ERICOPOLY

Then a warrant holder can lend them out. Maybe that's the key to why they are so expensive if people are defraying that cost by lending them. How much annualized is the cost to borrow them?

1. That's good for non US taxpayers as they are taxed on the common dividednd. 2. Then again, how do you expect to be taxed on a cashless dividend? A DTL would be similar to 1. for compounding. 1. Yes, a non-US taxpayer would appreciate the cashless dividend. 2. The cashless dividends are taxed in the US. There will be a little statement about how much dividend you own tax on. The IRS also taxes the inflation adjustment to principle when you hold TIPS securities -- that adjustment is also cashless. In short, US taxes suck with respect to the warrants. I mentioned this shortcoming to the warrants before. You wind up with a lot more dividend to be taxed on because you have a lot more leverage. You could have 60 cents of dividend from holding $12 worth of stock, but you would have more than $1.20 worth of dividends if you hold that $12 fully in the warrants. What if you are in California and have to pay state tax on that dividend as well as Federal tax. Yikes! It was a 60 cent dividend on the common, and the warrant holder might be writing a 40 cent tax bill to the Treasuries of the State and the Feds. Nothing like leveraging up on the tax bill. Haven't modeled what that does to the breakeven price between the warrants and common. This was one more way that the calls are better -- you get to keep your dividend in cash upfront so you don't get taxed on it (you get the dividend by implicitly paying less for the leverage in the first place).

I've explained this before but I'll say it again -- this is not my net worth growth, it's the growth in my RothIRA: During 2003,2004,2005, my net worth went up a lot (from investing/speculation) but my RothIRA declined those years. So in those first 5 years the RothIRA lagged the net worth gains. Then, since 2008, my RothIRA has grown more than my taxable account (but I live out of that account and can't go as aggressive, plus it lags with taxes). returns.tiff

Not so fast my good sir. The bet was $7 bil returned to the COMMON. I was very clear about it and asked that you confirm. I can't find it right now but go back to where we bet. I am still winning here. I will happily pay when it's $7 bil to the common. There is still 9.5 months to go. I went back and checked...you sneaky bugger! Yes, you stipulated in brackets "(common only), no other security". I'm going to have to get Txlaw to read any agreement between you and me on a bet going forward! ;D Remind me to give you your "100 Grand Bar" in Toronto. Now I've got to cross the border to get one. Can any of you Americans coming to Toronto, pick one up! Cheers! Perhaps you can have Kraven buy it for you on credit and he can hold the collateral until you pay up.

I also don't think buybacks support the stock in a pullback. It just means an extra 5 billion of shares will be dumped by mutual funds who are trying to sell whatever is liquid. So it might help support the overall market, but not the stock. It just makes it a bigger target for the sellers looking for liquidity.

30% volatility vs 50% volatility means nothing to me. Having computed that with Black Scholes, I've wasted my time because I still need to compute the cost of the leverage expressed in human terms (like an annualized cost of non-recourse leverage). Imagine if you went to go and get a mortgage and they quoted you some arcane number spit out by Black Scholes -- most people, myself included, would have no idea what that translates to in terms of leverage costs. So they'd have a class action lawsuit saying that the options market unfairly charged them too much and deceptively wouldn't just tell them what the leverage costs in plain English -- they'd say they were "predatory lenders" or something similar. Okay, joking aside... I'm interested in one main event here -- BAC getting to 15% ROTE and the market putting a 10x multiple on those earnings. That would be a $20 stock price based on current tangible equity value. So that runup of valuation is what I want to leverage. That's the part of the road I want to drive on with leverage. I don't want to drive on the flat part of the road that bumps along at 10% per annum, I want the supercharged slope of the road that captures all that speculative gain from revaluation to normalized 15% ROTE. So I don't want to overpay for those 10% years to come afterwards. The only way I can manage this is by paying for it in bits and pieces and then stop using leverage after we've climbed that steep slope of revaluation. The surest way of getting this wrong is to pay for all 6 years at 13% rate -- guaranteed to overshoot. Black Scholes doesn't know that the stock is going to rocket to $20 (or 1.5x tangible equity value) upon earnings normalization at 15% ROTE. It has no insight into this. So it's pricing all years cost of leverage exactly the same as the first two years (as the options market does it for the 2 year calls). This all will change if we are at that 1.5x tangible book valuation in two years -- the next 4 years of leverage will be much cheaper. I don't want to pay a rate of 13% for years 3-6 only to have happen what we know will happen once the stock is valued at 1.5x tangible book. Look at WFC -- it's options don't cost 13% annualized -- there isn't the volatility in them that BAC enjoys because nobody expects a big revaluation. The two year WFC leaps cost slightly BELOW 10% of strike for at-the-money $37 strike leverage. Exactly what is going to happen for BAC. You guys will be sorry when that happens. That's 10% of strike, not 10% annualized. Annualized, it's only a bit more than 5%. Compare that 5% to the 10% that BAC is currently priced for! And that 5% is really 8% including the WFC dividend. 8% for WFC leverage (including dividend) vs 13.3% for BAC leverage (including dividend). Were BAC to be quickly revalued, I'm absolutely positive that BAC's leverage costs will look more like WFCs.

