I am using the “Lifecycle Investing” strategy proposed by Barry Nalebuff and Ian Ayres in their book of the same name, which states that one should use 2:1 leverage for the first few years of their career as a long term investment strategy. The way they suggest doing this is by buying index funds like SPY with margin loans and LEAPS, among other means. I am currently trying to determine which of the first two is the better option by calculating which of those two would require the lowest stock price change to break even.
Let's say I had $10,000, and I put it in SPY with no leverage. Since SPY has a 30-day yield of 1.42, we may assume that the dividend returns would be 1.42% over then next year, so the stock price could fall by 100-100×(1/1.0142)=1.4% (-1.4% change) and you would still break even because of the dividend. Since I use róbinhood (pls don't hate), if I want to use 2:1 leverage through margin loans, I can borrow $10,000 to buy SPY, on top of the $10,000 I own with my money. The margin interest rate is 5% right now, which is calculated by adding 2.5% to the target federal funds rate, which will also go up to decrease inflation. Assuming it stays the same however, the price change for SPY to reach break-even with margin loans, would be (5-(2×1.42))/2=1.08%. I pretty much took the interest rate, subtracted from it the 30-day yield times 2, because now we get twice as many dividends because we have twice as many shares, and then divided that result by 2 because we also get double the gains for the same change in price. Furthermore, we can also attain 2:1 leverage by buying a $205 9/23 SPY Call. SPY is currently priced at $413, and that call's ask price is $214, meaning that SPY's break-even price change in this case would be ((205+214)/413-1)×100=1.45%. Since you miss out on dividends with calls, we don't need to consider them here.
According to my methodology, and please correct me if it is wrong, margin loans appear to be the superior option, especially for someone like me who is young and has a smaller account. The margin interest rate would need to go up by another .74% for the margin loan approach to have the same break-even point as the LEAP approach. You might say that's likely to happen given more future rate hikes by the federal reserve. But even then, each one of those calls costs $21,400, and thus this approach requires at least that much money, if not way more, to successfully implement. Finally, as prices fluctuate, your leverage will too. If I used the margin loan approach mentioned earlier and SPY fell by 25%, I would end up with $15,000 worth of SPY shares. Since I have $10,000 in loans, of that $15,000, only $5,000 would be mine, and therefore I would have 3:1 leverage. I would thus need to rebalance by selling stock to pay off my loans as the price goes down, and take out loans to buy more stock as the price goes up, to retain 2:1 leverage. The LEAP approach also requires rebalancing, but since each LEAP is ~$20K, you would actually need a lot more money than that to rebalance. Are there any factors that I have overlooked, or is the margin approach simply better?
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