ERICOPOLY

I find it amazing that a person can put their last penny into their 20% down payment, walk out with a 30 yr mortgage based on their income, and be 65 years old. Are they going to work until they are 95?

I suppose since I'm using the mortgage analogy, instead of "collateral" I could call that 80 cents "home equity". You mortgage your common share, leave 80 cents of equity in the stock, and walk out the door with $11.77 in cash at an 18% interest rate. Your "interest" is due as a balloon payment in Oct 2018. If you don't make that payment in full, your common stock is foreclosed on and you lose all of your 80 cents of equity. See -- any Mom and Pop investor can understand the risk of these B warrants. As a businessman, I'm not interested in them. There are cheaper forms of getting my 1.5x leverage.

Compare that B warrant to a non-recourse mortgage with 18% rate: 93.6% Loan-to-value ratio at fixed six year rate. Cash-out-refinance. Underlying asset is BAC equity (uncertainty). High LTV ->High Risk Partial Default -> High Loan Rate. And none of the interest payments are due until expiry.

A lender who offers a non-recourse loan for no collateral is a rare bird. You (Racemize) seem to be objecting to non-recourse loans that require no collateral. I agree!

Right, well I get that it doesn't make sense, I'm just pointing out that by using the definition of the "cost of leverage" we have been, even when the leverage costs nothing, it is still reported at a very high cost (i.e., 18% in my hypothetical 0 cost B warrants)--thus, it seems like there is a flaw in what we are saying about how much that leverage costs, if it has end cases which do not correspond to the price you pay. I said 80 cents is the collateral. It's the collateral in case you default on your non-recourse loan interest payments (or the cost of leverage to use another term). The story starts off where you hold 1 share of common. You then borrow $11.77 against it (cash you get to keep) promising to pay the lender all the profits up to $30.79 per share. He says, okay then, what can I hold in collateral in case you never pay me a dime? Oh, how about 80 cents? He takes it. It's not a free loan! And the 18% pound of flesh is charged because it's a very high risk that you'll default on a large portion of the interest payments (in his mind).

When you say decoupled from the price you pay, do you think the rate of interest is cheap or expensive? Are you realizing it's an extortionist interest rate, or do you think they are underpricing the "loan"? You have 1 warrant priced at 80 cents and an $11.77 cent "loan" that you pay 18% annualized interest on. You don't pay much of the interest upfront, rather you pay it in opportunity cost should the stock trade above $30. On the other hand, the lender might not expect the stock to trade anywhere near $30 and thus isn't really demanding that high of a rate after all. Well, I mean you could say the price was 0.00000000000000000001, and it would still show an 18% "cost of leverage", so that seems odd. Said another way, it could be a 0 cost, so you don't have any "leverage"--it seems pretty costless at that point, even though the calculation shows 18%. It has an opportunity cost. That 80 cents invested in the common would be worth something like $2.44. So that's what it costs you. So, I'm talking about if the price of the B warrants were 0--they cost nothing, so not the 80 cents they are now. In that case there would still be a "cost of leverage" since the common has to make it to the strike price. I want some of that! :) First you need a seller. The market currently thinks an 18% hurdle rate is worth 80 cents collateral for the non-recourse loan.

Look at writing covered calls, for example. I see the $22 strike 2015 call priced at a "bid" of $25 cents. I can write that call and put the 25 cents into the common. Once the stock gets to $22, that 25 cents will actually be worth roughly 44 cents. People buying A warrants might just be looking at the B warrant as a long-dated covered call. So perhaps they write the B warrant and invest the proceeds in the A warrant. That would put the B's under pressure. But it would make the A's cheaper to finance. So the A's might go up in price and the B's go down in price. Or not, just brainstorming...

When you say decoupled from the price you pay, do you think the rate of interest is cheap or expensive? Are you realizing it's an extortionist interest rate, or do you think they are underpricing the "loan"? You have 1 warrant priced at 80 cents and an $11.77 cent "loan" that you pay 18% annualized interest on. You don't pay much of the interest upfront, rather you pay it in opportunity cost should the stock trade above $30. On the other hand, the lender might not expect the stock to trade anywhere near $30 and thus isn't really demanding that high of a rate after all. Well, I mean you could say the price was 0.00000000000000000001, and it would still show an 18% "cost of leverage", so that seems odd. Said another way, it could be a 0 cost, so you don't have any "leverage"--it seems pretty costless at that point, even though the calculation shows 18%. It has an opportunity cost. That 80 cents invested in the common would be worth something like $2.44. So that's what it costs you.

