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What you were doing is increasing your risk of blowing up with this position.

 

I guarantee my LEAPS put premiums will all decay to zero "blowing up".

 

I also guarantee that you will lose 100% of your warrant premium "blowing up".

 

100% decline in value by expiry!

 

Absolutely guaranteed.

 

It's not a topic of interest.  All that matters is what it will cost under various assumptions.

 

Like... if it takes one year to hit $18, you would most likely realize a cost of roughly 50% for your leverage, completely wiping out your gains.  And thus your strategy was always one that was of the variety to give up early gains in favor of hanging on to a deep-in-the-money stock later on that doesn't have much margin of safety left in it.

 

Like I said at the beginning of the thread, I prefer to be leveraged in undervalued names and drop the leverage at full valuation.  We are just different I guess.

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What you were doing is increasing your risk of blowing up with this position.

 

I guarantee my LEAPS put premiums will all decay to zero "blowing up".

 

I also guarantee that you will lose 100% of your warrant premium "blowing up".

 

100% decline in value by expiry!

 

Absolutely guaranteed.

 

It's not a topic of interest.  All that matters is what it will cost under various assumptions.

 

Like... if it takes one year to hit $18, you would most likely realize a cost of roughly 50% for your leverage, completely wiping out your gains.  And thus your strategy was always one that was of the variety to give up early gains in favor of hanging on to a deep-in-the-money stock later on that doesn't have much margin of safety left in it.

 

Like I said at the beginning of the thread, I prefer to be leveraged in undervalued names and drop the leverage at full valuation.  We are just different I guess.

 

Maybe, it's also about our price targets. I have been expecting BAC to trade somewhere between 30 and 40 – which is what I would consider a fair valuation, but not within 1-2 years – over the mid term. I'm not going to sell anything at $18. If my price target had been $18, indeed, I wouldn't have chosen the warrants, because of my no. 2 – not juicy enough (but I wouldn't do it now either).

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The higher you say your price target is, it only serves as further argument as to why you should have been more conservative with respect to the skewness risk.  That's the very situation that led the warrant to become mis-priced, as you found out. 

 

Mis-pricing of these things for very undervalued stocks doesn't always work in your favor.  It works in your favor when you enter the warrant at a time when the stock price and warrant strike are very askew from one another (like now and when the stock goes higher).

 

But that wasn't the case when this thread began.  It began when the warrant strike was nearly at-the-money.  That's the precise time when the mis-pricing will NOT work in your favor.  It works against you.

 

And the longer the term, the more the mis-pricing of the warrant.  And the greater the undervaluation of the stock, the greater the mis-pricing of the warrant.  Those conditions coupled with the at-the-money valuation trapped you into paying way too much for the portion of the put at the tail end of the warrants life, when it will be just incredibly unlikely to still be at that level (due to the stock's initial extreme undervaluation).

 

The only thing "wrong" with this trade was that it was a very undervalued stock and the warrant was priced at-the-money.  The combination is a recipe for disappointment when the stock goes up 50% in the first year or two.  The more and more you argue that it was worth $30 or $40, the more likely it is that the market will figure it out and the stock jumps 50% sooner rather than later... but you don't participate in the gain.

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Eric, one question: Why do you think Warren Buffett was so stupid to demand in the money BAC calls with 10 years til expiration instead of simply insisting on cheaper preferreds? After all, he could have rolled standard LEAPs. I guess that any investment bank would gladly provide him with a sufficient amount. It must have been a time of really low volatility when he received those warrants…

 

He didn't prepay a premium.

 

He didn't take on any skewness risk.

 

You did !!!!!!!!!!!!!!!!!!

 

!!!!!!!!!!!!!!!

 

!!!!!!!!!!!!!!

 

Are you sure you are not just fucking around with me?

 

I don't even understand what you mean by not "prepaying" the premium. Of course he (pre-)paid a premium – this was all part of one package. Do you think BAC gave him 700m warrants for free? They paid him partly in warrants because they thought it would be cheaper for them! They believe in EMH and most likely used some variant of the Black/Scholes formula. Since volatility was extremely high at the time and the duration of the warrants very long (sound familiar?), they thought they could turn a bad deal into a mediocre one by selling "pricy" warrants as part of the parcel. He knew exactly that this was their way of thinking. And this is why he accepted it – I wouldn't be surprised at all if it had been his idea. "Shitty" warrants at a time of huge volatility – in the money – 10 years until expiration. Within your framework, he did everything wrong.

