is no way to know when BTAL and managed futures will go up, you need to size it correctly and hold on. In this current event, BTAL seems to be working the best. The alts that should be going sideways are doing that which is good but gold obviously is part of whatever is going on and managed futures is very long gold and silver so it is getting hit too.

She has a little more BTAL than me and a little less managed futures. 

Back to the quote at the top of the post as relates to lifestyle. We learn as children that it is important to exercise and not eat too much sugar. That advice is more important than we realized when we first heard it. Just as owning 40% in tech is teeing up for an adverse outcome, so too is no exercise and a sugary diet teeing up sickness. Getting exercise and diet in order is a very simple way to keep something bad physically from happening. Really it is about improving your odds of successful health outcomes. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Just Take A Breath

It's not getting a lot of attention but Bitcoin has taken quite a hit over the last few months. 

I threw Strategy (MSTR) on the chart too which is of course a leveraged proxy for Bitcoin. Over the weekend I saw that Jim Cramer was Tweeting about Bitcoin and that Michael Saylor should do something and then I saw this get retweeted during the day on Wednesday.

If you look at his feed, there are a lot posts about Bitcoin and several about Strategy. Gemini gave this answer,

It's difficult to know whether the emotion in the tweet really captures Jim's sentiment or if this is his TV persona expressing itself. If the tweet doesn't capture Jim's actual state of mind, there are HODLers who are as worried as how I take his Tweets. There are other people sitting on relatively large positions of the software stocks that got hit yesterday or broader tech that is getting hit today.

We spend a lot of time here talking about position sizing, having the right mix of assets and managing sequence of return risk if relevant. 

However difficult the task of enduring through stock market cycles and various events that come along, it will be orders of magnitude more difficult when every event whips up your emotion. 

Bitcoin is, was and always will be a speculative asset with a legitimately asymmetric return opportunity. It could go to the moon or it could crap out. Anyone who is sweating their Bitcoin position has too much. Their dread is then magnified when they read Tweets like Jim's or see new price targets to the downside from the extrapolators.

If you think Bitcoin is a scam, then the huge decline doesn't sway you the other way. True believers still truly believe and skeptics willing to bet on the asymmetry may have had their confidence shaken but in reality, the only thing that has changed is the price. Anyone whose position is stressing them out, ok sell some, maybe it will be a good decision or maybe it will be a bad decision, no idea, that is what it means to bet on asymmetry. I'm using the word bet on purpose. I would grain of salt the idea that it is truly an investment...for the most part. A diversified portfolio might allocate to, "invest" in, asymmetry so with sort of top down framing, maybe it is an investment. But from the bottom up, it's a bet.

Qualcom (QCOM) is getting hit after hours on its earnings report. The stock has been meandering for the last five years not making much progress and YTD it is down 13%. It earned $2.78 for the quarter reported versus $2.83 for the same quarter last year and it appears they are vulnerable to the shortage in memory chips.

The average analyst estimate for QCOM's 2026 earnings is $11.96/share and for 2027 the estimate is $12.25/share. I have no disclosures to make here but before the afterhours hit, it was trading at 12 times earnings and it's revenue is $45 billion. While I have no idea what the stock price will do, it is quite clear the company isn't going out of business anytime soon.. 

This isn't about Qualcom. If you own individual stocks, you own them for some reason, there was something that caused you to buy. A simple drop in price, especially when the sector that the stock is in is going through something, like parts of tech now, or when the entire stock market is going through something, probably has nothing to do with whatever your reasoning was for buying the stock so don't get worked up. Succumbing to emotion on a regular basis makes for a stressful existence and will hamper returns significantly. 

Just take a breath. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Leverage & Derivative Income? Go On, I'm Listening

NEOS is launching three ETFs that offer 1.5X covered call exposure of their call funds. So their covered call ETF SPYI references the S&P 500 and now the new Boosted S&P 500 High Income ETF (XSPI) will seek 1.5x the movement and yield of SPYI. For the QQQ they have had QQQI and now XQQI and Bitcoin BTCI with XBCI as the 1.5X companion.  