When you say decoupled from the price you pay, do you think the rate of interest is cheap or expensive? Are you realizing it's an extortionist interest rate, or do you think they are underpricing the "loan"? You have 1 warrant priced at 80 cents and an $11.77 cent "loan" that you pay 18% annualized interest on. You don't pay much of the interest upfront, rather you pay it in opportunity cost should the stock trade above $30. I suppose you could put the entire $11.77 into more warrants -- think of this as having a very high loan-to-value ratio and thus you are a high risk borrower. So you pay a high rate. I'm not sure what you think -- is this high or low?

The problem with solving alternative energy and global warming is it's perceived to be not in my generation's backyard. NIM"G"BY Jack Welch said something to the effect that "10 years ago Al Gore made a prediction that doesn't show up yet". What a douchebag. What happens in 100 years, 500 years, 1000 years, 10,000 years??? Planetary genocide. All for saving a buck.

Yes, it should be practically common sense. But I had to mention it because a lot of posters have been accusing me of risking 100% wipeout by going with LEAPS vs warrants because I hadn't considered a 2009 style crisis or whatever. I can accept that perhaps they just don't understand LEAPS strategies and thus didn't know what they were talking about, but never did they seem to acknowledge the risk in the warrant strategy of that exact same event wiping the warrant out 100%. So I used Wells Fargo as an example where a highly respected bank that Warren Buffett loves can go from $30 to $8 in a 3 month period of time. That should completely obliterate the warrant's value.

You are right. The LEAPS have tax-free dividend protection built into them. Not absolute dividend protection, as you can never get it exactly right, but it's an "approximately right" protection. That's a good way of looking at them. And I can take that certain dividend and buy stock with it. Rather than hoping for the company to not cut it's payout (or do what they did this week... not pay a dividend at all).

