I am 100% bonds, in my case it is return OF not ON, Capital.

Plus 55, people should not own stocks, cut your spending and stay with short term bonds.

That’s a good safe common sense response for most situations. The discussion I wanted to create was to ask why is that?

Just based on sheer random luck (which might be all you have for a 1 year time horizon) the market goes up more years then down right?

For anyone who isn’t familiar with options (I’m no expert) – volatility of the underlying securities is one of the key factors in the options price.

This post explains call options fairly well:

http://www.milliondollarjourney.com/how-call-options-work-i-the-basics.htm

Assumption: You start off with 100,000 and you need 100,000 after 1 year for housing downpayment. 1 GIC offers 4.0%. X is an index etf. X is 100 dollars a share. X’s 100 dollar call option ending in 6 month month is 10 dollars per contract.

Amount that you need to put in GIC:
100,000/1.04 = 96154

Amount that you can buy options with:
100,000 – 96154 = 3846

Lets save 146 dollars for brokerage comission cost.

Amount of options that can be bought: 370 contracts.

Potential good case scenario:
X rises to 125. X 100 dollar call option worth 30 dollars as a result. You sell 370 contracts at 30 dollars each. You received 11100.

Your total amount at the end of year one would be: 100,000 + 11,100 = 111,100.

Worst Case Scenario:
Your options are worth zero due to fact X falls in price.
Your total amount at the end of year one would be: 100,000 + 0 = 100,000

In the best case scenario, X went up by 25%, but your total return only went up by 11.1%. Is the market participation rate equivalent to 11.1/25 = 44.4% in terms of financial engineering? I am not very sure. Your bank salespeople will tell you this is very dangerous and do not do this at home and try to sell you their Market Riser GIC, Principal Protected Notes, etc. I think as long as you understand options: this GIC/options mix is quite doable.

Warning: Due to recent volatility, options have been very expensive lately.

If I have a 10 year time horizon and I could somehow manage to earn a 7% return on my GIc or CD in US ( i know those rates are unbelievable they are jsut for illustration purposes) that means that my principal will double in a decade. So if I invest 50% in stocks and 50% in GIc/CD earning me 7% ( which I could compound at 7%) then in one decade the WORST thing that will happen to me is to only have 10K ( if stock markets dropped to 0 and all dividends were reinvested in what essentially became a worthless stock).

Now if you can’t reinvest the CD/GIC at 7%, then the most stock allocation you could afford is 31,1%..

Of course if interest rates drop you will need a higher fixed income allocation..

I’m really glad to get your suggestions, I actually got the idea to write this based on your comments at CC’s blog. I wanted to test the idea for myself.

Maybe you can explain your call option / gic strategy a bit more? I’ll do some research to try figuring it out, but I don’t really understand it, options are another weak area of my understanding.

Personally I have several options to deal with a shortfall situation. Even with another huge 50% drop in equities I could make up the down payment from retirement savings. I’m self employed and also a US citizen so I’m very lucky that I can also move to a cheaper real estate market.

Based on my family’s situation I’m feeling pretty comfortable fully investing our down payment after I thought about the risks.

In fact if the Metro Vancouver market doesn’t have a +20% drop in 2009 I’ll probably pull up roots and move the family. But I have a pretty good/bad feeling this guess will come true, I think Mohican is a pretty smart guy at seeing the truth in our market.

I also sent you a personal email if you wanted to talk off site.