 

Why do I think it was his idea? Read his 2008 letter (pp. 20). He lays it all out there:

 

The Black-Scholes formula has approached the status of holy writ in finance, and we use it when valuing our equity put options for financial statement purposes. Key inputs to the calculation include a contract’s maturity and strike price, as well as the analyst’s expectations for volatility, interest rates and dividends.

If the formula is applied to extended time periods, however, it can produce absurd results. In fairness, Black and Scholes almost certainly understood this point well. But their devoted followers may be ignoring whatever caveats the two men attached when they first unveiled the formula.

 

[…]

 

The ridiculous premium that Black-Scholes dictates in my extreme example is caused by the inclusion of volatility in the formula and by the fact that volatility is determined by how much stocks have moved around in some past period of days, months or years. This metric is simply irrelevant in estimating the probability- weighted range of values of American business 100 years from now. […] Though historical volatility is a useful – but far from foolproof – concept in valuing short-term options, its utility diminishes rapidly as the duration of the option lengthens. In my opinion, the valuations that the Black- Scholes formula now place on our long-term put options overstate our liability, though the overstatement will diminish as the contracts approach maturity.

 

In other words: Volatility is at the center of the standard option pricing model. But reality is: The more you stretch the timeframe the less relevant it becomes. In the long term, it's completely irrelevant. Not so in the Black/Scholes model. And this is why I had no issue to buy those warrants at $7 one year ago when BAC was at $12 or 13. It's largely irrelevant what the volatility is, when you think that the equity is worth $30-40 and by sheer luck (i.e. TARP) get your hands on options with 5 years until expiration and insurance against future dividend payments – how great is that?! To me, this is worth a lot. Yes, even paying 13% cost of leverage.

 

The jury on this BAC deal is still out, but I think it's poised to become WEB's most profitable investment ever and it's certainly one of the best risk/reward equity deals at this size that I have ever seen. Mostly because of the warrants and the way he took advantage of the errors in the Black/Scholes model and its application by Wall Street geniuses.

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I don't even understand what you mean by not "prepaying" the premium. Of course he (pre-)paid a premium – this was all part of one package. Do you think BAC gave him 700m warrants for free?

 

Yes, I think they issued his warrants in exchange for zero premium.

 

Look it up instead of guessing.

 

He bought preferred stock in exchange, and that doesn't swing in value from skewness.  In fact, the value of preferred stock increases when uncertainty clears.  However, that's irrelevant.

 

 

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I don't even understand what you mean by not "prepaying" the premium. Of course he (pre-)paid a premium – this was all part of one package. Do you think BAC gave him 700m warrants for free?

 

Yes, I think they issued his warrants in exchange for zero premium.

 

Look it up instead of guessing.

 

Oh man, think about it! You could even sue them, if they had given him the warrants for free. As I said: It was part of one large package – no matter how it was portrayed in the media. Of course it was quit pro quo for higher pricing of the preferreds.

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Warren knew the preferred was a below-market interest rate that would only be below market until the uncertainty lifted.

 

That very same uncertainty lifting is what would drive the stock higher and cost him nothing from skewness (no warrant premium).

 

 

Warren:

Skyrocketing stock price costs him nothing because his preferred comes back to market level.  So it becomes a "no cost" warrant

 

You:

Skyrocketing stock price destroys your warrant premium

 

I think you struck a very bad deal compared to him.

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Re: the Berskhire investment. I think a simple way to look at it is, what would the deal have cost BAC had they not issued warrants? If for example, it would have cost 10% vs. the 6% they are paying now, then the 4% difference is the cost of the warrants for Buffett, IMO.

 

On day one, he was holding the preferred for a loss.  That loss was his "cost" for the warrants.

 

However the market erased the loss once uncertainty was lifted and the preferred yields settled back down.  His cost has essentially been refunded.

 

nico's premium is lost forever.  The market isn't going to gift it back to him.

 

 

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Re: the Berskhire investment. I think a simple way to look at it is, what would the deal have cost BAC had they not issued warrants? If for example, it would have cost 10% vs. the 6% they are paying now, then the 4% difference is the cost of the warrants for Buffett, IMO.

 

On day one, he was holding the preferred for a loss.  That loss was his "premium".

 

However the market erased the loss once uncertainty was lifted and the preferred yields settled back down.

 

nico's premium is lost forever.  The market isn't going to gift it back to him.

