ERICOPOLY

Most likely gaining on the rolls (gaining relative advantage to the current price paid upfront for the equivalent year in the warrant). As the stock moves away (higher or lower) from $12 the cost of rolling the puts (or calls) goes down. The scenario I don't want to have happen is if the stock isn't volatile -- if it just goes flatline on me. But then again, if that happens it puts the dividend at risk (higher dividends are likely if the stock is higher), as the management and/or Fed would favor buybacks. A similar thing happened this week as a matter of fact. And thus, the dividend protection of the warrant is worth less to investors, and thus IV drops. Also, a flatlined stock will keep IV low, so I suppose my cost of rolling LEAPS would go down. Will the warrant really remain at 50+% IV if the stock is flat for 2-5 years?

I still haven't looked at the AIG comparison I spent the whole day driving home from Death Valley N.P.

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. The skewness helped me get the extra year of leverage at a steep discount. Even though I had to sell some common at a low price, the option dropped in price a lot more. Or the opposite happens, the stock soars and I trade my 2015 calls for 2016 calls and once again... skewness brings me a bargain price for my extra year of LEAP duration. Then somebody argued with me that I was thinking linearly and that prices might move up and down -- uh huh, sure, I'm the one who is being linear here! The reason why I initially presented the idea by focusing on the straight-line depreciation decay of the warrant vs LEAPS is that if I talked about all this other fancy footwork I knew the conversation would get too bogged down and I'd get accused of making too many assumptions. So the funny thing is: 1) stock way up I win on rolling with LEAP vs warrant 2) stock way down I win on rolling with LEAP vs warrant 3) stock flat the entire time I don't lose -- I win in fact whenever the bank doesn't pay the "expected" dividend And if I roll the 2015 into the 2016 as soon as it comes out, I protect myself from rolling during a spike in implied volatility (it will be present in both options). Should the company struggle for years and years, that warrant dividend protection premium isn't going to turn out to be all that useful -- so that would hurt the appetite for the warrants (implied volatility drops). Or if the stock stays low and Moynihan favors buybacks over dividends, that too will hurt the implied volatility! So you kind of have to be rooting for him to pay dividends instead of buying back shares if you are a warrant holder -- and that's an odd perspective for a value investor to hold when the stock is this low! Yep, that's me -- the linear thinker!

Bingo! I'm a businessman looking for the lowest cost of financing non-recourse leverage. I'm simply trying to finance the leverage of an appreciating asset. I haven't read those cases. I've been too busy battling people who claim I'll lose 100% of my cost of financing. My answer to that is basically, well "No shit, Sherlock!". Losing 100% of the cost of financing is business 101. Or I don't even think you need a class for that. Who here thinks they can find 0% non-recourse loans?

In the real world I am using LEAPS calls instead of margin+puts. However, when I take delivery of the common I may (depending on market prices of the common) go the route of using some margin to take delivery on the shares. Note that if the common stock is at $14 or less I will just roll the calls. Of course, if the stock is at $20 I won't have much if any appetite for leverage. I only want to leverage the steep part of the appreciation, which is the rise to "normalized earnings". Somebody earlier said that they can get up to 2.2x leverage with the warrants but that I can't do so with the margin+puts. I agree with them, but I also don't want 2.2x leverage! This isn't a game of where can I get the most leverage. I just want the leverage that I want, and then I want to find a cheaper way of getting it. I am going with a mix of common+LEAPS and my leverage is "only" 1.5x. But most of that leverage is either at-the-money or near-the-money calls, so I sleep like a baby.

So if buying non-recourse leverage is like buying groceries, I should be happy then if the price of bananas goes on sale.

A 2009 style crash helps the businessman, it doesn't hurt him. It creates opportunity. You guys do recognize we're talking about non-recourse loans, right? I only lose my "cost of leverage". A businessman loses 10% a year if he borrows money at a 10% rate. Fairfax "loses" the rate of interest costs each year at their holding company. They lose the same amount whether or not a crash is happening. Are you guys just trying to mess with my head? Look, the incremental cost of rolling the 2015 $12 strike calls into the 2016 $12 strike calls will be lower if there is a major crash underway -- somebody above told me the correct term for this is "skewness". As the calls go further out of the money they drop more rapidly.

The cost base being lower does not equal more leverage. 1 warrant is 1x leverage 1 LEAP is 1x leverage The businessman thinks about how many shares of upside he wants. When he decides it's more than he can afford with buying straight common on cash, he then things about how to finance the leverage. So if he wants 1.5x leverage, he scratches his head and puts pen to paper to decide whether the leverage is cheaper by mixing warrants and common, or mixing LEAPS and common.

