ERICOPOLY

You might purchase the at-the-money calls with $12 strike for $2. You benefit greatly if the shares decline to $7 (you can dump the calls and just buy the common). For a highly volatile stock this gives options an increased strategic value. You might derive the expected or "implied" volatility from the premium people are paying for the options. There would be no sense in paying a big premium for them if a large movement in the stock weren't expected -- thus, the volatility is implied by the premium the market is paying. A long call is similar to owning the common and hedging with a put. Due to skewness, the put declines in value as the price of the stock moves away from the strike price. Just take a look at the price of out-of-the-money puts versus at-the-money puts. The at-the-money are always the most expensive relative to the strike price. For example, if at-the-money puts cost 20% of strike price, then far out-of-the-money puts might cost just 3%. So as the stock price rises, I'd expect the value of the $13.30 strike put in the warrant to decline (due to skewness). But skewness causes it's price to change at a faster % rate than the common. $10 and $12 were the closest to at-the-money when I bought them. I prefer at-the-money so that my "loan" is non-recourse. I will likely choose at-the-money when I rollover in order to lock in my gains (protect from a pullback). The funny thing is that I expect the cost of at-the-money puts to decline as the uncertainty is lifted and when it trades closer to book value. Yet today the cost of the at-the-money put is similar to what the warrants cost if viewed on an annualized basis. So not only will I benefit from having that put strike being at higher stock prices when I roll to at-the-money, but I expect it to cost me less. Given those two things, I can't imagine why anyone prefers the warrants. I don't care that the first two years cost me 10% annualized. That seems fine to me. Given a 3% dividend rate, that would be roughly the same as the 13% annualized cost of leverage in the warrants. It's the next four years after that which are at issue. That isn't the case. The 10% may very well be 13% if a 3% dividend is paid. The price issue is that the options strategy is expected to be much cheaper once the uncertainty in the stock is lifted. Plus, you can move up the strikes to lock in gains. More profits if you pay less for the cost of the leverage. Of course, you get more for your money too if you can move up the strike of the at-the-money put on future rolls. The value of this maneuver will be more obvious to you if the stock then pulls back quite a bit after one of these rolls. Four years ago during a period of uncertainty, Wells Fargo was $8 and today it's closing in on $40. Yet today it costs only something like 5% annualized for a WFC at-the-money put. So I don't think you can rely on large price movements to justify continued high cost of leverage. The high cost of leverage is associated with a period of uncertainty, and after that uncertainty is lifted it goes back to normal leverage cost. The uncertainty today is whether or not BAC will pull off this reduction in expenses. This will result in a one-time repricing of the stock's valuation. After that, no more uncertainty premium in the options. Anyhow, that's my opinion -- perhaps others have another theory on what is causing the uncertainty discount.

I'm not worried about the downside of the common. I'm worried about the perils of leverage. So I'm only hedging the leverage. EDIT: And it's not LEAPS+Hedges. The LEAPS contain the hedge.

The statements made initially were comparing two forms of non-recourse leverage. You are completely changing the subject now. By definition, non-recourse comes at a price -- you have eliminated that price. Sure, but you can save money by not having fire insurance on your home while you are at it. We believe the stock should be much higher in 6 years, but we don't believe the path will necessarily be linear. There may be a horrendous recession/crisis along the way. PS: Expiry is January 2019 for the "A" warrants -- not 2018.

I'm afraid I don't understand. Can you tell me what the price movements were that you saw? First, volatility increased, and that's an input into the formula that moves premium prices. That's "skewness" that causes at-the-money to move (in absolute dollar terms) more than out-of-the-money, for a given input of volatility. A change in volatility will have a "skewed" impact on the range of strikes. But in relative dollar terms the opposite happened -- the premiums of further out strikes increase by a higher percentage. For example, 2 cents is 100% greater than 1 cent, but 3 cents is 50% greater than 2 cents. But anyways... more obvious statements from me :D

I'm afraid I don't understand. Can you tell me what the price movements were that you saw?