 

 

 

True, but you also have to account for the lower dividend payment vs. if there were no warrants. And theoretically, he could have picked up similar BAC preferred stock in the market below par (though obviously not $5 billion worth), and that difference he won't get back. And does anybody know if the Berkshire warrants have an anti-dilution provision?

 

Having said all that, I haven't run the numbers, but I'm sure the cost of leverage on his warrants was less than 13%.

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True, but you also have to account for the lower dividend payment vs. if there were no warrants.

 

Pretty low -- it would just be the delta between the two.

 

So if he could have bought them for 10% but is instead getting 5%, then his cost of leverage is the opportunity cost.

 

So cost of leverage is 5% for Warren's warrants.

 

No skewness risk to erase early gains because this is different from buying a premium that swings in value.

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One thing interesting about the warrants now vs holding the equity + holding puts is the tax treatment of dividends in a taxable account.  In case the dividends get a lot larger say $.15 per quarter starting Aug of next year.  Holding the equity + puts would give you $.60 annually but you would be taxed at possibly 40% (ordinary income)  -- you net out $.36 annually. Whereas -- whereas with the warrant you pay only 20% (Long term cap gains) of $0.56 -- which would net out about $0.45 annually. I guess that's only 9 cents a year per share at a 15 cent dividend -- but it makes a bigger and bigger impact as the dividend gets larger.

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One thing interesting about the warrants now vs holding the equity + holding puts is the tax treatment of dividends in a taxable account.  In case the dividends get a lot larger say $.15 per quarter starting Aug of next year.  Holding the equity + puts would give you $.60 annually but you would be taxed at possibly 40% (ordinary income)  -- you net out $.36 annually. Whereas -- whereas with the warrant you pay only 20% (Long term cap gains) of $0.56 -- which would net out about $0.45 annually. I guess that's only 9 cents a year per share at a 15 cent dividend -- but it makes a bigger and bigger impact as the dividend gets larger.

 

US taxpayers pay dividend taxes on the warrant even though it is a non-cash dividend.

 

There is no double-tax because they add the dividend to the warrant cost basis.

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So imagine if the stock were at $24 today with a huge $1 dividend...

 

US taxpayers holding the warrant would have to throw extra cash into the deal to pay the taxes.

 

Those holding the leveraged common could just use a portion of the cash dividend.

 

Why would you want the dividend invested into a fully-valued stock anyhow?  Kind of a problem with the warrants once we get near full value.

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The ridiculous premium that Black-Scholes dictates in my extreme example is caused by the inclusion of volatility in the formula and by the fact that volatility is determined by how much stocks have moved around in some past period of days, months or years. This metric is simply irrelevant in estimating the probability- weighted range of values of American business 100 years from now. […] Though historical volatility is a useful – but far from foolproof – concept in valuing short-term options, its utility diminishes rapidly as the duration of the option lengthens. In my opinion, the valuations that the Black- Scholes formula now place on our long-term put options overstate our liability, though the overstatement will diminish as the contracts approach maturity.

 

 

I added bold red to the Warren quote above.

 

Warren wrote those puts, he didn't buy them.

 

He is telling his shareholders not to sweat the inflated option premium because it overstates the liability.

 

You chose to ignore his warning when you bought a similarly overstated liability represented by the put embedded in the BAC warrant!  On your books it is an overstated asset (you are the buyer), and on Warren's books it is an overstated liability (he is the writer).

 

Yet you claim that Buffett's comments encouraged you to buy them!!!

 

The following is what you wrote:

 

In other words: Volatility is at the center of the standard option pricing model. But reality is: The more you stretch the timeframe the less relevant it becomes. In the long term, it's completely irrelevant. Not so in the Black/Scholes model. And this is why I had no issue to buy those warrants at $7 one year ago when BAC was at $12 or 13.

 

You completely misunderstood his message.  He told you long dated puts (with high volatility priced in) aren't worth their premiums, not the other way around!!!

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So listen to Warren!

 

He tells us that long term puts (like the ones in these warrants) that are priced in a high volatility environment are inflated in value because they "overstate the liability" of the writer of the option.

 

Oh yes, I didn’t realize this… I really didn’t understand what this Buffett guy was talking about. ::) Yes, it actually seems that the flaws in the Black/Scholes model cut both ways…

 

Ok, this is getting tedious for me, too. I summarize my position and then I’m going to move on:

 

My rule of thumb is this: Don't make predictions about future volatility or interest rate movements, but calculate the value of options on an absolute basis, meaning: Compare the potential reward with the risk of total loss. Don't make it too complicated. (For the sake of the argument, yes, pay 13 % cost of leverage for a non-recourse loan! But only do it, if you expect the investment to throw off 30% annualized.)