Eric...What is your reasoning behind using 1.5x leverage as opposed to a higher or lower amount. Or is this just pure personal preference based on the cost of that leverage and the upside you believe BAC has. Also, in the case we see a decline in BACs share price before the 2015 LEAPS are rolled into 2016's...would you roll into 2016 $12's or would you use a lower slightly in the money LEAP? Thanks again BTW. 1.5x leverage is just personal choice. No formula. The leverage was higher when the upside was greater. Not sure what strike I'll roll into if the share price declines significantly. By the same token, I might roll into a $17 strike calls in 2015. The trouble with the warrants is that you're stuck with that deep-in-the-money put the entire time (it ought to be deep-in-the-money in the later years, like when the stock is above $20). What if, as the stock advances, I keep moving up the strikes to at-the-money every single time I roll my calls? All I need to do is hedge the amount of money that I initially "borrowed". So I would be purchasing fewer and fewer contracts as the price rises, and as the uncertainty is lifted in the stock (along with the rising price) I'll probably still be paying decreasing financing costs (as IV declines). Okay, so now it's 5 years from today, my strikes have been moved up to $25 as I roll my LEAPS, and now the stock crashes all the way back to $10 due to a systemic event worse than 2009. What say you now warrant lovers! ;) Is that worst case scenario something you have planned for? Perhaps you want to rethink again what a "worst case" scenario looks like, eh? So as the pice of the underlying has increased (more risk) you have decreased your leverage(as well as shopped for the cheapest leverage). At what point along this risk spectrum do you see it necessary to hedge? Also,how much of the 1.5x leverage position do you hedge out and a what price? Let's say the stock is at $25 and I am rolling my calls. I figure how much I'm levered at the time, and purchase puts to hedge only the leverage (keeping it non-recourse leverage). The warrant guy can't do this -- he is stuck in that $13.30 straight-jacket. And that warrant put will be about as comforting as a wet blanket when the stock is at $25. Look at what a "clear sailing" put sells for on a bank -- Wells Fargo puts cost something like 5% annualized for at-the-money. So even though I may be hedging at-the-money when I roll my LEAPS as the stock rises for BAC, I might very well still be (and likely will be!) benefitting from declining financing costs for my leverage. So not only are people paying a dear price for the put in the warrants, they'll likely come to find that it brings them no comfort when people start worrying about the next crisis as it gets near expiry. Makes sense. So..using todays prices and assuming a 1.5x leverage position......hedging the leverage would work as follows? BAC Share Price= 12.57 2015 $12 Call = 2.40 2015 $12 Put = 1.85 1.5x levered position = 1 x 2015 $12 Call + 0.5 x BAC common = $2.40 + $6.28 = $8.68 cash outlay (downside is 100%) Now to hedge you are protecting the 0.5x common position by purchasing 0.5x 2015 $12 put for $0.92. So in the worst case scenario BAC goes to 0. Your $2.40 call is wiped out. Your $6.28 in common less cost of put $0.92 = $5.35 Therefore your downside is $8.68 - $5.35 = $3.33 or 38% (3.33/8.68). Is this right Eric. Thanks Again That's not quite what I'm doing. Think of it like I'm putting first 100% into the common, then backing out just enough common to purchase $12 calls so that the leverage is 1.5x. So I will have a fractional ownership of 1 call mixed with a fractional ownership of 1 share common. I'm hedging only what I'm borrowing. I wouldn't be hedging at all if it were 100% common. And when this whole discussion began, the stock was at $12.03 so there was no intrinsic value in the LEAPS calls -- that made it easier to think about. How do you determine this ratio though. I mean to have 1.5x leverage you could go; 1 Common to 0.5 Leap on one end of the spectrum (cash outlay= 17.77) or 1 Leap to 0.5 common on the other end of the spectrum (cash outlay= 9.88) or you could go with something in between....but how do you determine which ratio is optimal It was pretty confusing the way I said it. Today the LEAPS have some intrinsic value to them but they didn't when I put on the trade -- they were truly at-the-money. That's the trouble of having the stock price move while this discussion has been going on. The prices and examples keep changing and I'm getting tired of running the math twice. So if you were purchasing a $100,000 BAC position that you wanted to be levered at 1.5x, you'd find the math equation that brings it to 1.5x if you mixed cash and at-the-money LEAPS with no cash left over. I would give the equation to you if I had one, but I don't -- just need to figure it out. I see another mistake in your scenario that doesn't reflect what I'm doing: You wrote: Now to hedge you are protecting the 0.5x common position by purchasing 0.5x 2015 $12 put for $0.92. I don't own any $12 puts in my "2019 LEAPS" strategy. The puts are implicitly embedded in the $12 calls -- that implicit put protects the "borrowed" money that gives me my leverage. That implicit put adds the non in the word non-recourse.

Wells Fargo dropped from $30 to $8 over just 3 months in early 2009 during the financial crisis, and that was a strong well-led bank! It's therefore possible for the warrants to lose 100% of their value in the final minutes before expiration -- even if the stock has been trading up near $30 before the crisis hits. But that's impossible with the LEAPS strategy if the gains are continually locked in every year by rolling to at-the-money strikes.

Cashless or not, the warrant will have no value if it's trading below the strike at expiration. Same with the LEAPS. But if I roll the LEAPS every year to an at-the-money strike price (locking in my gains along the way), then that price might be $25. Thus I've locked in all my gains and it would then be impossible to lose any of them if the stock went back down below $25 (assuming it's a temporary decline only). But with the warrant you risk losing 100% when the stock goes back down. That's not a risk with the "2019 LEAPS" strategy if you go the route of rolling to at-the-money strikes.

They account for the double taxation threat by adding the adjustment to your cost basis. But you lose because you have to clip the warrant and miss out on future appreciation.

