$SPY $DBX $KRBN $ANGI $ATUS $ARKG $SNAP $VYGVF $USDC.X

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The investment strategy laid out in this post utilizes USD Coin (USDC), a cryptocurrency known as a stablecoin and pegged to the US dollar, and Voyager, an app-based digital asset trading and financial services platform.

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USDC is issued by Circle, a US-based company which is currently expected to go public in the US via SPAC combination with Concord Acquisition Corp (NYSE: CND). USDC is fully backed by USD and treasuries and is seen as the most stable, reliable and resilient stablecoin in the market, but is potentially subject to unknown risks stemming from the crypto economy and/or regulators. For example, in a worst-case scenario, one might conceive of regulators freezing and/or confiscating crypto assets, including USDC.

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Voyager (TSE: VOYG | US OTC: $VYGVF**) is a publicly traded company on the Toronto Stock Exchange and US OTC. If you’re unfamiliar with different crypto platforms, you can think of it like Coinbase.**

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USD deposits on Voyager are FDIC insured. However, USDC and other digital asset holdings are not FDIC insured, and in the event that Voyager were to go bankrupt, depositors of digital assets might lose some or all of their deposits.

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Read more about Voyager and USDC here and here.

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I highlight these risks upfront because other stablecoins, most recently Terra (UST), which was an algorithmic stablecoin not fully backed by USD, have lost their peg and gone to effectively zero. USDC’s primary competitor and the stablecoin with the largest market share currently, Tether (USDT), is another “fully backed” stablecoin but there have been doubts about the nature and quality of the assets backing USDT.

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While Voyager doesn’t support algorithmic stablecoins, they do support USDT. If USDT were to lose its peg, it’s not clear to me what the ramifications would be Voyager as a company. As such, I consider the risks to include bankruptcy and potential customer forfeiture of some or all of their digital assets on the platform.

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I consider these tail risks, perhaps of the nature inherent to almost any investment. As such, I do not recommend putting 100% of your capital in this trade, even though I will refer to aspects of the trade below as risk-free for simplicity of communication. Owning USDC is not risk-free in the sense that owning USD is risk-free, and some (but surely not all!) of the risks specific to USDC have been covered above.*

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NOT INVESTMENT ADVICE!!!

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Now, on to the fun part :)

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If you’re like me, in between pondering if you’re just completely wrong about everything recently you might have been pondering how to take advantage of Voyager’s high interest rates on USDC without reducing your exposure to stocks or crypto after a 60% drawdown.

Currently, you can get paid interest on USDC held on Voyager according to the following tiers:

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Just straight selling everything and investing $100k at a risk-free* blended 7.69% is not a bad option. In fact, it’s a really, really good option. The long-run average annual return for the S&P 500 is ~8%.

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In hindsight, this would have been a great option in, say, November 2021. But punching out of the stock market now after the S&P 500 just suffered its worst start to the year through April since World War II might not be best time to find religion with respect to your investments (or maybe it is!).

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But what if I told you you could have your cake and eat it too? Retain all of your equity exposure and protect your capital in the event we are in a multi-year bear market and stocks still have much lower to go?

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The Trade

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Imagine you own 100 shares of SPY at today’s closing price of $412.93 for a total investment of $41,293. By using long-dated call options and utilizing Voyager’s interest rates on USDC you can retain 100% of the upside of owning 100 shares of SPY and limit your downside to +4% over the next 2.5 years.

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Yep, that’s right. Your risk " is +4%.

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If the S&P 500 falls by 50%, you make 4%.

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If the S&P 500 gains 50%, you make 54%.

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All of the reward and none of the risk.

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Here’s how (prices reflect 5/31/2022 last traded prices):

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By replacing your stock portfolio with options, you limit your losses to the premium paid, in this case $6,380.

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Of course, typically the trade-off for limiting your downside by using call options is a commensurate reduction of your upside. It’s like buying insurance. It only pays off if shit hits the fan.

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A typical call option payoff profile looks like this:

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The y-axis is the portfolio % return. The x-axis is the % return of the underlying equity.