 

Does doing it this way mean that you won't get the same bet cheaper some time into the future (which is essentially your whole point with rolling shorter durations)? No. Does this make it a „stupid“ bet to begin with, as you are so readily implying? No.

 

Yes, you are right, there certainly are times when volatility is so high that option pricing becomes ridiculously expensive and you’d have to get a Warren Buffett kind of deal to buy them at a reasonable price. That will also be the time when you discover – using my rule of thumb – that options don’t have a good risk/reward expectancy. Therefore, using my rule of thumb, you’d never buy a call that is nearly as expensive as the equity (recent example: SHLDW).

 

However, I'd argue that 2013 was not such a time for BAC. What was so special about BAC in 2013? Volatility halved compared to 2012. Well, it halved again in 2014 – my bad. The fact that the BAC warrants are now extraordinarily cheap doesn't mean that they were extraordinarily expensive back in 2013 (Btw., have you looked at a volatility chart recently? Equity volatility is literally at an all time low now – there has never been a period like this before. You tell me that you knew in 2013 that volatility was heading lower, really?!).

 

You feel very right now because the price of the warrants stayed flat while the stock and shorter duration options moved. There are two reasons for this disparity, I’d argue you couldn’t predict:

1. BAC didn’t pay a serious dividend all the way until recently;

2. Volatility decreased significantly (which is less bad for shorter duration calls than longer duration calls).

You didn’t "predict" that. You just said that one option was cheaper than the other one - implicitly assuming volatility heading lower (whether you knew it or not). I actually can’t remember whether you pointed out this risk directly. But I remember thinking: Maybe it’ll turn out that way, maybe not. I read your comments then and partly agreed. I agreed that the LEAPs were a good deal, I disagreed that, therefore, the warrants must have been a bad deal.

 

Test scenario: How would the picture look like if volatility (not the price of BAC!) had stayed at the level of 2013 or actually increased and/or BAC had actually begun paying normal dividends back in 2013? Where do you think the warrants would trade now compared to the LEAPs? And how expensive would your LEAP roll-over strategy have turned out to be? Don't tell me you pointed to all those risks, you didn't. Yes, you pointed to the risk of the price of BAC going nowhere and to the dividend risk. But you completely overlooked the risk of  increasing volatility – which would have destroyed your whole strategy of rolling shorter durations.

 

I think what I’m saying is that your „cost of leverage“ comparisons are nothing but guesses about the way future volatility develops. I think you are a brilliant guy but, yes, I also think you didn’t realize this. And this is why you got so angry.

 

What I didn’t realize is that Cardboard has already kind of made this point a while ago:

 

Black Scholes works and I think it would save a lot of time to the members here trying to compare cost of various options of various strikes and expirations. The formula gives you that via implied volatility. This cost of leverage idea is really the same thing, but quite tedious to calculate at times. We are reinventing the wheel here.[…]

 

Your answer to that:

 

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).

 

Well, yes, but you’re glossing over the volatility risk this way. Your calculation of „cost of leverage“ is nothing but the calculation of implied volatility. So what you're saying is: I'd rather buy an option with low implied volatility (shorter term) than with higher implied volatility (longer term). Problem is, with standard assumptions (meaning past = future re. volatility/interest rate), the market won’t misprice those options relative to each other because the market, like you, is using implied volatility pricing – that's the way Black/Scholes works. Therefore, to beat the market and having your rolling LEAP strategy work, you have to make guesses about the direction of volatility.

 

This is all fine with me, but don't call me stupid when I'm not willing to make these guesses.

 

I close with a Howard Marks quote (he refers to declining markets, but I think it's always true): "There are two essential ingredients for profit in a declining market: you have to have a view on intrinsic value, and you have to hold that view strongly enough to be able to hang in and buy even as price declines suggest that you’re wrong. Oh yes, there’s a third; you have to be right."

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So listen to Warren!

 

He tells us that long term puts (like the ones in these warrants) that are priced in a high volatility environment are inflated in value because they "overstate the liability" of the writer of the option.

