ERICOPOLY

Adding to that comment... And the problem in this case was that with 13% cost of leverage, the volatility priced into the warrant was already pretty high. It was high because people perceived an elevated probability of big stock price movement given all the uncertainty at the time. So you weren't exactly getting a ton of protection from spiking volatility given that relatively high level already priced in all the way to 2019. So it was contrarian to go against the crowd by choosing the instrument most likely to be clobbered by any such expected price volatility :D

I specifically commented early in this thread that the LEAPS are not likely to be better if the stock remained flat the entire time. So you should go for the warrants if you expect the stock to be flatlined without violent swings. So then you mention the possibility of unexpected negative events... on that topic, keep in mind that the warrants declined to $2 in 2011 when stock hit $5. Anyone could have rolled $12 strike LEAPS very inexpensively at the time because the stock was so far from strike Volatility was extremely high at the time. So ironically, even though the warrant holders had locked in a calmer volatility environment, they still got their asses handed to them when volatility spiked coupled with actual heavy price movement in the stock. This is because the skewness is such a powerful force. You keep mentioning spiking volatility but that's really only going to be the driving risk to the LEAPS if we are unfortunate to have a stagnant stock price. Anytime the stock breaks hard up or down, skewness becomes the overpowering risk. So actual large stock price volatility (up or down) made the warrants the worse choice. So the warrants become a great way to leverage into a stock that is fully priced and a low risk business model. They are best for stocks that lack any expectation of big moves. So the models that priced these warrants were probably influenced by an EMT mindset that can't properly price them for "undervalued" situations that would clobber them with skewness on large upwards movements..

It would make sense in my RothIRA if I had any money there, but I don't.

The whole point of owning them was to get a leveraged return... ...but a near-term stock spike destroys the return due to skewness as stock moves far away from strike. So it was just a mistake to own these because you were in the stock on the belief the stock would rise a lot! And the longer the duration, the bigger the mistake. Had there been another 4 years before expiry (if they were 14 year warrants) then there would be yet another 32% hit today (64% total!)... that 64% is in addition to the 13% annual cost thus far. So a total cost of roughly 84%. That 64% is a lot to pay for your worry and concern over interest rates and rolling at higher volatility. The greater risk was always the duration... the longer the duration, the worse your profits would be if the common rose (or declined!) by a lot. The skewness drives the premium decline and it just ripples across all the remaining years in the warrant.

That's the risk as I laid it out early in this thread. You are saying that I overlooked this?

They were then, too. Nothing changed. Everything changed for me. 13% cost of leverage declined to 5%. That was the risk then which I clearly defined. So not only did it cost 13% a year since then, but you've had an added 32% cost tacked on to it from the remaining 4 years declining from 13% a year down to 5%. Well, you aren't taking that risk anymore today with it already at 5% and supported in part by the rising dividend. The LEAPS never carried that risk, so it was a no-brainer to go with the lower-risk LEAPS. The warrants didn't make a nice defensive tool either back then because you would lose as much as $5.65 per share if stock hit zero. The LEAPS had less money at risk and thus less risky if price dropped sharply. This risk you defined is largely dependent on how volatility and interest rates are developing. I think this is a flawed way of looking at options, especially under the assumption of not having a strong opinion on the development of these two variables. By your way of framing it, you are glossing over the risk of owning shorter duration LEAPs over longer duration warrants. Your "cost of leverage" difference between LEAPs and warrants is highly dependent on how volatility develops over time. You implicitly make the assumption that volatility either stays the same or is declining, because you'd need to pay up to roll-over those LEAPs if volatility increased. The same is true in the scenario of levering the equity and owning the comparable put, because you own the same roll-over risk. Owning that risk – and the risk of dividend increases – is what you were paid for by owning the LEAPs over the warrants. That said, it's a good idea to diversify between durations. My way to look at it has always been: Intrinsic value of BAC: $30-$40; so, under the assumption that stocks reach their IV over the longer term (3-5 years), IV of the warrants = ~$17-$27. The potential upside was then and is now 140-280% compared to owning the equity outright with now 70%-130% (then 110-180%) upside. My main risk is the limited duration of options, i.e. that BAC won't reach its IV until expiration. This risk increases over time, because day-to-day volatility becomes more important the closer the expiration date is coming. Of course, there is an offsetting effect of BAC's business working for me. But, in the end, I want to have as much time as possible. Let's say we were back at the point where this thread started... Instead of paying 13% a year until 2019 for the warrant... ... the phone rings... it's Brian Moynihan! He is offering to swap your 2019 warrants for a new class of warrants with the same strike and terms, except the new expiration has been moved all the way out to the year 2040! Another 21 years! ... but the pricing remains the same... the cost of leverage is still going to be 13% a year, so you will be coughing up a lot of cash as part of the deal. In your haste, you take it based on the logic you laid out above... Can you comment now on how happy you are or would you like to reverse this deal? Is it a lower risk deal as you've argued because duration is longer?

I thought about saying that earlier but I hesitated as I don't know what the borrow cost is on the shares. Even non dividend paying stocks have options that get sometimes strongly out of put/call parity, due to the cost of borrow. So I can't say for sure.

I haven't bought the options yet. Still thinking that one out.