The worst case is the 10% cost of leverage decay over two years. So if that means "kill yourself", then you are risking much more decay in the warrants. So are you going to take a Post Office with you on your way out of this life if that happens? Sorry - I don't understand the post office metaphor? I think we just have different views/things we're focussing on. If I chose to put some money in LEAPS vs. some money in Warrants then the worst that can happen is that I lose all of the money in the LEAPS and some money in the warrants. The proportional loss will be smaller in the warrants (easy, since you're comparing against a 100% loss in the LEAPS). And there's nothing magical to any of this - you either pay up for more optionality or you don't. Whether the markup for more optionality is justified can only be determined ex-post facto, once we know which scenario occurred. Before that we can pick a price at a point in time and figure out what's cheaper or not if that price materialises. To make this a fair comparison, we'd have to roll forward our assumption and play the game a few times until we match the warrant expiration date with our option rolls. Adding stock to either of these will change the numbers but not that principle. As I said, if you're 100% sure of the stock going up then the choice is clear, no argument to be had. Regarding the post office metaphor: People "go postal" in America -- they walk into a Post Office and shoot the postal workers, then they shoot themselves. Losing 100% of the options is okay because we're prepared to lose it. We know upfront what we're losing. The only way that feels relatively more painful than with the warrants is if the warrants decline by a lesser absolute dollar value. But if the warrants decline by a lesser absolute dollar value, then by definition the remaining time value in the warrant is rising in cost of leverage per annum. So once again, if that's the plan and that's the reason for going with the warrant, then it's the greater fool theory at work! And the warrants of course can decline by a larger dollar value over two years than the options. Your argument sounds a bit like saying I ate 100% of my slice of pizza but you only ate 10% of your entire pizza. Thus, I ate more pizza than you because 100% is greater than 10%.

You are comparing "ALL IN" strategy to one where a lot of cash is not even invested. I believe a more fair comparison would be: (a) 2.57x2 with $10 in cash left over so I'm long 2 shares (b) 5.50x2 with $4.02 in cash left over so I'm long 2 shares There, now that both strategies each have a put per share, we can compare them. After all, if you've already made a decision to hedge each share of upside (in order to leave cash on side), it's only a matter now of deciding how we can contain the cost of leverage. (also, it's 5.69 cost of the warrant today at yesterday's close. you've updated the cost of the $12 call since this discussion began when it was $2.10 and was at-the-money. It's now slightly in the money, and the warrant costs a bit more now. It's 5.69 now.)

The worst case is the 10% cost of leverage decay over two years. So if that means "kill yourself", then you are risking much more decay in the warrants. So are you going to take a Post Office with you on your way out of this life if that happens?

That's pretty much the way I look at it too.

Look, I'm making an assumption that the warrants will decay at 13% annualized -- yes, that's linearity. Presumably you claim this is unfair and that maybe they'll only decay at 7% annualized for the first two years. Okay, then think about this... if that's true, then for the remaining 4 years the embedded cost of leverage is even higher than the 13% that it is today. This is the Greater Fool's Theory game. Don't worry if it's expensive -- perhaps we can sell it (the premium cost of years 3-6) to somebody for even more down the road!!! It's outside of my DNA to think of that kind of outcome as the reason why we should pick the warrants over the LEAPS. But that's your only rebuttal to my "linear thinking" and from this you conclude the calculations "make no sense and should not be used to guide your investment approach".

And this risk is unnecessary is my point. We can instead contain the cost of premium decay to no more than 10% annualized cost of leverage by going with the LEAPS. Risk control! We can alternatively hope that the warrants cost more than 13% annualized for the leverage in 2015, but that is the game of the greater fool (per Greater Fool's Theory). So you are engaging in that game if you think the warrants are the way to go because they have a shot of costing less than the options over the first two years. Okay, let's take the chance! Why??? That's a game I'm not even going to consider playing with options. You might get lucky, but do you feel lucky? Again, it's relative to what we know costs only 10% per annum in decay. The question isn't if they'll make money in the end, or if they'll beat the common in the end... the question is if they'll beat the alternative forms of leverage in the end. And once again, they are more risky in the first place because you have to put more money on the table to get the same amount of leverage. What if the common is only priced at $5 in two years?