 

Oh yes, I didn’t realize this… I really didn’t understand what this Buffett guy was talking about. ::) Yes, it actually seems that the flaws in the Black/Scholes model cut both ways…

 

Ok, this is getting tedious for me, too. I summarize my position and then I’m going to move on:

 

My rule of thumb is this: Don't make predictions about future volatility or interest rate movements, but calculate the value of options on an absolute basis, meaning: Compare the potential reward with the risk of total loss. Don't make it too complicated. (For the sake of the argument, yes, pay 13 % cost of leverage for a non-recourse loan! But only do it, if you expect the investment to throw off 30% annualized.)

 

Does doing it this way mean that you won't get the same bet cheaper some time into the future (which is essentially your whole point with rolling shorter durations)? No. Does this make it a „stupid“ bet to begin with, as you are so readily implying? No.

 

Yes, you are right, there certainly are times when volatility is so high that option pricing becomes ridiculously expensive and you’d have to get a Warren Buffett kind of deal to buy them at a reasonable price. That will also be the time when you discover – using my rule of thumb – that options don’t have a good risk/reward expectancy. Therefore, using my rule of thumb, you’d never buy a call that is nearly as expensive as the equity (recent example: SHLDW).

 

However, I'd argue that 2013 was not such a time for BAC. What was so special about BAC in 2013? Volatility halved compared to 2012. Well, it halved again in 2014 – my bad. The fact that the BAC warrants are now extraordinarily cheap doesn't mean that they were extraordinarily expensive back in 2013 (Btw., have you looked at a volatility chart recently? Equity volatility is literally at an all time low now – there has never been a period like this before. You tell me that you knew in 2013 that volatility was heading lower, really?!).

 

You feel very right now because the price of the warrants stayed flat while the stock and shorter duration options moved. There are two reasons for this disparity, I’d argue you couldn’t predict:

1. BAC didn’t pay a serious dividend all the way until recently;

2. Volatility decreased significantly (which is less bad for shorter duration calls than longer duration calls).

You didn’t "predict" that. You just said that one option was cheaper than the other one - implicitly assuming volatility heading lower (whether you knew it or not). I actually can’t remember whether you pointed out this risk directly. But I remember thinking: Maybe it’ll turn out that way, maybe not. I read your comments then and partly agreed. I agreed that the LEAPs were a good deal, I disagreed that, therefore, the warrants must have been a bad deal.

 

Test scenario: How would the picture look like if volatility (not the price of BAC!) had stayed at the level of 2013 or actually increased and/or BAC had actually begun paying normal dividends back in 2013? Where do you think the warrants would trade now compared to the LEAPs? And how expensive would your LEAP roll-over strategy have turned out to be? Don't tell me you pointed to all those risks, you didn't. Yes, you pointed to the risk of the price of BAC going nowhere and to the dividend risk. But you completely overlooked the risk of  increasing volatility – which would have destroyed your whole strategy of rolling shorter durations.

 

I think what I’m saying is that your „cost of leverage“ comparisons are nothing but guesses about the way future volatility develops. I think you are a brilliant guy but, yes, I also think you didn’t realize this. And this is why you got so angry.

 

What I didn’t realize is that Cardboard has already kind of made this point a while ago:

 

Black Scholes works and I think it would save a lot of time to the members here trying to compare cost of various options of various strikes and expirations. The formula gives you that via implied volatility. This cost of leverage idea is really the same thing, but quite tedious to calculate at times. We are reinventing the wheel here.[…]

 

Your answer to that:

 

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).

 

Well, yes, but you’re glossing over the volatility risk this way. Your calculation of „cost of leverage“ is nothing but the calculation of implied volatility. So what you're saying is: I'd rather buy an option with low implied volatility (shorter term) than with higher implied volatility (longer term). Problem is, with standard assumptions (meaning past = future re. volatility/interest rate), the market won’t misprice those options relative to each other because the market, like you, is using implied volatility pricing – that's the way Black/Scholes works. Therefore, to beat the market and having your rolling LEAP strategy work, you have to make guesses about the direction of volatility.

 

This is all fine with me, but don't call me stupid when I'm not willing to make these guesses.

 

I close with a Howard Marks quote (he refers to declining markets, but I think it's always true): "There are two essential ingredients for profit in a declining market: you have to have a view on intrinsic value, and you have to hold that view strongly enough to be able to hang in and buy even as price declines suggest that you’re wrong. Oh yes, there’s a third; you have to be right."

 

If I may interrupt, it's not the change in volatility that has killed the warrants, per se, it is quite simply the change in moneyness. ATM options have the most extrinsic value, regardless of vol., you pay the most time premium ATM.