Look, if you guys want to hear my magic bullet theory on where the bulk of the problem lies with the warrants, it's this. 1. They trade at a cost-of-leverage premium due to the dividend protection (in essence, you are paying for the dividend when you buy the warrant). Except you are putting the cash down upfront when the stock is at $12. 2. Later the company will pay you the bulk of those dividends when the stock is trading north of $20. Perhaps north of $24. So you might be paying 1 dollar of value today to get 50 cents of value paid back to you later. 3. Let's say banks normally trade at a 3% dividend yield based on payouts of 1/3 earnings and P/E 10 multiple. Later on, when I roll my calls at-the-money and the stock is at $30, a 3% dividend yield would be 90 cents. So it looks like you might be getting a bargain price for all the dividends you are collecting in the future from the warrants if you are expecting $3 of dividends to be paid over the life of the warrant, but keep in mind that if you invested that "dividend protection" warrant premium today when the stock is $12, it too would grow to a large amount over time (simulating a large future dividend). So I'd rather pay a 10% cost of money and invest that excess money into the stock at $12. Others would rather pay a 13% cost of money and get that dividend back in the future (and get taxed in the process if US taxpayers). Besides, I don't believe I will be always be paying 10% -- I feel it will fall to 7% or perhaps 5% annualized cost of the at-the-money calls when the stock normalizes in price (uncertainty is lifted). And for US taxpayers the guys with the warrants will have to clip a bit of their warrants every year to pay that dividend tax. So that raises the breakeven point of the warrants vs common because they'll have fewer warrants at expiry.

Eric...What is your reasoning behind using 1.5x leverage as opposed to a higher or lower amount. Or is this just pure personal preference based on the cost of that leverage and the upside you believe BAC has. Also, in the case we see a decline in BACs share price before the 2015 LEAPS are rolled into 2016's...would you roll into 2016 $12's or would you use a lower slightly in the money LEAP? Thanks again BTW. 1.5x leverage is just personal choice. No formula. The leverage was higher when the upside was greater. Not sure what strike I'll roll into if the share price declines significantly. By the same token, I might roll into a $17 strike calls in 2015. The trouble with the warrants is that you're stuck with that deep-in-the-money put the entire time (it ought to be deep-in-the-money in the later years, like when the stock is above $20). What if, as the stock advances, I keep moving up the strikes to at-the-money every single time I roll my calls? All I need to do is hedge the amount of money that I initially "borrowed". So I would be purchasing fewer and fewer contracts as the price rises, and as the uncertainty is lifted in the stock (along with the rising price) I'll probably still be paying decreasing financing costs (as IV declines). Okay, so now it's 5 years from today, my strikes have been moved up to $25 as I roll my LEAPS, and now the stock crashes all the way back to $10 due to a systemic event worse than 2009. What say you now warrant lovers! ;) Is that worst case scenario something you have planned for? Perhaps you want to rethink again what a "worst case" scenario looks like, eh? So as the pice of the underlying has increased (more risk) you have decreased your leverage(as well as shopped for the cheapest leverage). At what point along this risk spectrum do you see it necessary to hedge? Also,how much of the 1.5x leverage position do you hedge out and a what price? Let's say the stock is at $25 and I am rolling my calls. I figure how much I'm levered at the time, and purchase puts to hedge only the leverage (keeping it non-recourse leverage). The warrant guy can't do this -- he is stuck in that $13.30 straight-jacket. And that warrant put will be about as comforting as a wet blanket when the stock is at $25. Look at what a "clear sailing" put sells for on a bank -- Wells Fargo puts cost something like 5% annualized for at-the-money. So even though I may be hedging at-the-money when I roll my LEAPS as the stock rises for BAC, I might very well still be (and likely will be!) benefitting from declining financing costs for my leverage. So not only are people paying a dear price for the put in the warrants, they'll likely come to find that it brings them no comfort when people start worrying about the next crisis as it gets near expiry. Makes sense. So..using todays prices and assuming a 1.5x leverage position......hedging the leverage would work as follows? BAC Share Price= 12.57 2015 $12 Call = 2.40 2015 $12 Put = 1.85 1.5x levered position = 1 x 2015 $12 Call + 0.5 x BAC common = $2.40 + $6.28 = $8.68 cash outlay (downside is 100%) Now to hedge you are protecting the 0.5x common position by purchasing 0.5x 2015 $12 put for $0.92. So in the worst case scenario BAC goes to 0. Your $2.40 call is wiped out. Your $6.28 in common less cost of put $0.92 = $5.35 Therefore your downside is $8.68 - $5.35 = $3.33 or 38% (3.33/8.68). Is this right Eric. Thanks Again That's not quite what I'm doing. Think of it like I'm putting first 100% into the common, then backing out just enough common to purchase $12 calls so that the leverage is 1.5x. So I will have a fractional ownership of 1 call mixed with a fractional ownership of 1 share common. I'm hedging only what I'm borrowing. I wouldn't be hedging at all if it were 100% common. And when this whole discussion began, the stock was at $12.03 so there was no intrinsic value in the LEAPS calls -- that made it easier to think about.