So using current stock price of $12.57 and current $12 LEAPS call price of 2.45, I'll show you how to get that same warrant return with less leverage: 1 shares $12 LEAP call = $2.45 cash outlay $10.12 in remaining cash buys .805 shares common Total notional leverage is 1.8x At $20 per share: 1 x $8 = $8 .805 x $20 = $16.1 $8+$16.1= $24.1 So we have $24.1 total which is 91.7% upside. (slightly better than the 100% warrant approach) Yet we used "only" 1.8x leverage vs 2.2x in the warrant.

Note that you are taking on 2.2x notional leverage with putting 100% in the warrants vs 100% in the common. 2.2x leverage (if non-recourse leverage costs were completely free) would have given you: 130.6% (just multiply the common's gain by 2.2x) So the leverage of the warrants in your scenario costs: 130.6% - 91.2% = 39.411% The reason why 39% cost is a hell of a lot more than 13% per annum is because of the repricing of the leverage. So there you go. Paid roughly 50% more for the leverage over the two year time period because of the decay in value of the remaining 4 years of leverage.

Zero cash. I have a margin account. It routinely (every month) transfers my "paycheck" to my Wells Fargo checking account where I pay my bills. I have enormous margin borrowing power -- I hedge all of the margin loan directly with the underlying security. It is a very tiny margin loan -- I have more than $2m "available cash" in the account according to IB. To keep that from suddenly vanishing, I keep the hedges in place. Ok, back to being dense again--how can you have an embedded put without any cash? or said another way, how can the strikes give you "hedging"? Perhaps you mean that they are hedged only when discussing them in terms of notional value? It works like this: 2 parts $12 strike LEAPS calls (12 strike embedded puts) 1.5 parts $10 strike LEAPS calls (10 strike embedded puts) 4 parts BAC common stock Then lots of puts on $7 strike and $5 strike to protect my margin borrowing capacity.

I realize I'm likely being completely dense here, but how can you have the embedded put if you are more than 100% long? Doesn't it require you to have kept the cash you would have had to have the put? I mean yes, you only lost the amount you put in, but you still lost of all that amount, so this only works out if you put less in than you would have had it been a different vehicle. e.g., if you would have bought 1 common, you only buy 1 warrant or 1 LEAP rather than the same amount of money. If I have $12 dollars, and I purchase a $12 strike call (keeping the rest in cash) I am 100% notional value long. aha, I was being dense. So how much cash does that leave you in your account then (% wise)? Zero cash. I have a margin account. It routinely (every month) transfers my "paycheck" to my Wells Fargo checking account where I pay my bills. I have enormous margin borrowing power -- I hedge all of the margin loan directly with the underlying security. It is a very tiny margin loan -- I have more than $2m "available cash" in the account according to IB. To keep that from suddenly vanishing, I keep the hedges in place.

I realize I'm likely being completely dense here, but how can you have the embedded put if you are more than 100% long? Doesn't it require you to have kept the cash you would have had to have the put? I mean yes, you only lost the amount you put in, but you still lost of all that amount, so this only works out if you put less in than you would have had it been a different vehicle. e.g., if you would have bought 1 common, you only buy 1 warrant or 1 LEAP rather than the same amount of money. If I have $12 dollars, and I purchase a $12 strike call (keeping the rest in cash) I am 100% notional value long.

No I didn't! I feared that if that were the case, I'd have wasted a money by purchasing leverage at 13% cost that could later be resold at only 10% cost. I pulled the 10% out of thin air -- don't rely on it! I never meant for anyone to mistake it for what I expect it to be at. Run it again, but this time use Black Scholes to tell you what it will be. Remember, at that point (if the stock is at $20) people will be really bullish on BAC. By definition practically, the uncertainty will be lifted. There will be little volatility priced into the warrants.

Don't forget the most important part. Black Scholes determined the price of that leverage in the warrant. Take a look for yourself at the cost of leverage expressed as a percentage of strike: at-the-money puts/calls have the highest cost of leverage deeply out-of-the-money or deeply in-the-money have the lowest cost of leverage The price of the warrants will be fighting a headwind as the stock rises significantly above that warrant strike price. Think of the warrant as containing 6 years worth of puts dropping like a stone in value as the warrant goes deep-in-the-money. Everyone who has ever tried to short a stock with puts knows that when the stock rises dramatically, the value of the puts drops dramatically. So the value of those puts (six years of them) are embedded in the value of the warrants. High stock price? Poof!!!!

