BAC leverage

[ERICOPOLY]

N/O but why would anyone go heavily leveraged on BAC now anyway?

 

It always depends on the price of non-recourse leverage.

 

For example, one could ask why anyone would take on the unleveraged downside of SHLD.  Just 1x downside exposure.

 

Now, if you find that person, they might be interested in seeing what they can buy for that downside if they write SHLD puts with 2016 expiry.

 

Further, it might be possible to leverage BAC with 4x leverage to the upside using 2016 $15 strike puts to protect against BAC downside risk below $15.  I think in order to get all the way out to 4x leverage, you would have to write the $20 strike BAC covered calls in order to afford all those puts while keeping just 1x SHLD downside.

 

So, a 4x leveraged gain on the common to $20 would be 128% gain from BAC over the next 20.5 months.

 

No, you don't need to be leveraged to the downside -- it's just... will SHLD do better given that you are taking on that risk?

 

So, well, that's the world we live in.  These trades are there to be thought about, even if you don't want to engage in them.  They help put things in perspective for me.

 

Anyways, you had to ask  :)

 

[gary17]

Eric

if portfolio margin isn't available, what would you have considered as an alternative to leveraging BAC?

[jmp8822]

N/O but why would anyone go heavily leveraged on BAC now anyway?

 

It always depends on the price of non-recourse leverage.

 

For example, one could ask why anyone would take on the unleveraged downside of SHLD.  Just 1x downside exposure.

 

Now, if you find that person, they might be interested in seeing what they can buy for that downside if they write SHLD puts with 2016 expiry.

 

Further, it might be possible to leverage BAC with 4x leverage to the upside using 2016 $15 strike puts to protect against BAC downside risk below $15.  I think in order to get all the way out to 4x leverage, you would have to write the $20 strike BAC covered calls in order to afford all those puts while keeping just 1x SHLD downside.

 

So, a 4x leveraged gain on the common to $20 would be 128% gain from BAC over the next 20.5 months.

 

No, you don't need to be leveraged to the downside -- it's just... will SHLD do better given that you are taking on that risk?

 

So, well, that's the world we live in.  These trades are there to be thought about, even if you don't want to engage in them.  They help put things in perspective for me.

 

Anyways, you had to ask  :)

 

This seems interesting - could you potentially clarify?  If I follow, you are saying you can sell a put on Sears, maximum loss being the share price, less premium.  And then buy puts and sell covered calls, i.e. owning directly 4X BAC common?

 

If you could maybe put dollar values to the names, it might be easier to comprehend.

 

Thanks for your insight.

[ZenaidaMacroura]

N/O but why would anyone go heavily leveraged on BAC now anyway?

 

It always depends on the price of non-recourse leverage.

 

For example, one could ask why anyone would take on the unleveraged downside of SHLD.  Just 1x downside exposure.

 

Now, if you find that person, they might be interested in seeing what they can buy for that downside if they write SHLD puts with 2016 expiry.

 

Further, it might be possible to leverage BAC with 4x leverage to the upside using 2016 $15 strike puts to protect against BAC downside risk below $15.  I think in order to get all the way out to 4x leverage, you would have to write the $20 strike BAC covered calls in order to afford all those puts while keeping just 1x SHLD downside.

 

So, a 4x leveraged gain on the common to $20 would be 128% gain from BAC over the next 20.5 months.

 

No, you don't need to be leveraged to the downside -- it's just... will SHLD do better given that you are taking on that risk?

 

So, well, that's the world we live in.  These trades are there to be thought about, even if you don't want to engage in them.  They help put things in perspective for me.

 

Anyways, you had to ask  :)

 

This seems interesting - could you potentially clarify?  If I follow, you are saying you can sell a put on Sears, maximum loss being the share price, less premium.  And then buy puts and sell covered calls, i.e. owning directly 4X BAC common?

 

If you could maybe put dollar values to the names, it might be easier to comprehend.

 

Thanks for your insight.

 

I think he means by shorting/writing a shld put and with the premium buying 4 contracts of the $15 call on BAC, while shorting/writing the BAC $20 call.  You create a spread where your maximum payout is $5 per option (if BAC closes at $20 or above).