 

Ni-co chose to pay all the extrinsic value up front and risk losing it if/when the moneyness changed. Eric thought it would be better to not pay that all up front. Some would say Eric took more risk because he has to roll and no one knows the path of the stock and options pricing. Others (including me) would say ni-co took more MTM risk and tail risk by paying up all that extrinsic value up front; if BAC ended up a goose egg because of depression, you'd lose 100% since you own something with no intrinsic value and all extrinsic value.

 

You both took a view on the path of the stock in terms of medium term mark to market value of your positions. Ni co only cares about hold to maturity value and that's fine. Be content that you lost your extrinsic value and wait til maturity since that's what you care about.

 

The warrants were expensive because they have scarcity value. They offer restricted 40 act funds and long only s the chance to lever up, which they can't do because of size / regulation.

 

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You feel very right now because the price of the warrants stayed flat while the stock and shorter duration options moved. There are two reasons for this disparity, I’d argue you couldn’t predict:

1. BAC didn’t pay a serious dividend all the way until recently;

2. Volatility decreased significantly (which is less bad for shorter duration calls than longer duration calls).

You didn’t "predict" that.

 

LOL!!!

 

I predicted that skewness would destroy the option premium and erase most of the gains as the stock headed towards $20.  Of course that's predictable!

  That's how skewness works.

 

So, given your comment above...

 

I'm pretty sure at this point you think that skewness is either

1.  BAC's dividend policy

2.  Implied volatility

 

HINT:  neither!  ;D

 

You would need either a massive hike in dividend policy or a HUGE spike in volatility to overcome this.

 

1)  huge dividend hike has to be approved by the Fed so the risk was ZERO over the first year

2)  volatility falls when uncertainty drops, and falling uncertainty lifts stock prices

 

So it was most likely that you'd get smacked by both skewness and declining volatility at the same time if uncertainty around BAC diminished.

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Therefore, to beat the market and having your rolling LEAP strategy work, you have to make guesses about the direction of volatility.

 

No...

 

Any large moves in the stock price trumps the impact of implied volatility risk.  You should be an expert on skewness by now  :)

 

My point all along is that my "scary" scenario is that BAC remains flatlined near $12 stock price for the entire first 4 year period. That's the trading range where I'm exposed to volatility spikes that could increase my costs higher than 13% on successive rolls.

 

But I actually get paid for that risk when the stock jumps 50% over the near term.

 

You didn't get paid. 

 

Like you said earlier, you don't get something for nothing.  By giving up your first 50% gain, in exchange you saved a few pennies (possibly) by locking in your leverage at 13% vs risking it going higher.  You take on more tail risk at the same time -- BAC goes to zero in first 2 years and you lose all the premiums paid for years 3,4,5,6.  Or BAC goes to $20 and you similarly lose a ton of premiums for years 3,4,5,6 (due to skewness).  It's sort of funny that a good outcome for the stock kills your premium, but it is the way the world works.  And yes, predictable and expected -- options that are deep-in-the-money have almost no premium (that's skewness).

 

Now let's step back a moment and reflect shall we on the wisdom of risking 32% from skewness if the stock rises 50% over the first two years.... the very near term where we were all expecting earnings to go positive, legal clouds to diminish, bad loans to runoff, "newBAC", LAS expense runoff....

 

And now you only have two years left for this stock to make hay for you... after that you'll be terrified because it will effectively only be a 2-yr LEAP and your strike can't be increased like mine can.  So you risk losing everything, but I don't because I'm moving up my strikes when I roll. 

 

So it's my strategy that will outlast a crash that comes at the end of the 6 yr window -- you are carrying tail risk.  Even WFC dropped from $30 to $8 in 2009.  Six years earlier, at the start of 2003, nobody could predict that crisis.

 

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If I may interrupt, it's not the change in volatility that has killed the warrants, per se, it is quite simply the change in moneyness. ATM options have the most extrinsic value, regardless of vol., you pay the most time premium ATM.

 

Ni-co chose to pay all the extrinsic value up front and risk losing it if/when the moneyness changed. Eric thought it would be better to not pay that all up front. Some would say Eric took more risk because he has to roll and no one knows the path of the stock and options pricing. Others (including me) would say ni-co took more MTM risk and tail risk by paying up all that extrinsic value up front; if BAC ended up a goose egg because of depression, you'd lose 100% since you own something with no intrinsic value and all extrinsic value.

 

 

Precisely!

 

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