I haven't, I just know it's better to have a 5% hurdle rate than a 13% hurdle rate. When BAC is at $20 the cost of a $12 put may very well be a 7% hurdle rate (including the cost of the margin loan). Or it might be as low as a 3.5% hurdle rate (1% margin loan). Just look at the $7 LEAPS put today 33 cents! They're priced at a cost of 2.5% annualized! I hope everyone with the warrants is seeing that the leverage will NOT COST AS MUCH AS 13% when the puts with the same strike cost 2.5% annualized. The cost of leverage will be the puts plus the margin interest rate. Whatever that rate is. It could be as high as 10.5% margin interest rate (matching that of the warrants). People said the warrants hedge them against high interest rates... well... so does my strategy. 10.5% margin rate! Likely the margin rate plus cost of put will be somewhere in between. Maybe 5% or 6%. Maybe 8%. But 13%???

I haven't done anything with the AIG warrants yet -- will get to that soon (haven't done any comparison shopping yet). I have about 140% long notional value net worth upside exposure to BAC (140% of net worth upside in BAC). 100% of the leverage in the BAC position is hedged near-the-money with either the puts embedded in $12 strike LEAPS or the puts embedded in $10 strike LEAPS. Then I have a bunch of ultra cheap November 13 puts at strike like $7 and $5. Just in case! They cost almost nothing for peace of mind in a going-to-zero black swan. Plus the puts will offset my short-term gains so they don't cost much considering the IRS gets a chunk of it anyhow. Then I have about 12% exposure to AIG warrants (down from 25% recently so that I can have cash for a house). I have roughly 25% of net worth hedged by the ultra-cheap BAC puts at $5 and $7 strike. So really I have about 37% of net worth left if BAC alone is at zero tomorrow. Less if AIG is down too. I might just write some $22 strike LEAPS calls and use the proceeds to purchase $7 strike LEAPS puts. Then I can bring my BAC downside way, way down, with almost zero added cost! Oh yes, I forgot, options are risky. BAC is going to soar past $22 and then I'll find out the real cost of that strategy! Oh wait, that's fine too! I'm looking at writing the $22 strike because I want to ride the steep part of the revaluation curve with leverage, prepared to hold until maturity in two years. I figure it will take about that much time anyhow. Will probably only write covered call on the leverage portion of my holding -- that way if the stock rallies quickly to $20 I can dump a lot of the stock without the headache of soaring covered calls being bought back at a loss.

I'm not saying that exactly. I'm just shopping for cheaper leverage if I can find it. Downside first should be the mantra. Even when you use leverage, you should first think about the downside. And the downside I'm thinking about with the cost of leverage in those warrants is that Black Scholes will kill off the value of their embedded puts when the stock reprices to "normalized earnings" once the expenses at BAC runoff over the next two years. Ironically people keep thinking I'm missing something with regards to Black Scholes. I fully understand the market relies on Black Scholes and that's why I'm staying the hell away from the warrants for now. Once the market reprices the BAC common (in two years) I will look again at the warrants after Black Scholes reprices their leverage. I don't see how it can be any more obvious -- Black Scholes relies on an efficient market... that reliance gets exposed by undervalued securities that reprice long before warrants expire. So it's a bizarre case that value investors who don't believe in efficient markets would consider wading into the warrants for a stock they strongly believe to be undervalued. It's like a suicide mission of opportunity cost in the amount they are overpaying for their leverage in the years after the repricing of the common.

I do know the worst case cost of X over two years but I don't know the worst case cost of Y (and I'm going to be defensively minded and not take that risk!). I've calculated "X" already in this thread. Let X be the LEAPS -- over a two year period the leverage will cost me 10% annualized Let Y be the Warrantss -- over a 6 year period the leverage will cost me 13% annualized I know I can't do worse than 10% annualized if I go with the LEAPS. I could take a gamble and hope that somehow the Warrants will decay at less than 13% annualized rate, but that's getting pretty damned hopeful. Because if it decays at LESS than 13% rate, it only means the next 4 years will be a higher than 13% rate. So operating on the greater fool theory, then yes go right ahead and hope you can sell those warrants for a higher cost of leverage in two years time. Best of luck, because warrant holders are expecting the stock to rise (why else are they in this game?). Once the stock rises, it's going to crush the value of the leverage embedded in the put. It's a terrible strategy for somebody who is expecting the stock to swing high to the upside (they have a strong opinion of present common stock undervaluation). Black Scholes only understands that the market is efficient.