It's also not an apples-to-apples comparison. The LEAPS strategy, if I roll to at-the-money strikes is a safer strategy. At every roll I lock in my gains as the price rises. The Warrants strategy -- the put never moves. It never gets higher than 13.30. So in this sense, the LEAPS strategy is not only less risky (locking in gains as they come), but potentially lower cost as well. We then are not merely arguing about price here -- it's also about the underlying value of a strategy with a rising put strike versus a static one. Risk adjusted, I'll take the rising put strike strategy even if it works out to have no cost advantage. Sure, but I'm just trying to verify that there isn't a case where the LEAPS strategy, over time/rolls, underperforms the warrants--isn't that what you have been saying? I'm trying to find the downside, is there really not one? I hope you find it if it's there. I'd like to know about it. Then I can decide if all of the upside in the scenarios I mentioned far outweigh the downside that you find.

Just compute the compounding rate at which a 100% warrants strategy breaks even versus a 100% common strategy (at warrant expiry date). Think of two separate accounts, each one with a NAV at expiration. At what compounding rate are the two exactly the same? That would be the cost of leverage rate -- the rate at which the asset appreciates at the same pace as the cost of financing it.

It's also not an apples-to-apples comparison. The LEAPS strategy, if I roll to at-the-money strikes is a safer strategy. At every roll I lock in my gains as the price rises. The Warrants strategy -- the put never moves. It never gets higher than 13.30. So in this sense, the LEAPS strategy is not only less risky (locking in gains as they come), but potentially lower cost as well. We then are not merely arguing about price here -- it's also about the underlying value of a strategy with a rising put strike versus a static one. Risk adjusted, I'll take the rising put strike strategy even if it works out to have no cost advantage.

Eric...What is your reasoning behind using 1.5x leverage as opposed to a higher or lower amount. Or is this just pure personal preference based on the cost of that leverage and the upside you believe BAC has. Also, in the case we see a decline in BACs share price before the 2015 LEAPS are rolled into 2016's...would you roll into 2016 $12's or would you use a lower slightly in the money LEAP? Thanks again BTW. 1.5x leverage is just personal choice. No formula. The leverage was higher when the upside was greater. Not sure what strike I'll roll into if the share price declines significantly. By the same token, I might roll into a $17 strike calls in 2015. The trouble with the warrants is that you're stuck with that deep-in-the-money put the entire time (it ought to be deep-in-the-money in the later years, like when the stock is above $20). What if, as the stock advances, I keep moving up the strikes to at-the-money every single time I roll my calls? All I need to do is hedge the amount of money that I initially "borrowed". So I would be purchasing fewer and fewer contracts as the price rises, and as the uncertainty is lifted in the stock (along with the rising price) I'll probably still be paying decreasing financing costs (as IV declines). Okay, so now it's 5 years from today, my strikes have been moved up to $25 as I roll my LEAPS, and now the stock crashes all the way back to $10 due to a systemic event worse than 2009. What say you now warrant lovers! ;) Is that worst case scenario something you have planned for? Perhaps you want to rethink again what a "worst case" scenario looks like, eh? So as the pice of the underlying has increased (more risk) you have decreased your leverage(as well as shopped for the cheapest leverage). At what point along this risk spectrum do you see it necessary to hedge? Also,how much of the 1.5x leverage position do you hedge out and a what price? Let's say the stock is at $25 and I am rolling my calls. I figure how much I'm levered at the time, and purchase puts to hedge only the leverage (keeping it non-recourse leverage). The warrant guy can't do this -- he is stuck in that $13.30 straight-jacket. And that warrant put will be about as comforting as a wet blanket when the stock is at $25. Look at what a "clear sailing" put sells for on a bank -- Wells Fargo puts cost something like 5% annualized for at-the-money. So even though I may be hedging at-the-money when I roll my LEAPS as the stock rises for BAC, I might very well still be (and likely will be!) benefitting from declining financing costs for my leverage. So not only are people paying a dear price for the put in the warrants, they'll likely come to find that it brings them no comfort when people start worrying about the next crisis as it gets near expiry.