I believe in that case it would be worth paying a higher annualized cost of leverage for a very short term call with at-the-money strike. Then: 1) you suffer less absolute dollar loss due to skewness 2) you can then roll to lock in gains if you think the stock still has a lot more appreciation left in it And note that I pointed out the assumption of a higher annualized cost of leverage for the shorter term option? This is what this discussion all boils down to. You are getting lots of benefits from shorter term options (multiple rolls to lock in gains and less absolute dollar loss from skewness on major stock moves). You should therefore be paying a higher cost of leverage (get what you pay for). Thus, why am I finding the LEAPS priced at similar cost of leverage to the Warrants? The LEAPS have so much advantage, they should be the one with the more expensive annualized leverage cost. Not the warrants!

I believe in that case it would be worth paying a higher annualized cost of leverage for a very short term call with at-the-money strike. Then: 1) you suffer less absolute dollar loss due to skewness 2) you can then roll to lock in gains if you think the stock still has a lot more appreciation left in it

That's my experience with my BMO RSP account too. Then you guys can participate: Example 1) Buy SHLD common (take SHLD downside) 2) Write SHLD covered call (collect premium) 3) Buy BAC call with premium from step 2

I'm not after the lowest cost of leverage. I'm after the lowest cost of non-recourse leverage. Margin leverage, unhedged, is not in the cards for me. This entire discussion is about comparing a 6 year warrant to a 2 year LEAPS. They have different pros and cons, and for the life of me I can't put that many "pros" in the warrant column given it's annualized cost of leverage. I've seen a lot of people post on this board about how they hold their BAC position as mostly common, and a few warrants mixed in. Thus, I think they already are not trying to leverage to the max. I'm just trying to explain that for what they want (a little bit of leverage), there seems to be a way of getting much more advantage (like rolling to higher strikes), while quite likely spending a lot less for the cost of leverage at the same time.

Stupid question (maybe), where are you putting the gains on your rolls as you do this, back in common? Yes, back in common. So if the stock is double where it is today, I'll have 1.25x upside and 1x downside. I'm just buying a hedge that protects the amount initially borrowed, leaving any gains on the table.

Or that same scenario happens a year from now after I roll at $16, and then the crash happens. Maybe I'm rolling back into it at $10 on the next roll. I've got $4 taken off the table, and I'm getting back in at $10 strike now.

Let's say then that I succeed in rolling into at-the-money LEAPS when the stock hits $20, but you were holding out for $30 with your warrants. Then the crash happens. Now you lose with the warrants. Possibly not everything you put into it, but remember I'm locked in at $20 strike (with $8 safely taken off the table) and you are at $13.30 strike. You only have one chance to pull the trigger on your gains. I will be locking in whatever gains are there once a year.

Can't you theoretically defer taxes forever with this technique? I don't see why not.

I believe if the stock stays at $12 the entire time, never up nor down, the two strategies will roughly break even with each other. However, I believe mine will win if I can do a roll when the stock is depressed far below $12 (due to "skewness"). And if I ever roll at-the-money at a higher strike, then I'll most certainty win from a risk-adjusted standpoint (because I will have not lost that amount of option premium, it's no longer left on the table anymore). Suppose for example I roll into the 2016 call when the stock is at the money on a $14 strike. Then $2 of my initial capital outlay can not be lost for the whole rest of the time. It is now "locked in". You are never locking anything in with the warrant. It's all or nothing, baby.

Let me remind you of one possible worst case scenario. The stock goes up like I expect, it's even up to $30 in late 2018, but then (just like Wells Fargo in early 2009), it crashes from $30 down to $8 over a span of three months and you lose 100% of what you invested in the warrant. Me? I'll be sitting on a massive gain... and keeping it. That's because I lock my gains in as I go, on every success roll of the LEAPS. Once again... the warrants are risking 100% loss because you are locked in that $13.30 strike straightjacket. Got it now??? My strategy is less risky. And I happen to think it will also be cheaper. Because the LEAPS are of less duration to maturity, and I have multiple rolls where I lock in gains, they have more optionality.

