ERICOPOLY

Can you direct to any sources on these types of option strategies? I.e. using options to maneuver into/out of a position for an indirect benefit. I.e. avoiding taxable events, selling puts to enter a position, selling calls to exit a position, etc. I don't have any sources. No book or website that I know of. My usage of options comes from knowing that calls give you the right to buy at a certain price, and puts give you the right to sell at a given price. From that knowledge, think strategically.

Back in Aug 2009 I wrote deep-in-the-money FFH calls (to hedge that position while raising cash) and used the proceeds to purchase ORH deep-in-the-money calls on speculation of the buyout. I did it this way to avoid paying capital gains tax on my FFH position. Once the buyout happened, I sold the ORH calls and bought back the FFH calls I'd sold. I paid tax on the ORH sale, but did not also have to pay tax on my FFH position. The "constructive sale" rules changed the holding period of my FFH position for US tax reasons -- it reset the short-term capital gains clock on my FFH position to the date of the hedge activity and restricted me from selling or hedging FFH for the next month (the penalty being a taxable event if I did). Given that value investors often seek to trade into positions of better opportunity (and possibly trade back later on), this is a valuable trick to know about. Important though to read all of the rules on this -- you need to close out that hedge at the latest by the end of the first month of the new year. So really it's utility is limited to short-term purposes.

That's why I'm richer than Mayo. (As Dimon would say)

75% of my net worth is in my BAC allocation. The $10 strikes are 10% of my net worth. I have less than 1% in 2014 strikes.

75% of my net worth is in my BAC allocation. The $10 strikes are 10% of my net worth.

Yes, isn't it great? Q4 2012 revealed that they are making $1.62 a share annualized right now (if you wash away those expenses that are planned to be runoff by 2015). So that would be a $16 price on the stock at 10x earnings without giving any consideration to improvements in earnings and accumulated earnings over the period. Moynihan has also been saying that he was unloading his backpack and is now going to outpace his competitors. So to me it means he is now going after revenue and so that $1.62 a share (only 12% ROTE) is going to improve towards the 15% ROTE metric that he discussed in the webcast (back in November or December).

Interesting strategy, Eric! Although, I am a bit confused about how this can potentially be a 11x return. Would you mind explaining? Well, if the stock is at $20 in two years I'll have $10 per share in cash. I can then pay $5 per share for the 2017 $15 strike calls. Sure, maybe it costs a bit more than $5 for the $15 strike calls. I was perhaps oversimplifying there. Perhaps it would really cost you $6 for the $15s if the stock were at $20. The higher the price goes by 2015, the more difficult it becomes to double the leverage. But perhaps if things are looking that bright by then you could go with $17 strikes instead of $15 strikes. Now if things aren't quite that bright and the stock is only at $16, I'm pretty sure you could pick up the $15s for no more than $3 apiece. $10 is a 3.77x return on $2.65 outlay. Then $15 is a 3x return on $5 outlay. 3.77 x 3 = 11.31

Well, considering they recently said something to the effect of "We have no liquidity issues at MBIA Corp... but... if we did it would be BofA's fault". Now that's funny right there, I don't care who you are. - Larry the Cable Guy

They can get to $30 a share if they can manage 10% ROE over the period and pay out a 30% dividend along the way. The other 70% of capital generation is assumed retained for growth or utilized to reduce the share count. In other words, if the $20 book value grows at 7% per annum, we get to $30 in six years. The first two years may seem like a long shot for 10% ROE, but there is the DTA which can boost capital generation. But this is why I don't touch the B warrants with their $30 strike. Too much needs to go smoothly in order for those to expire in the money. Alternatively, for more speculative money I'd rather go with the $10 strike 2015 calls for $2.65 (bought some yesterday). I feel like less has to go smoothly for them to finish in the black, and when they expire I can take the money and plow it all into 2017s at perhaps $15 strike with twice as many calls (doubling the leverage). Then it would be an 11x return at $30 (whenever we get there, which may be after 2018 warrants expire). I have more faith in the $10 strikes being safe than a strike triple that figure. Plus, if there is going to be an execution I'd rather it be a swift one. It's a 10% position. 10% of my net worth is in the $10 strike 2015 calls. Perhaps this 10% allotment makes my net worth double in six years. It seems reasonable that it will.

They can get to $30 a share if they can manage 10% ROE over the period and pay out a 30% dividend along the way. The other 70% of capital generation is assumed retained for growth or utilized to reduce the share count. In other words, if the $20 book value grows at 7% per annum, we get to $30 in six years. The first two years may seem like a long shot for 10% ROE, but there is the DTA which can boost capital generation. But this is why I don't touch the B warrants with their $30 strike. Too much needs to go smoothly in order for those to expire in the money. Alternatively, for more speculative money I'd rather go with the $10 strike 2015 calls for $2.65 (bought some yesterday). I feel like less has to go smoothly for them to finish in the black, and when they expire I can take the money and plow it all into 2017s at perhaps $15 strike with twice as many calls (doubling the leverage). Then it would be an 11x return at $30 (whenever we get there, which may be after 2018 warrants expire). I have more faith in the $10 strikes being safe than a strike triple that figure. Plus, if there is going to be an execution I'd rather it be a swift one. It's a 10% position.