Eric...What is your reasoning behind using 1.5x leverage as opposed to a higher or lower amount. Or is this just pure personal preference based on the cost of that leverage and the upside you believe BAC has. Also, in the case we see a decline in BACs share price before the 2015 LEAPS are rolled into 2016's...would you roll into 2016 $12's or would you use a lower slightly in the money LEAP? Thanks again BTW. 1.5x leverage is just personal choice. No formula. The leverage was higher when the upside was greater. Not sure what strike I'll roll into if the share price declines significantly. By the same token, I might roll into a $17 strike calls in 2015. The trouble with the warrants is that you're stuck with that deep-in-the-money put the entire time (it ought to be deep-in-the-money in the later years, like when the stock is above $20). What if, as the stock advances, I keep moving up the strikes to at-the-money every single time I roll my calls? All I need to do is hedge the amount of money that I initially "borrowed". So I would be purchasing fewer and fewer contracts as the price rises, and as the uncertainty is lifted in the stock (along with the rising price) I'll probably still be paying decreasing financing costs (as IV declines). Okay, so now it's 5 years from today, my strikes have been moved up to $25 as I roll my LEAPS, and now the stock crashes all the way back to $10 due to a systemic event worse than 2009. What say you now warrant lovers! ;) Is that worst case scenario something you have planned for? Perhaps you want to rethink again what a "worst case" scenario looks like, eh?

I hope my comment/thoughts about market crash or systematic events did not come across as rude, that was not my intention. Just trying to think outside the box in terms of how the trade could blow up, you know take care of the downside and the upside will take care of itself. Barring some crazy worldwide meltdown that prevents rolling over (which I agree is out there :) ), it seems like the major things are: 1. Being mentally defeated from a price collapse and you do not stick to the roll over plan. Need to know yourself and how you react to these things. 2. Not having the resources to roll over because you did not adhere to keeping the cash or common around. 3. The market screws you over through enough roll over periods that you no longer have the capital to continue (which is not specific to this strategy, you would get owned here with the warrants as well). No, that isn't rude either. It's the people who posted on here about how silly the discussion is. Get a life folks! If people are having a discussion on the internet it's not your place to call their discussion a silly one. The place for trolls is under the bridge. Given that we've already decided to use leverage (the title is "BAC Leverage"), what's silly about discussing the various options!

You have to look at option #1 (common/leaps) as a 2019 $12 Leap.....it just has to be renewed a few times on the way there (and possibly at a different implied cost of leverage. Once 2017 comes along you will have two very similar choices to compare. This is why you can't go wrong investing in the lower cost choice of the two...... implicitly...it is costing you less. That is the right way to think of what I'm doing -- as a 2019 $12 Leap. It starts out as a combination of 2015 at-the-money LEAPS and the rest in common. Absolutely no cash remaining. No money borrowed with margin either. Personally I'm after 1.5x underlying shares of leverage. I could do the exact same strategy by mixing a warrant with common stock (also with no cash left over). People worried what would happen if the market crashes? Well, that's what I'd want to have happen if my goal is to really embarrass the people who say warrants are better. You see, if the common is down 50% the $12 LEAPS will be down a lot more than 50% due to skewness. So I take an opportunity like that to clip a little bit of common (raising cash) and use that cash to roll the 2015s into 2016s -- reconstructing it with 1.5x leverage once again. Hi Eric Well, I wasn't really out to embarrass anyone. Nor have I said that warrants are better. Good luck. C. Nor were you the rude one I was thinking of.