The specific verbiage is the new funds will have 150% of the notional exposure trying to pursue higher levels of tax efficient monthly income and enhanced market participation. That leaves some wiggle room if 1.5X is not precisely linear. 

The website for BTCI says it "yields" 27% so the math checks out on the performance dispersion between total return and price only. The price only versions of BTCI and 1.5 BTCI did go up through August of last year as IBIT lifted so with the right path it is possible. 

SPYI and 1.5X SPYI has done a decent job of trading sideways while paying out 12% for SPYI. Trading sideways for a high yielder is a good outcome for these. The crazy high yielders generally are not capable of that. Of course, the next time the S&P 500 drops 20 or 25% covered call funds should be expected to have a pretty high downside capture. The yield might help a little but not a lot. 

It's not a good assumption that the new 1.5X funds will deliver 1.5 times anything. The S&P 500 version should have a better chance because it should be less volatile than the Bitcoin funds.

Short post tonight, had to help go get Walker Fire's new brush truck. One of our guys had the idea of transferring the fire apparatus from our old, 2006 Ford onto a newer chassis. This probably saved the department $150,000 versus buying a whole new brush truck.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

A Leveraged Fund Actually Did Better?

Just a couple of very quick snippets tonight.

Netflix (NFLX) has taken quite a hit over the last seven months or so with the attempt to buy Warner Brothers probably a contributing factor.

NFLY is the crazy high yielding version of Netflix, it is down a little more on a price basis but when you add the yield back in, it has actually outperformed by 800 basis points (per Testfol.io). NFXL is a 2X version of Netflix and the way the sequence of daily returns played out, it helped NFXL to be down less than 36% times two. The 2X funds and the derivative income funds are not automatically bad holds but they certainly would be tricky holds. Both have sort of worked out during this period but flip of the coin, they could have gone the other way. 

Man Financial came out with an ETF in December that goes 100% S&P 500/100% managed futures in a manner similar to the ReturnStacked fund with symbol RSST.

MATE is the new Man Financial ETF, Portfolio 2 is building MATE yourself with client/personal holding AHLT as the managed futures piece and Portfolio 4 is an AQR fund that does something similar but is not 100/100 and that one is a personal holding. 

RSST pretty much never comes out ahead in any sort of study we do. If we take MATE out and go back to RSST's inception, RSST outperformed IVV/AHLT for the first half of the back test but overall lagged by 488 basis points compounded.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Insanity And Stability All In One Blog Post

Yesterday, I said I wanted to give the insanity spilling out over the weekend time to "breathe" and then things got more insane. Peter Attia of all people is apparently all over the Epstein files. Kevin Warsh is in there quite a bit, Eddy Elfenbein theorized that his nomination will be rescinded. Now I need time to breathe, I cannot wrap my head around any of this. Even Casey Wasserman is in there. Who? He's in charge of the LA Olympic Organizing Committee and he has apologized for exchanging emails with Ghislane Maxwell. 

Moving on with a quote from Russell Napier, "chasing yield is dangerous most times, but exceptionally dangerous below 2%." While I agree with the sentiment, the sample size is pretty small with the years leading into late 2021 being the only one I can recall lasting any real amount of time. A little more broadly, chasing yield regardless of the nominal levels can be dangerous. 

In wildland firefighting there is a list of what are called watch out situations. For example, fighting a fire in the dark, in a place where you've never been is something to watch out for increased risk. That doesn't mean, you don't do it, it means you do so carefully, there are way to mitigate that risk. 

Similarly, the risks of accessing yields above the prevailing risk free rate can be mitigated. One is to diversify exposures to avoid loading up on the same risk. If you own a catastrophe bond fund and a high yield fund, the risks are diversified. Of course, there could be a terrible hurricane during a credit crisis, the risks are totally unrelated. Another way to mitigate risk is to avoid risks you don't understand. No one will understand everything well enough to invest (me with autocallables), just avoid the ones you don't understand. A third one I'll add is to think long and hard before buying a derivative income fund that "yields" 80%. 

