As long positions appreciate, portfolio equity grows and so does margin capacity, acting like a synthetic cash injection that sustains tax-loss harvesting potential
I just want to confirm and clarify something. You say that "appreciation in long positions boosts portfolio equity and margin capacity". If your short book goes up by an equal amount, and holding all things equal that seems like a safe assumption, you don't gain any margin capacity.
If your account has 100K in equity, you are 130 long / 30 short. Let's say the market then doubles. You are now 260 long / 60 short, with 200 in equity, but you didn't gain any margin capacity. Your leverage was 1.6x before the rise in the market, and it's 1.6x after the rise in the market. You can obviously harvest losses in those short positions, but it's not quite the same as an injection in cash, right?
Now if you are using factor overlays, and those factor overlays generate alpha, that DOES create more margin capacity. So if you were 130 long / 30 short, and your factor overlay (let's say long value) generates 10% alpha (using a ludicrously large number for this example), and you are now 135 / 25 short, your leverage went from 1.6x to 1.45x, and you can now lever back up to 1.6x with what is essentially 'new cash'.
Yes, if you are net long, and the market goes up, your equity expands. We're on the same page there.
But your leverage didn't go down. So you don't gain any margin capacity, as you implied in the body of the post.
Even though I don't think your example is QUITE the traditional 130 / 30, I'll follow your example.
Before market growth, your gross exposure was 160 (130 + 30), with 130 in equity, that's 1.23x leverage. After market goes up 10%, in your example, your gross exposure is 176 (143 + 33), with 140 in equity. That's now 1.26x leverage. So your leverage went UP. So the market going up doesn't provide you with spare margin if you want to keep gross leverage near constant values, as you would in a 130 / 30 product. To beat a dead horse, when you had 130 in equity, you had 130 in longs. After the market rise, you now have 140 in equity and 143 in longs in your example. See how your leverage went up, not down?
I would have tweaked your example a bit to say that you take 130 long and 30 short when you have 100 in equity (i.e. you deposit 100 at your broker), as opposed to your example where you had that gross exposure with 130 in equity. If you then assume a 10% rise in the market, the equity rises to 110, and leverage stays constant. Leverage started at 1.6x at beginning ((130 + 30 ) / 100), and remains at 1.6x at end ((143 + 33 ) / 110).
This dialogue got me thinking about a topic that I have not seen covered, although I may have just missed it. If you have 100k in equity, and you invest in a 250 / 150 SMA, what do the mechanics look like for your borrowing if there is a real bull market? i.e. if you are long 250 and short 150, and the market doubles over five years, you are now long 500 and short 300. The increase in value in your shorts will take cash out of your account, to the tune of 150. The borrowing on that will start to add up over time. Do you follow? Could be an interesting and important topic to cover.
I just want to confirm and clarify something. You say that "appreciation in long positions boosts portfolio equity and margin capacity". If your short book goes up by an equal amount, and holding all things equal that seems like a safe assumption, you don't gain any margin capacity.
If your account has 100K in equity, you are 130 long / 30 short. Let's say the market then doubles. You are now 260 long / 60 short, with 200 in equity, but you didn't gain any margin capacity. Your leverage was 1.6x before the rise in the market, and it's 1.6x after the rise in the market. You can obviously harvest losses in those short positions, but it's not quite the same as an injection in cash, right?
Now if you are using factor overlays, and those factor overlays generate alpha, that DOES create more margin capacity. So if you were 130 long / 30 short, and your factor overlay (let's say long value) generates 10% alpha (using a ludicrously large number for this example), and you are now 135 / 25 short, your leverage went from 1.6x to 1.45x, and you can now lever back up to 1.6x with what is essentially 'new cash'.
Assume:
• long 130
• short 30
• equity = long FMV + short proceeds - short cost to cover = 130 + 30 - 30 = 130
• market grows 10%
1 year later:
• long FMV = 130 * 1.10
• short cost to cover = 30 * 1.10
• equity = 130 * 1.10 + 30 - 30 * 1.10 = 140
Equity expanded without alpha.
Drags on margin capacity = net financing costs, port mgt fees, t-costs
Tailwind for margin capacity = positive drift, alpha
Let's ignore alpha for now.
Yes, if you are net long, and the market goes up, your equity expands. We're on the same page there.
But your leverage didn't go down. So you don't gain any margin capacity, as you implied in the body of the post.
Even though I don't think your example is QUITE the traditional 130 / 30, I'll follow your example.
Before market growth, your gross exposure was 160 (130 + 30), with 130 in equity, that's 1.23x leverage. After market goes up 10%, in your example, your gross exposure is 176 (143 + 33), with 140 in equity. That's now 1.26x leverage. So your leverage went UP. So the market going up doesn't provide you with spare margin if you want to keep gross leverage near constant values, as you would in a 130 / 30 product. To beat a dead horse, when you had 130 in equity, you had 130 in longs. After the market rise, you now have 140 in equity and 143 in longs in your example. See how your leverage went up, not down?
I would have tweaked your example a bit to say that you take 130 long and 30 short when you have 100 in equity (i.e. you deposit 100 at your broker), as opposed to your example where you had that gross exposure with 130 in equity. If you then assume a 10% rise in the market, the equity rises to 110, and leverage stays constant. Leverage started at 1.6x at beginning ((130 + 30 ) / 100), and remains at 1.6x at end ((143 + 33 ) / 110).
good points, appreciate that
This dialogue got me thinking about a topic that I have not seen covered, although I may have just missed it. If you have 100k in equity, and you invest in a 250 / 150 SMA, what do the mechanics look like for your borrowing if there is a real bull market? i.e. if you are long 250 and short 150, and the market doubles over five years, you are now long 500 and short 300. The increase in value in your shorts will take cash out of your account, to the tune of 150. The borrowing on that will start to add up over time. Do you follow? Could be an interesting and important topic to cover.
I'll work on this today. You've inspired me to go a level deeper.