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Company or Unit Trust to Trade Equity Options

Discussion in 'Accounting, Tax & Legal' started by DaveL, 7th Jan, 2007.

  1. DaveL

    DaveL Member

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    Hi All,
    My very first post, and so would appreciate your kind assistance.

    With a good friend, I am looking at setting up either a Company or a Trust to initially trade Equity Options on the US Markets. We have prepared a detailed Business Plan and are currently finalising the Option Trading Strategies we will use. In the near future we will open an account and commence trading. We have both studied and traded markets for many years and fully understand the risks of options trading and strategies to manage those risks. We believe we each have complementary strengths in the market which we can leverage into a genuine market "edge" to ensure consistent long-term profits.

    We intend to only put in about $5K each initially (perhaps plus entity set up costs). The intention would be to build our trading capital from profits and compound them to the greatest extent possible. Once the performance milestones in our business plan are met (which confirms the merit of our strategies) we may add more funds. I do have a family trust already set up and am considering the family trust would own my initial shares in a Company or units in the Trust if that proves, on balance the best structure.

    So the question is what would be the better entity to use - a company or a unit trust? Would appreciate your views please on the merits of each and then on balance, what you may feel is the "better" alternative (and also your reasons for that conclusion).

    Some other considerations we want to address are:

    the ability to allow money (initial funds plus profits) to grow in that entity or alternatively, to have a strategy to roll profits back into the entity if that is necessary;

    the ability and flexibility to get money (profits) out of the entity when we choose to, as either dividends or distributions;

    taxation implications, including eventually having the entity pay many of the costs associated with our trading activities (such as charges for internet access, market data, trading software, educational activities, etc.) and taxation implications of trust distributions vs. (hopefully fully franked) dividends;

    ability to pay ourselves a salary at some future time (that is, we may eventually be employees of this new entity as well as and share / unit holders in it);

    set up costs and ongoing "running costs" of the entity; and
    any other aspects you feel may be important considerations in deciding which entity is the best option.

    Ideally, whatever entity type we choose will be able to meet our needs into the foreseeable future as our trading capital (and therefore profits) grows.

    We will of course seek professional assistance to set up a structure and the reason for this post is to seek as many views as possible to gain the greatest understanding so that we become "informed".

    Thanks very much for your help.

    DavidL
     
  2. Nigel Ward

    Nigel Ward Team InvestEd

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    Hi Dave

    Sorry for the delay in responding. Can I ask your indulgence for a bit longer so I can come back to you with my thoughts - been a bit snowed under lately.

    Cheers
    N.
     
  3. DaveL

    DaveL Member

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    Thanks Nigel

    No worries Nigel, very much appreciate your desire to assist and looking forward to your response.

    DaveL
     
  4. Nigel Ward

    Nigel Ward Team InvestEd

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    Dave

    I haven't forgotten about this, still just a bit pressed for time. In the interim, perhaps you could have a look at .

    Will respond on your points soon.

    Cheers
    N.
     
  5. DaveL

    DaveL Member

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    Nigel, many thanks, appreciate you are busy. Will checkout LawCentral.

    Great stuff, thanks again
    Dave
     
  6. Nigel Ward

    Nigel Ward Team InvestEd

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    DaveL - sorry it has taken me so long to respond. My thoughts are set out below in blue.

    In summary I think either a company or a unit trust with company as trustee where your shares or units (as the case may be) are owned by your Discretionary Trust will work. The Company may be preferable if revenue will be trading rather than capital gains and you want to retain profits. Set up will be more expensive with a UT and corporate trustee.

    BUT you must get financial and legal advice for your specific circumstances.

    One issue that you may have thought through in detail already, but certainly need to if you haven't, is how the decision making will occur both on a day-to-day basis and for big decisions like one of you wanting to exit.

    Good luck with it and keep us posted how you go.
    N.

     
  7. DaveL

    DaveL Member

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    Nigel,
    Many thanks for your excellent response. My friend and I researched the questions posted and concluded, for us, the Company had the edge and so I am delighted your response very much resonated with our views and for this I thankyou. The points you raised are excellent and I'd like to share with you and the forum members that we have spend many many hours developing our Business Plan, which covers the Business aspects of Trading Options and setting up a structure and general rules for operation. We also have annexes which describe precisely how we determine a view of the market, and more importantly, how we place an option position given that view. We will patiently start by developing only one strategy and only execute that strategy when the odds are significantly in our favour. Our strategy initially, is not speculative, but income where by we use volatility and statistics (probabilities) in our favour. We have also documented via flow charts, the precise entry and trade management processes for the trade. So after a few years slogging away, we are putting money, albeit, small sums on the line with the view that our perfomance is on the line before more funds may be committed. We certainly believe we have an edge, but in case this is not the case, we will not loose much, but in a nutshell, we have metrics generated to measure our performance and we will be strict to ensure our decisions are supported by our performance milestones.