 

I understand he means that it would require BAC common appreciating approximately 32% (then times 4) but I don't know how you would compare the "128%" gain on BAC to the upside of owning shlds though. 

 

[ERICOPOLY]

but I don't know how you would compare the "128%" gain on BAC to the upside of owning shlds though.

 

That's the golden question.

 

 

[gary17]

I agree - so this comes down to a test of psychology than anything else....

 

As per my example... my leverage is from home equity - and as long as I have a job in Canada & paying the interest.... that loan is basically not affected by the BAC share prices (unlike a margin account) - so it really comes down to in those hours of market panic, will I have the guts to double down OR run like everyone else & suffer permanent capital loss?  IF - if the answer is that I am able to analyze this properly and not get emotionally involved, then I should, theoretically, not require any puts to protect me, and take the opportunity to double down......  So it comes down to: do I trust the insurance offered by the puts or my own intellect?  LOL  Gary

 

Hi Gary,

 

Would that be home equity line of credit?  I think I remember reading that some people's HELOC lines were reduced during the 2008/2009 financial crisis.  It might be uncomfortable during a crisis to have your HELOC credit limit reduced to the amount outstanding so you don't have any additional credit... and your outstanding loan is concentrated in company shares you are underwater on. Then say you lose your job at the same time.

 

I don't think it's a question of trusting your intellect. Lots of high-IQ people get into trouble using leverage. Leverage works great on the way up.

 

--

Maybe you are talking about a home equity loan?  What term length can you get in Canada on these? What conditions do you have to meet to renew the loan at end of term?  Is there any risk they wont renew the HELoan if the housing prices have dropped, say 25%, during the term of the loan?

 

sorry, i completely forgot to answer  - I did see on my BB -

 

it's the "RBC Home Line Plan"

i have to check the terms about this is home equity on the portion of the home i have already paid.... up to the maximum value of the home it was appraised at.

 

I suspect as the home value decreases the loan will get decreased as well - however, I do think this will happen slower than stocks which would have an immediate impact on a margin account.

 

On use of leverage-  while this may seem crazy at this time given the current market valuation; I am using them to buy what I view are value stocks... and the amount of leverage is about 50% of my current annual income.  The bank was willing to lend me money to buy a home 9times my current income and the home I live in now is a little less than 4 times  - so with this i felt i am pumping as much fund into the investment as much as i can -- while not being excessively leveraged as i've kept the cost down by living small & driving a small car too :) 

 

I feel like I need to buy FairFax as a punch card holding these days; however, I appear to have miss the boat !

 

 

 

[Grenville]

Question regarding when option expiration months become available for BAC.

 

Bac is a cycle 2: Feb, May, Aug, Nov

 

I would have assumed for the month of May, the following expirations would be available: May, Jun, Aug, Nov (Jan 15, Jan16)

 

What I don't understand is why the Feb 15 expiration is available now? I thought it wouldn't be available until after the Jun contracts expired.

 

What am I missing? From what I've read online is that only four months are available at a time excluding the leaps.

 

Thanks!

[rkbabang]

I just noticed that the warrants are looking pretty good right now.  I hold 2016 calls in my IRA, but in my wife's Roth IRA I've been trading back and forth between the warrants and the common.  Back at the beginning of May I sold all of her warrants and bought the common, this morning I just went in the other direction selling the common and purchasing the warrants back. She now has >11% more of the warrants than she had in May.  I've done this 3 times in the last year and a half increasing her number of warrants significantly.

 

I've been using this cost of leverage calculation in my spreadsheet here (I've posted this before: BAC Warrants Cost of Leverage)  to gauge how the warrants are priced relative to the common and various calls.  It looks like about 8.7% cost of leverage, but that will be around 8% if you factor in the reduction of the strike price due to the next year or so worth of dividend payments at $0.05/qrtr. 