You could make 13% annualized for six years by purchasing the common and shorting the A warrant (covered short). Only risk is of taking the downside on the stock below $6.50 ($12 minus $5.50). So that would be around $6.50 on the stock. You collect the 13% annualized return for 6 years unless: 1) The stock finishes at less than $13.30 in 6 years 2) There might be a borrowing cost for shorting the warrant (I have no idea) This is the same downside risk as writing $7 LEAPS puts for 50 cent premium, but if you do that you don't get 13% annualized. So I'm suspicious that there must be an interest cost to borrowing the warrants.

Bird in hand worth two in the bush. Capital plan approved, no dividend. I have my 60 cent dividend upfront already invested at $12. You might get a fully 60 cent dividend next year, but I doubt both that high of a dividend number and this low of a stock price! A 60 cent dividend at $12 is worth the same as a 90 cent dividend at $18. Even more than $1.10 if you are a US taxpayer holding your warrant in a taxable account. 60 cents is the new 1.10. Hey, that's almost a 50 cent dollar!

Two years ago today it was trading at $14.50 and heading down into the abyss! Thus, you don't want to go with the warrants. This is a no-brainer if you are defensively minded. The warrants were trading at $8 two years ago. Then they declined all the way to $2. A market decline of $6. The calls were priced at around $3 -- impossible to decline by $6. Be defensive if you are defensive! Walk the walk if you talk the talk, so to speak. And is $0 per share completely impossible? Yet you would think it to be lower risk to pay for all six years of leverage upfront? Hrm... $14 -$3 is $11. So you had $11 in cash on the side. Then you could have purchased common stock (without leverage) at $5. You would have been able to utilize your $11 in cash to purchase a bit more than 2 shares of stock (without leverage) for every one share of warrant you have today (well, with your $6 in cash you could have bought a bit more than 1 share of common, but 2 shares of common is better than 1 share of common plus 1 warrant). And don't forget you still had those calls in your inventory for additional possible upside! So my strategy would have netted you 2 shares of common in addition to a call, and your warrant strategy would bring you 1 warrants plus 1 share of common. StubbleJumper thinks my criticism of the warrants doesn't consider the possibility of disappointing declines to below $6 in the common, but I assure you my strategy is the better one of the two if the stock does indeed go that low.

That was too kind, but thank you. As for talking about options in terms of Theta, Gamma, Alpha -- is that a sorority full of hotties or something? Because that seems to be where the party is going on! I'm over here all by myself. (I can't talk about options in those terms because I haven't learned the terms)

Here is another one we didn't talk about: In year 3 if we do in fact want to keep invested in BAC with leverage, we can do so by either purchasing new calls at-the-money or by exercising shares on margin and hedging the loan with at-the-money puts. What if the shares are $18 at the time? Okay, we'll you'll be hedging at $18. Yes, you'll be locking in your gains to date. Yes, the cost of the at-the-money calls and puts will likely be roughly the same as today, about 10% annualized, but the dividend rate will also still likely be 3% (on a higher stock price). So instead of paying 13% annualized for the low strike puts embedded in the warrants upfront, in year 3 and 4 you will be getting a high-strike put if you go my preferred route that I've undertaken. So this way, the leverage comes at the same price but you get much higher strike priced puts. The put strike in the warrants never adjusts upwards (so you never have the chance to lock in the cumulative gains to date as the stock rises).