We've built much of our thesis on how to replace traditional fixed income by using liquid alternatives in a manner that spreads the risk out so that if something blows up in some sort of unpredictable manner, the portfolio impact would be very small. If you have 10% of your stability sleeve (stability, not fixed income as a nod to TPA) in merger arbitrage that might be 4% of the overall portfolio. If merger arb cuts in half, that would be awful but the impact on the portfolio would be minimal. Compare that to 40% in AGG when it drops 13% as it did in 2022. On a price basis, AGG is down 15% from its 2021 high. The only way it makes that back is if interest rates plummet. 

Barron's had warning article about alternatives that I think excludes a huge part of the use case. The context seems to focus on trying to add alpha with things like private equity. That is a much more difficult effect to try to pull off versus a lot of plain vanilla equity for growth and using alts that seek stability and in the case of the ones we look at here, succeed at delivering stability. 

AQR is out with its capital market return assumptions as follows.

The numbers are after inflation so if inflation is running at 2.8%, they'd expect 60/40 to return 6.2% (2.8 plus 3.4) in nominal terms. The 3.4% number is lower than what they say is normally a 5.0% real return for 60/40. Playing around with different time frames on testfol.io I get higher numbers than that, more like in the high sixes. Looking at the asset classes, the expectation for US equities is lower than the historical norm but the fixed income expectations seem pretty good for those income market sectors. A 2% real return for treasuries is considered good. Or at least it use to be.

That rule of thumb is built largely on the 40 year decline in yields which is now over. Buying a ten year note and holding it for a 2.4% real return is fine, not so with treasury ETFs, but that could prove out to be a very volatile ride. Is a 2.4% real return adequate compensation for the potential volatility? For me, the answer is no. With a little more engagement, management and diversification I think the real return can be nudged up and the potential volatility reduced significantly. This is the difference between 40% in bonds versus 40% in stability. 

All of the talking points we've hit on in this post are why I continually try to find new ways to improve the stability sleeve which brings us to a fund coming this week, the VistaShares BitBonds 5 Year Enhanced Weekly Option Income ETF which will have symbol BTYB. The fund will have 80% in five year treasury notes and 20% in a synthetic covered call (short put, long call, short call) position in Bitcoin with the objective of trying to get twice the yield of the five year note. 

The idea is to blend a smaller slice to higher "yielding," higher volatility with very plain vanilla exposure. I don't know, maybe an 80/20 split addresses the bleed that goes with Bitcoin derivative income funds.

I believe YBTC is the first Bitcoin covered call fund. The 80/20 mix still has plenty of downside volatility relative to fixed income products. The 90/10 mix is a little more interesting but it's more of a yield enhancement (I realize that is the name of the fund) as opposed to doubling the yield. This doesn't make a great first impression but I'll probably follow it. The path to figuring this space out has been rough. Where I believe client/personal holding PPFIX has figured it out, there will be other funds/strategies that also figure it out.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

A Complicated Benefit Of Working In Your 60's

This is shaping up to be an insane weekend coming after Friday's fallout, the chatter being driven by the release of more (all the remaining?) Epstein files and Bitcoin is cascading lower flirting with Strategy's (MSTR) break even price as I write this on Saturday afternoon. I'll give all of that another day to "breathe" so that we can look at some HSA/Medicare/Social Security retirement stuff.

Barron's kicked it off with Healthcare Inflation Can Be A Runaway Train In Retirement. They pegged CPI running at 2.8% and that official numbers for healthcare expenses are inflating at 3.5%. To Barron's credit they called BS on 3.5% in the next sentence. I have no idea what the inflation rate is for actual medical services but there are countless anecdotes and news stories about people being forced to pay much more for health insurance. 

A few weeks ago we looked at a scenario where Healthcare.gov subsidies stopped at $84,000 of family income being the difference between paying almost nothing and jumping up to twenty something thousand/yr. Maybe there are enough alternatives out there, I don't know but where is a family making $90,000-$100,000 supposed to get $20,000 for health insurance this year after paying nothing last year? 

The criticism that a well structured healthcare system shouldn't need subsidies like the ones that just expired (is it too late to reinstate them for 2026?). That's true but the answer isn't just ending them, leaving people stuck.