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The blue curve represents the % return of the option + cash portfolio. It’s losses are capped at -15.5% (the flat left half of the blue curve), which represents the premium paid to acquire the option ($6,380 loss). No matter how low the underlying equity goes, you can only lose what you paid for the option. But on the upside the option + cash portfolio underperforms by the cost of the option (illustrated by the blue curve being below the orange line for all positive returns of the underlying equity).

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The orange line represents the % return of the all stock portfolio. The orange line is just y = x.

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Here’s the same payoff profile using portfolio $ value for the y-axis instead of % returns. Remember our starting portfolio is $41,293, indicated by the intersect of the orange line at 0% return.

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Options are a capital efficient way to get exposure to financial asset prices. Said differently, they have embedded leverage.

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In the trade above, you gain exposure to $41,293 worth of SPY but only have to put up $6,380 to do it. Now you’ve got SPY exposure and $34,913 in cash laying around.

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The payoff profiles above assume you don’t earn any return on that cash. For the better part of the last 15 years, that has been an accurate assumption and thus this trade hasn’t been as exciting. The unique opportunity we are presented today arises from the fact that we can invest a stable, dollar-pegged, risk-free asset in USDC at advantageous interest rates of up to 9%.

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Let’s look at these payoff profiles again, this time assuming we invest the $34,913 in USDC on Voyager at the tiers offered above.

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Notice that the blue “options+cash” curve is now permanently above the orange “stock” line. The rates we can get on USDC are so good that we can more than recoup the premium paid for the call option in interest paid on USDC over our holding period, which is determined by the expiration date on our option, 12/20/2024 (2.56 years from now).

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The blended interest rate on $34,913 invested in USDC on Voyager is 8.5%. $34,913 compounded at 8.5% for 2.56 years = $43,026 for a $8,113 gain on investment.

This $8,113 gain more than pays for the $6,380 premium on our option!

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Thus, by replacing our 100 shares of SPY with a 12/20/2024 $410 strike call option and cash invested in USDC on Voyager, we can create a portfolio with more return for less risk.

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We effectively get paid to take on an insurance policy. We lock-in a minimum 4% portfolio level gain over the 2.56 year holding period while retaining all of the upside if the market takes off.

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Reward: check. Risk: none*.

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Absent tax consequences or an inability or aversion to holding options and/or USDC on Voyager (fair!), or a view that the interest rates on USDC are going to imminently collapse (also fair!), there’s not a good reason in my mind to continue holding SPY exposure when implied volatility is this low in this environment and you can earn 9% on cash.

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The Other Trade

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Let’s say you actually have a view stocks have bottomed and expect decent returns from here over the next couple years. You’re willing to take on a little downside risk for some more upside exposure.

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By purchasing two options contracts instead of one, you can juice your returns and get a more convex payoff curve.

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Now you’re risk is truncated at -14% since you’re spending twice as much on premium and have less cash left over to invest in USDC.

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Notice now we also have some area where the blue payoff curve is below the orange payoff line of simply owning equity. If SPY returns all in a range of -14% to 12% from now until 12/20/2024, we will have performed worse than if we had just continued to hold SPY.

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But notice also how we start to outperform more and more for higher returns of the underlying SPY. If SPY gains 50% from here, this portfolio returns a whopping 87%, as opposed to the 54% in our risk-free* portfolio construction above. With a 50% gain in SPY during our holding period, this portfolio grows to a nominal $77,265 vs. the prior portfolio’s $63,955. This turbocharged portfolio has better returns for all returns of the underlying SPY 18% or greater.

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What we have created is functionally a way to maximize returns on the view that the stock market is going to rebound strongly from current levels over the next 2.5 years, while keeping a parachute in our back pocket in case we’re totally wrong. In a sideways market, we end up leaking capital.

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A Few Considerations…

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Thanks to Harley Bassman (@convexitymaven on Twitter) for the idea that inspired this trade. Here’s a link to his piece from November 2021 where he explains what I try to explain above, but way better. If I only I’d have listened to him then…

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Disclosure: I own USDC, DBX+calls, ANGI+calls, ATUS+calls, KRBN+calls and ARKG