The borrowing constraints are something I thought about before I swapped in my taxable account. Here is my thinking: First the obvious scenario: 1) Initially, the leverage starts out as a $12 call for first two years (years 1 and 2) 2) For year 3 perhaps I don't want to leverage the stock anymore (price is at $20) Second scenario: 1) Stock is still in the dumps ($14.10 or less will be tax-free roll of the calls). Purchase another at-the-money call Third scenario: 1) Take delivery of the stock using margin hedged with a put. So it's the third scenario you are concerned with -- borrowing capacity. Here's what I have to say about that.... A) you are saying that brokers won't give you that much borrowing capacity, but really you only have slightly more than 2x notional upside with the warrant at maximum. B) In two years time when the calls mature you can take delivery on a partial amount of the shares hedged with put, but rollover perhaps 1/2 into the calls. Keep in mind this will trigger some long-term capital gains on only the calls that get rolled over, and those capital gains will need to be paid in year 3. C) Because those capital gains would have been due anyway eventually upon selling the warrants and/or stock, it's not quite so bad as it looks. Just put a bit more money into the calls (financing the tax bill at the rate of borrow in the calls) D) On the brighter side from a tax perspective, in years 5 and 6 there will be capital losses to utilize from those puts expiring worthless if this is a process worth repeating. Needless to repeat, but you don't need as much leverage in the first place if your borrowing cost is significantly below 13%. Like for example that 1% borrowing cost from margin. However I was always assuming that if you were using margin you would hedge a good portion with $12 puts. That raises the costs significantly unless the stock is much higher than today in year 3 or in year 5 -- in that case the $12 puts will be cheaper.

I'm thinking about it regarding the AIG warrants as well. I have the warrants in my RothIRA but the LEAPS might possibly be better (haven't yet done the math though).

So, question: Can you lend out your warrant to short sellers for lending income? You can do this with common stock, but can you do it with warrants? See my comment above about purchasing the common stock and shorting the warrant for 13% annualized yield but only $6.60 per share downside. Only works out that way if: A) no lending fees for borrowing the warrant B) stock above $13.30 in six years.

So you want to leverage at a 13% fixed rate into market that could be spooked by rising rates? Takes balls. No thanks for me. This is why I'm saying just take a "wait and see" approach. Go with a 2 year term and be flexible. Maybe we do in fact have a wicked recession matched with rising rates -- the company might be boosting loan loss provisions, taking hits from sudden rise in interest rates, and maybe... more legal reserve increases. Yet people have the balls to presume that none of that matters... let's just lockup the leverage for 6 years because nothing can go wrong. Again, wait and see. Caution. Fools rush in (no, I"m not calling you guys fools, it's just a saying).

Also, it seems funny that some people won't buy BAC because they question whether the bank can earn 13% ROTE. I find this funny because of the following: A shareholder can earn 13% annualized for 6 years if they put on the following trade: 1) Purchase BAC common 2) Short the A warrant That's a trade: A) gives you max downside of owning the common stock at roughly $6.60 cost B) Earns you 13% annualized yield for the next 6 years. You only need the stock to trade above $13.30 in six years in order to get your full 13% annualized. You'll make less if the stock is below $13.30 in 2019. Anyways, BAC at $6.60 cost isn't risk-free, but I'm still surprised it's worth 13% annualized. Translation: you can lend money at 13% rate for 6 years (fixed rate and fixed term) -- your downside risk is if BAC tanks below a cost of $6.60 and you only get paid in full if the stock is above $13.30 in six years. (ahhh... didn't check the cost of borrowing a warrant, whatever that may be).

History lesson. When the stock was $5 in December 2011, the warrants sold for $2. When I purchased the warrants for $3.70 in October 2012, the stock was $9.30. So the stock had risen 86% since the $5 bottom, but the warrants had only risen 85%. No advantage whatsoever from the warrants during those first 10 months if you held and didn't trade them up to that point. This is because the cost of leverage tanked over that period. Then when I bought the warrants at $3.70 I made a 52% gain during my holding period during a period when the common went up only 29%. Better lucky than good I suppose.

And at a price of $9.30, the normalized earnings yield ($1.60 earnings at 13% ROTE) was 17.2%. I was borrowing at 13.7% to get a normalized earnings yield of 17.2% -- a spread of 3.9%. Today (at $12 stock price) that same yield is 13.3%, but cost of leverage is 13%. So spread is now only 0.3%. Prospects are nowhere near as good. And who, I ask again, will keep paying 13% when the earnings yield is only 10% (at $16 stock price)? Hmm? This is not even to mention that by this time much of the speculative gains will have been realized (going from $9.30 or from $12 to $16 is a great tailwind). What tailwind will be left? Yes, we could do this argument with a higher ROTE (like 15% or 18%), but the same story remains -- at some point the stock hits a point where it trades at normalized earnings and you won't be able to sell your leverage at 13% cost anymore.