BAC is trading below tangible book and capable of earning 13+% on tangible book. I'm burning 10% a year waiting for that to be reflected in the stock. One day it will. In two years? I don't know. But that's the proposition -- one day it will. There is no 100% certainty of anything. There is no risk of a margin call with my strategy.

Let me clear up a misconception.... "Optionality" ranks in this order (from lowest to highest): 1) Common (least optionality) 2) Warrants (more optionality) 3) LEAPS (most optionality) You get more and more optionality when you shorten the maturity date of the option.

The capital levels (no serious dilution risk). The years of being in a hard market (only the best credits getting a loan). The scrutiny by regulators. The visible underlying earnings power (once LAS runs off) The business on every street corner. Boring business model. Simple. No fancy innovation to maintain their lead over competitors (like with tech companies) Trading a 2x best case normalized earnings, 5x worst case. Simple proposition from how I see it.

Perhaps that's what Buffett refers to when he talks about 1 ft hurdles. For me, my self esteem (with regards to my business knowledge) is so low that nearly everything goes into the "too hard" pile. If it takes complexity, I'm lost. It has to be a very simple proposition for me to understand it (and I guess that's what a 1 ft hurdle is, after all).

The question is then, why is Russia protecting it's tax evaders? The answer might be, the tax evaders are powerful.

However 75% of Coke's sales are not in the US.

The tax brackets weren't adjusted in the 1970s and early 1980s. So incomes got taxed more and more as the nominal wage was rapidly pushed upwards by inflation into a progressive tax structure. It's unclear to me how much of the pressure on households came from this issue. Mortgaged homeowners lost much of their positive operating leverage to this problem of taxation. So it was like a powder keg of demand building up that was set off when Reagan brought the tax rates back down. This time around, if they let the tax brackets adjust annually for inflation it won't be the same kind of situation. I'm not sure if they will though -- it sort of defeats the purpose of using inflation to bring down the Govt's debt.

It's also important not to be deceived by the seemingly cheap leverage in deep-in-the-money calls. The at-the-money calls are discounted to account for the anticipated dividends (if any). Let's say for example a $10 stock is paying a 30 cent dividend and you have a $3 strike deep-in-the-money call. You miss out on the dividend for all of your "in-the-money" cash tied up in the option. So you can't simply compute the cost of leverage as the premium you are paying along for the $3 strike -- you have to also consider the yield you are missing out on by having so much cash tied up in a deep-in-the-money call. Anyways, that's obvious to some people but others can be fooled for a period of time. It's much easier to compare leverage across strikes when the company is not expected to pay any dividends.

Hyten...I believe you are correct.....that is how the gains are locked in. That isn't exactly my plan. Okay, suppose you start out with 1.5x leverage -- you initially hedge the 0.5x. Later the stock doubles and the account is now leveraged 1.25x. When I roll, I plan to hedge only .25x. So I'm only interested in hedging the amount "borrowed". Over time, the amount "borrowed" becomes a smaller percentage of the pie -- but nonetheless, I always hedge the absolute dollar amount initially "borrowed" at ever roll. As long as the stock is rising, this means fewer and fewer contracts on successive rolls. Dont you lose money everytime you roll? i think this is sort of hidden cost with options. For example if you roll BAC 7$ call to 10$ call today you should get 3$ but if you look at the quotes you will get more like 2.7-2.8$ by rolling You are borrowing more money at $10 than at $7. So you have to account for that. Shave 20-30 cents off of $3 to account for the interest costs on that $3 you are borrowing.

Wow this is amazing find. Is Mr Market really so dumb to offer this opportunity? Or is there more to it? Of course we will only know for sure who is so dumb with hindsight. Eric...I assume you only use this strategy in your taxable accounts... unless the tax-free account rules are different in the US. In Canadian tax-free accounts (RRSP, TFSA) ...we cannot sell naked puts. I have, in the past, sold cash-covered puts in my RothIRA and used the premiums collected to buy calls. Mostly, it's exactly the same.