A little further down in the article, they cited 5.8% as being the average annual increase of healthcare costs throughout retirement according to a report coming soon. I'm not sure I believe the 5.8% number either. Actually, I am sure. I don't believe that number. 

The Barron's article then drifted into income levels where IRMAA kicks in which as we looked at last week is $109,000 for single filers and $218,000 for married filing jointly. Up to $274,000 IRMAA is an additional $81 per person per month for Medicare Part B. Up to $342,000 of income and Part B is a total of $405 per person per month. 

Of course health savings account entered the discussion. Starting quite a few years ago, having an HSA eligible plan rarely has made sense for us being self employed. Our insurance guy said something about certain things have to be covered that insurance companies don't want to cover so they make the plans more expensive. Awful if accurate but either way we've only had an HSA eligible plan in the 2020's. We were very diligent putting money in every year when they did make sense for us without needing to take any out.

I asked Copilot what the median HSA balance is for families making at least $150,000. I got an absurdly low number so I pushed back a little bit and it came up with $19,000 plus or minus a couple of thousand. If that number is correct, then it wouldn't be enough to pay for something expensive that insurance won't cover but there are expenses where it could cover including paying for Medicare. 

It's a little tricky. Part B premiums are deducted from our Social Security payment. But it is valid to reimburse yourself that expense out of your HSA. The reimbursement can go to your bank account to be spent however you like including Part G Medicare. Technically, you can't use HSA money to pay for Part G but once the reimbursement hits your account you can spend it as you wish. This was per Copilot and corroborated by Grok.

The table from Copilot shows what it believes are averages for Part G per person.

Copilot thinks Part G is inflating by as much as 8-15% per year.

We'll all have Part B to contend with. How likely are you to be subject to IRMAA? Copilot estimates that 7% of people on Medicare pay the IRMAA surcharge. Depending on how long I work, there's a chance we'll have to pay it. I don't know the odds but between various streams of income, it seems plausible. We are all entitled to our own opinions but an extra $160/mo will not be at the top of my list of things to be worried about. 

Somewhat more concerning is the visibility for Medicare to eat up an ever bigger piece of Social Security checks.

That leads us to another article from Barron's (used a gift link for this one) that was not easy to understand, I may not understand it but it got into the minutia of how Social Security is calculated and what seems like a reward for working beyond 60 at your maximum income level. 

Starting at age 60, the calculation stops adjusting wages for inflation which apparently can be a positive. The key is that you're making the most you've ever made in your 60's. The example Copilot gave was someone making $150,000/yr in their 60's would benefit if their $50,000 income at age 30 was only adjusted for inflation up to $120,000. In this simplified example, $150,000 at age 62 would replace inflation adjusted $120,000 from age 30. 

Our Social Security payments are based on our highest 35 years of earnings so however many years you work in your 60's at your highest income level are replacing your lowest earnings years from when you were a kid. 

When I first read the article, I thought it was saying that your whole year by year scale moves up but Copilot said not exactly but that your "primary insurance amount" PIA is moving up. I'm not entirely sure what the difference is. If you log in to your SS online account you can see your year by year earnings record adjusted for inflation. For example, I worked at Charles Schwab for a year before going to college, I made $11,000 or $12,000 from July to July but when I last looked a few years ago, that $11 or $12 had been inflation adjusted up into the high $20,000's combined if I recall correctly. At this point, whatever the correct inflation adjusted number was from 1984/85 has since been replaced in my calculation.

If I continue to work as I plan on doing then I would be able to replace most of the years from ages 23-33 which were my lowest post-college earnings years. 

A logical question is what if SS gets cut in 7-9 years? If you're going to get $4000/mo but that gets cut to $3000/mo, then working through your 60's as described above can be thought of reducing your $1000 haircut by a few hundred dollars. If that's not worth it to you then by all means, don't do it. 

A couple of final administrative points to make. Copilot couldn't read a gift link, I had to past the text in to get help with it which surprised me. I couldn't work it in easily above but I'll include my standard lift weights/cut carbs recommendation as a way to keep healthcare costs down. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.