I've been mulling it over today... Like you say, the options market is already pricing in a cut. So I'm more inclined to buy puts -- this way it won't stress me out if the dividend stays intact, in fact it would benefit me and would make it cheaper than going with calls. And although I'd suffer a bit of decay if the dividend gets cut sooner than the options market expects, it would still be a positive event overall in terms of improving the future upside potential. So for my emotional wellbeing and positive spiritual good feelings, I choose the puts+common as it will make me a happier shareholder however management ultimately decides on this issue.

If ;) ;) ;) Okay, now where were we... Someone pointed out the dividend policy as a risk. I'm merely showing how the "risk" is in the eye of the beholder. If it's a risk then hedge for it, and then be pleasantly surprised at how what once seemed like a risk is actually the opposite. The risk then becomes if they cut it. The ideal scenario is you worry so bad about management that you hedge for it, and then you are relieved to find out that the management turns out to be far worse than you thought and actually raises the dividend. So if one's mind is made up either way about the dividend, it's not a reason to avoid the name. It becomes harder if you can't read them, like me.

What gives you the impression that I believe they will raise or maintain the dividend? Is it because I pointed out that a higher dividend would cover the current cost of hedging? You could find worse things to worry about than free hedging.

The 2017 $3 strike put (9 cents in the money) has a $1.50 "ask". I might add that if they raise the annual dividend to 71 cents and cut back harder on capex, you've got a completely free option. So is cutting the dividend back really what's best for you?

With Taxes, probably. Are they borrowing against their foreign cash reserves to avoid getting hit by bringing foreign earnings onshore?

Didn't think of looking there yet.

You think AAMC is crooked but not EOX, SD, etc. ? In my opinion, I would put stocks in the following tiers based on integrity (highest to lowest): BRK.A AAMC and KMI (pre-merger KMI) XOM/Exxon, MCF CLR, Peyto SD CHK Average piece of **** smallcap independent E&P. e.g. REXX. Worldcom, Penn West EOX, MILL yes, EOX is worse than Worldcom. ----------- Guys... a lot of these stocks have terrible management teams. The ones that sold off the most have the worst management teams. They are the ones who deceive shareholders the most. You know that the typical independent E&P inflates their reserves right? You rate Pennwest with Worldcom? Why is that? That is quite an assertion with no proof and no apparent analysis. I agree on SD, and CHK I figure he is referring to the expenses that were capitalized to juice reported earnings. I chalked it up to old management.

I haven't read that thread yet.

What was your rational behind 60% into PWE vs an equal split? What do you think is a fair value range for PWE? After Enron and World Com I put equal amounts in the survivors, some went to zero but the winners more than made up for it. I defer to the rest of the thread as to where fair value is for PWE -- it all depends on whether this is a temporary or permanent oil price. If T. Boone Pickens is right, I may have a 10x return. I bought the others in smaller amounts because of various reasons.

And I don't. Which is why I'm not willing to pass up on buying today. Yet not willing to let it get too expensive.

Using industry lingo, a big price drop would have clobbered the warrant premium due to "skewness". It showed it's ugly face when the stock shot up, and would have shown itself similarly if stock had instead declined. That's because the stock traded near the warrant strike back then. Today, it would move TOWARDS the warrant strike and thus "skewness" would be favorable this time around. TOWARDS is favorable, AWAY is negative. Starting near the warrant strike leaves only NEGATIVE possibility. So today is very different from then.

They were then, too. Nothing changed. Everything changed for me. 13% cost of leverage declined to 5%. That was the risk then which I clearly defined. So not only did it cost 13% a year since then, but you've had an added 32% cost tacked on to it from the remaining 4 years declining from 13% a year down to 5%. Well, you aren't taking that risk anymore today with it already at 5% and supported in part by the rising dividend. The LEAPS never carried that risk, so it was a no-brainer to go with the lower-risk LEAPS. The warrants didn't make a nice defensive tool either back then because you would lose as much as $5.65 per share if stock hit zero. The LEAPS had less money at risk and thus less risky if price dropped sharply.

The scenario you mention was just as real when oil traded above $100. High price produces profitable drilling of expensive oil -- this raises supply and that can lead to lower prices. They even have a term for this "shale boom" and much has been written about it. The difference is that now we have better risk/reward because there is much more upside if that oilmageddon doesn't play out. The PWE investment is 2% of my total net worth. I can increase into the remaining survivors when the end draws nigh. So I'm still acting cautious.

The warrants are actually a nice defensive tool if purchased today. A move back down towards $15 would spike the volatility premium which would cushion the blow given the longer duration. And the dividend protection is a big part of the leverage cost that people have been so willing to prepay for -- dividend will likely be increased. Precisely the opposite mentality of when I started the thread.

I also bought my first SD, XOM, LUKOY, OGZPY. All today. Something I bought will get slaughtered no doubt -- probably not XOM though. 60% of the money went into PWE, 20% into XOM, the other 3 split evenly.

Prepare to lose a lot more soon. I finally got sucked into this one. I read the thread yesterday for the first time -- so glad to have ignored it. Thanks to all who contributed to this thread. And no, I have no experience at all in this sector. Literally my first ever purchase in the oil/gas space.

hi Eric... do you think the warrants are attractively priced now - or may be put another way the cost of leverage is now "cheap"? I find little to criticize today.