    So once again, many thanks. We will be proceeding with a Company set up and are scheduled to be in a position to place trades by the end of Jan 07. I will keep you and others posted on our progress. We will be documenting everything, and who knows, when our success is proven, others may benefit from our hard work and commitment to success.

    I thankyou for your valuable contribution to our success

    DavidL
     
  8. -T-

    -T- Well-Known Member

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    Wow, that sounds very interesting Dave. You'd probably want to keep that "document" under lock and key. Maybe you can send it on this way and I'll setup encryption for you. :p

    Seriously though, it would be interesting one day to find out how you'll be trading around probability. I'm assuming use of binomial trees but am not sure how you'd predict the movements to calculate the probabilities for the tree. It's normally done through std deviation/volatility of the underlying asset isn't it? I'm guessing you have something else up your sleeve though. Are you guys actuaries or mathematicians or similar? Very cool!

    Anyway, good luck!
     
  9. DaveL

    DaveL Member

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    Hi T, We are both Engineers with a good understanding of probability and volatility, but honestly, we are not doing "analysis paralysis". We both have studied and used options and after being beaten up a few times, we figure that income strategies are superior for both probability of keeping your money and consistent return. No sophisticated algorithms, but essentially a robust understanding of the option Greeks. For example delta is pretty much the probability of the option expiring in the money and so by knowing this, many rules of thumb can be used. If you are interested in fantastic free resources in options education, go to CBOE - Home and find webinar's and pretty much view everything from Dan Sheridan. There truly is some unbelievable subtle information there and Dan knows his stuff and is entertaining.

    Good luck and take care.
     
  10. -T-

    -T- Well-Known Member

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    Hey Dave

    I checked out the CBOE webcasts that you mentioned. That Dan guy must be one of the funniest guys on the planet. They're really enjoyable webcasts; which is good since they're so long.

    As for the content, there's some really great stuff hey. In uni when we studied calendar spreads I remember thinking: "how could that be useful?" But the correlation with the normal distribution of prices really shows the advantages of these income strategies. That is one of the best examples of the subtle information you mentioned.

    A few questions, if you're willing. Do you plan to trade on the CBOE and other US options exchanges, or the ASX/SFE? Dan seems to focus on indices in the earlier videos and I can see why; is that what you're going for? I realise you can trade SPI futures options on the SFE, but I wonder about the brokers in Aust. As he mentioned about margin requirements, brokers who aren't "option-friendly" can cut your yields in half.

    Also, are you using OptionVue or are you using you're own spreadsheets/software. We did implied volatility calculations yesterday at uni; not that complicated once you know it, but still pretty involved stuff.

    Anyway, many thanks for the link.
     
  11. DaveL

    DaveL Member

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    Hi T,
    Away on holidays in Bateman's Bay at the moment, so just a quick reply since at the local library.
    Dan the Man Sheridan is outstanding and higly recommend viewing every Webinar he has done. His material is by far the best I have found and I have read and studied vast amounts.
    I will begin trading indexes in the US, the Russell (RUT) and the SPX (S&P based index). The brokerage in Australia is such that a small player as myself will not make money and so the US is the best option for us small dudes. www.interactivebrokers.com is very good and as such, cheap brokerage is the only way to go for income strategies.
    Have not got optionvue, thinking about it, but this will be later. Just using simple option software from online sites.
    cheers
    DaveL
     
  12. Glebe

    Glebe Well-Known Member

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    Dave,

    Thanks for your heads up regarding the links to the webcasts.

    Can I ask you what you consider to be a worthwhile return on equity given your time and effort, and the opportunity cost of other investments.

    Thanks.
     
  13. DaveL

    DaveL Member

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    Outstanding question Glebe, thankyou and sorry for delay in responding - just got back from Bateman's Bay on a week off. Our calculations are confidently suggesting a return of 14% against margin for holding an option position to expiry is readily achievable. We would be looking at not holding to expiry, but about a month and so the return would be a little less, probably 10-12% against margin. We will never commit more than 50% of our trading capital for margin and so, based on our account, we are looking at a return of 5-6% per month (> 50% per annum) .and this I suggest, is easily achievable and very conservative. The above is what we have determined for the Condor Strategy I mentioned earlier in this post. As we grow with experience and simulate trading, we will introduce more strategies and returns are likely to increase more. I do stress that this Business is really fun for us and we are doing it for the fun and eventual lifestyle which will follow and so the constant study and effort is really a pleasure rather than a hinderance. Hope this helps

    DaveL
     
  14. dostortugas

    dostortugas Active Member

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    so how did this go - two years later?
     
  15. DaveL

    DaveL Member

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    how did I go

    I am profitable. Did take a hit when the market went down heavily. I did turn the system off for a while (mistake) and then re-entered a few months ago. Have covered intial loss from Market decrease and back into profits. Awesome really. Had I kept the system going, would be very profitable (damn).

    Dave