It is worthwhile to point out that paying $11 with no capital return for two years is a better investment than paying $13 and getting $2 of capital return over the same period. But this is apparently advanced reasoning.

because he is an event driven investor and primarily a small and mid cap investor. under normal conditions bac does not prevent opportunities for him. but the crisis changed that. he is invested in citi because it's cheap on the numbers, he believes it's a cleaner story, capital return potential is there, and he likes the international exposure. he probably like the new ceo as well. Waiting a couple of years for a 50 cent a year dividend is only missing $1 in capital return. You don't sell at $7 after paying $15 because of $1. Count the buyback and it's $2. But anyways, we all know they had to build capital and that's where it went. Either it comes out of near-term capital return or late-term capital return. Either way, it needs to be retained to build capital. And now that it's over, he won't buy it. Hah :)

How can you say 'ordinarily' he would never invest in a bank like bac, and that he wouldn't make it a big position? C is a top five holding for him. Or maybe he only invests in BAC when the capital levels are low (likely to build capital), the risks are still high, but then dumps it after the price plunges and capital levels are high (likely to return capital).

there is a growing sense, or meme, in hedge fund land that the bac story is going to take longer to play out than many hope. There was that sense apparently in late 2011 as well.

What is Price's opinion of BofA today? I tried to find it but I ran across some old news on him from Dec 2009. At the close of 2009, Price was eager to purchase the shares at $15. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aB1srD9ZAwyc Eric, for sure Price is not buying BAC... http://www.dataroma.com/m/hist/hist.php?f=MFP&s=BAC Wow, the poor guy sold more than 75% of his position in Q3 and Q4 of 2011. No wonder he is negative. Hell hath no fury like a woman spurned an investor burned.

What is Price's opinion of BofA today? I tried to find it but I ran across some old news on him from Dec 2009. At the close of 2009, Price was eager to purchase the shares at $15. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aB1srD9ZAwyc

Isn't Mayo just out for publicity? He didn't just put out $30b in a private research note to clients, he said $30b in a press conference. He learned, in March 2011, that he was largely ignored by the press when he put a $2+ per share earnings power number on BAC's core business. So then six months later he puts out a $7 or $8 price on the stock and his name is in lights. Same company, six months later. Fortunately these days BAC could throw down another $30b by this year's end and still be above 8.5% Basel III 2019 capital levels. So whether Mayo is right or not, the stock is still going up.

I like Moore but he needs to admit that Ericopoly was right about the price of gas in California as evidence of hyperinflation (his take) vs. a short-term supply issue (my take). I can't suffer the survivorship bias of gloating with only the predictions that are working out :D

Yes (aside from the 35% tax rate upon selling shares) I suppose he'd hate to have the press always asking him if his opinion had soured on Coca Cola. Otherwise (ignoring taxes and press issues) he could just sell some shares and not care too much either way.

Okay, I see the pattern that was surprising me. But it's not specific to BAC, the same holds for others (like KO for example). I was expecting the 2014 BAC puts to be at least 1/2 of the cost of the 2015 strike puts (because it was like that back when the stock was at $8 a few months ago). But I was surprised that they (the 2014s) now cost only 1/3 as much as the 2015s. Suddenly the ratio between their respective prices changed as the price of the underlying moved up. Compare that to strike closer to the money. For example, the BAC puts with $10 strike today will cost you less than double for the 2015s vs the 2014s. So I guess all my chattering is just that I noticed/learned a put will decay at a faster pace if the expiration is nearer (in this case roughly 1/2 the time). So if you were expecting another fast movement down in the stock, you would want to buy the 2014 strike put and trade it for the 2015 after the ratio fell back near the prior level. I guess this is just "duh" for some of you -- but I hardly ever look at puts. I guess under the put/call parity theory this should be expected -- normally I expect nearer-strike calls to appreciate at a faster pace, so it should work in reverse too I suppose (with puts).

Prices of BAC puts: 2014 $7 strike: 18 cents 2015 $7 strike: 54 cents I find this rather odd. The cost of insurance rises dramatically after 2014. Thoughts on why this is? Only 18 cents for the first 11 months, but an additional 36 cents if you want 12 more months beyond that?

Tax laundering might be your term if you want to claim it -- I think I was using "dividend laundering". Well, whatever, they're both good things! If only more managers would wake up to the idea instead of paying cash dividends. Just keep buying back shares until you die, then your heirs get all the accumulated dividends tax free. You can even pay 200% of intrinsic value for the shares where it's still not necessarily worse than paying a dividend (provided you are paying a 50% tax rate on the dividend, which you just might be in the near future in a place like California). In a more normal scenario, anytime the shares are perhaps only modestly overvalued (say 10% or so), it's an obvious slam dunk to buy in the shares and to NOT pay the dividend in cash. Especially clear is this strategy if this is going to be your investment vehicle going forward and you plan to hold onto the shares until your death. Yes, we've all heard Warren Buffett claim a company should pay the cash dividend instead unless it's extremely undervalued... but he's in a special situation where he holds his passive investments within portfolios of insurance companies. In other words, the dividend tax is only like 14.5% for him. But the capital gains tax is 35%. I can understand his point of view better and might even agree with him if I too had those skewed tax incentives to form my opinion.

I joined in 2005. It has been life changing. Thanks Sanjeev!

Plus, how would taking it private be the right deal for the Fairholme Fund shareholders? A mediocre one-time pop is not how Bruce B typically seems to invest. He's supposed to be looking out for their best interests.

I guess that hurts the people who are cashed out (the fund sellers), but the rest of the fund shareholders don't get hurt by this provided they don't also sell. However, I can see why it was annoying for Bruce. Take BAC and C for example. He starts out with 5% in each and he sells out of C 100%. He keeps his BAC which is now at 10% position. BAC was discounted more than C at the bottom. So by ditching C and keeping BAC, the fund benefitted. Implicitly it was the same as if he'd sold C and bought more BAC with the proceeds. So on the surface it looks and feels like he was only selling at the bottom, but implicitly he was doubling down on what he didn't sell 8) So it's a bit of an optical illusion.