Stock was $9.30, warrants were $3.70. 9.30 - 3.70 = 5.60 13.30 / 5.60 = 2.375 So about 13.7% annualized over 6.25 years.

1. I own the AIG warrants -- 8% seems reasonable cost for non-recourse leverage. I look at the notional value of my total portfolio and would rather take on the leverage where it's cheaper. So if I wanted to hold both AIG and BAC, and I wanted leverage, I'd juggle it so the leverage lies in the warrants that have lower cost. What matters in the end is total portfolio leverage, so use the leverage where it's cheaper. You mention WFC warrants being cheaper still, but I'm not invested in WFC. Thing is, WFC is cheaper leverage because it has less (market believes) upside. Same reason why I'm saying the BAC borrowing costs embedded within the warrant will drop like a stone as BAC approaches $20. This will happen when the earnings normalize and uncertainty is lifted. So why fight that headwind!!! Today BAC is just below tangible book and they might earn 13%-15% on tangible book, as well as a premium to tangible book based on that coming out to 10x P/E. So people are willing to pay a higher price for leverage. Once it's at P/E of 10x normalized earnings and potential gains above 10% annualized in the common are difficult, then nobody (I assume) will want to leverage at 13% cost. The people who pay 13% annualized today for all 6 years will be pissing fire when they realize they paid 13% annualized for years 3,4,5, and 6 but the market only wants to pay 10%, or maybe only 8% -- all because the stock went up which is what they were hoping for. Be careful what you wish for, I guess. 2. The break-even point is still $25 -- so it still costs you 13% annualized for the leverage. Only... now you have more leverage. What happens if I buy two calls for $2 apiece for a total outlay of $4? Same story... the leverage in the calls still costs me 10% annualized no matter how much I leverage it (same with the warrants). You can't change the cost of the loan by borrowing more! You just have more risk for more potential gain. Works great if the stock (dividends included) compounds more than 13% annualized... otherwise, maybe not so good. 3. Yes. A RothIRA is a non-margin account and I currently hold AIG warrants there (and just sold my BAC warrants there). But I also hold my BAC calls there. Why did you raise this point? Were you not realizing that you can hold options in cash-only accounts?

Plus, don't forget for you US taxpayers, they'll tax you on your warrant dividend adjustments even though it's a "cashless" dividend. My (approximate) 60 cent "dividend" is tax-free. That's worth a lot more than 60 cents in a California taxable account.

I've replied in the strategies section.

We all agree that if we are to tread water (for no net gain nor net loss) on borrowed money, the investment must compound at the rate at which interest is paid. Right? So if you have borrowed money at 13%, in order to break even you must have your asset compound at a 13% rate. Well, keeping that in mind, first figure out the point where the BAC common and the BAC warrant wind up the same. The breakeven point where one is no better than the other is $25. Given that one is no better than the other, then at that point the asset must have compounded at the rate of borrowed money. And $12 (today's common stock price) compounds at 13% rate for 6 years in order to reach $25.

I just posted a reply to this in the strategies section.

Put it this way... If $2.10 is the cost of the 2015 $12 strike call at a cost of leverage rate of 10% annualized, then at a 13% rate it would cost what... roughly 60 cents more (I'm not being exact, just winging it after 4 drinks in Death Valley and no calculator). I have 60 cents of cash still in my pocket from paying a 10% rate instead of a 13% rate. So I decide to invest that 60 cents in the stock at $12 per share. Call it... a certain dividend that I get paid upfront. Meanwhile, other people buying the warrants are implicitly speculating that the dividend over the next two years will exceed 60 cents. So confident are they that they are paying the 60 cents upfront, hoping to get a dividend that exceeds 60 cents. They'll lose money on that if it comes in below 60 cents (cumulatively over two years). But it's better. My way, I'm investing my 60 cents into the stock at $12 per share. The warrant holder? Maybe a some of the dividend gets invested at $12, maybe some at $15, maybe a good chunk of the 2nd year dividend gets invested at $18. Hmm... a 45 cent dividend invested at $18 is no better than a 30 cent dividend at $12. Does anyone really want to throw away a certain 60 cents dividend reinvested at $12 today just to gamble on a bigger dividend that will probably get invested at a much higher price? So yes, the warrants ostensibly have "dividend protection" -- me, since I have the calls at 10% cost of leverage I have that approximate 60 cent dividend already invested in the stock at $12.