Creating Our Own Bonds Through Option Positions

The size of the global bond market (~$130T) is considerably larger than the global stock market (~$109T). So only focusing on stocks is akin to ignoring 54% of the total potential playing field.

At the current interest rates (you can earn ~5.4% risk free on a 1 Year US treasury), the opportunity cost of being completely oblivious of the bond market can be quite expensive.

To put things in perspective, the opportunity cost of an initial capital of $100K earning a meagre 2% in a savings account instead of a possible ~6% in a cash equivalent (it is possible) over a 50 year investing lifetime, is $1.57M. Can we just afford to throw away $1.5M like this?

The problem is that of ‘access’ for retail investors. Usually the ticket size for bond investments is much larger (typically > $200K-250K) and hence when suitable opportunities to invest in stocks are not forthcoming, a lot of money is left idle, waiting for the ‘right time’.

What if I told you that while you are waiting, you could easily park the funds in safe govt. treasuries (which are cash equivalents) and easily earn ~ 5% risk free?

However here also the ticket size makes a difference. For example returns from parking $100K for a short period (< 3 month) in % terms, would be considerably higher than parking idle funds of $10K for the same period…simply because the commission charges on the $10K will eat away a chunk of your % Yield.

Now what if I told you there is an elegant way around this? This is where understanding options comes useful. Here we are NOT talking about speculating with options or trading options. Did you know you can create your own risk-free ‘bond’ (similar to a US treasury) that can generate a higher yield than a treasury, without having the downside of the ‘size effect’.

The picture below shows the actual transactions that I had done on 10th Oct.

Those who are very familiar with options, would be able to see that this combo of these 4 SPX options is EXACTLY equivalent to a zero-coupon US treasury maturing in 5 months.

The only difference is that on 10th Oct, directly investing in a 5 month US treasury for the same amount would have given me a return (IRR) of ~5%, where as this particular position guarantees me of a return of ~5.9% irrespective of where SPX is, by the expiry date of these options.

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