 

[ERICOPOLY]

I just noticed that the warrants are looking pretty good right now.  I hold 2016 calls in my IRA, but in my wife's Roth IRA I've been trading back and forth between the warrants and the common.  Back at the beginning of May I sold all of her warrants and bought the common, this morning I just went in the other direction selling the common and purchasing the warrants back. She now has >11% more of the warrants than she had in May.  I've done this 3 times in the last year and a half increasing her number of warrants significantly.

 

I've been using this cost of leverage calculation in my spreadsheet here (I've posted this before: BAC Warrants Cost of Leverage)  to gauge how the warrants are priced relative to the common and various calls.  It looks like about 8.7% cost of leverage, but that will be around 8% if you factor in the reduction of the strike price due to the next year or so worth of dividend payments at $0.05/qrtr.

 

Strike adjustment doesn't change cost of leverage.

[racemize]

I just noticed that the warrants are looking pretty good right now.  I hold 2016 calls in my IRA, but in my wife's Roth IRA I've been trading back and forth between the warrants and the common.  Back at the beginning of May I sold all of her warrants and bought the common, this morning I just went in the other direction selling the common and purchasing the warrants back. She now has >11% more of the warrants than she had in May.  I've done this 3 times in the last year and a half increasing her number of warrants significantly.

 

I've been using this cost of leverage calculation in my spreadsheet here (I've posted this before: BAC Warrants Cost of Leverage)  to gauge how the warrants are priced relative to the common and various calls.  It looks like about 8.7% cost of leverage, but that will be around 8% if you factor in the reduction of the strike price due to the next year or so worth of dividend payments at $0.05/qrtr.

 

Strike adjustment doesn't change cost of leverage.

 

Agreed.  FYI, I have it at 8.95% common appreciation cost of leverage, or 9.13% total cost of leverage, depending on how you want to think of it.  Link to my calculation is:

https://docs.google.com/spreadsheet/ccc?key=0AhTPR9eP5nWedEF1SGVLdllJTnBMSDMzM3lYZ2d0SlE&usp=sharing

[rkbabang]

I just noticed that the warrants are looking pretty good right now.  I hold 2016 calls in my IRA, but in my wife's Roth IRA I've been trading back and forth between the warrants and the common.  Back at the beginning of May I sold all of her warrants and bought the common, this morning I just went in the other direction selling the common and purchasing the warrants back. She now has >11% more of the warrants than she had in May.  I've done this 3 times in the last year and a half increasing her number of warrants significantly.

 

I've been using this cost of leverage calculation in my spreadsheet here (I've posted this before: BAC Warrants Cost of Leverage)  to gauge how the warrants are priced relative to the common and various calls.  It looks like about 8.7% cost of leverage, but that will be around 8% if you factor in the reduction of the strike price due to the next year or so worth of dividend payments at $0.05/qrtr.

 

Strike adjustment doesn't change cost of leverage.

 

I'm using:  cost of leverage =  ((strike / (common-warrant))^(1 / 4.5 years)) - 1

 

If you change the strike price it changes the answer.  How would you calculate the cost of leverage?  For options the strike can't change (you lose the dividend), but for the warrants it will so that needs to be taken into account somehow.

 

[CorpRaider]

Stating the obvious here but it makes sense, theoretically, that the anti-dilution provisions should compensate the warrant holder for the $ .04 of foregone dividend via strike and warrant number adjustments, but the math has lots of moving targets based on share price on day prior to payment of divvy. 

[rkbabang]

I just noticed that the warrants are looking pretty good right now.  I hold 2016 calls in my IRA, but in my wife's Roth IRA I've been trading back and forth between the warrants and the common.  Back at the beginning of May I sold all of her warrants and bought the common, this morning I just went in the other direction selling the common and purchasing the warrants back. She now has >11% more of the warrants than she had in May.  I've done this 3 times in the last year and a half increasing her number of warrants significantly.

 

I've been using this cost of leverage calculation in my spreadsheet here (I've posted this before: BAC Warrants Cost of Leverage)  to gauge how the warrants are priced relative to the common and various calls.  It looks like about 8.7% cost of leverage, but that will be around 8% if you factor in the reduction of the strike price due to the next year or so worth of dividend payments at $0.05/qrtr.

 

Strike adjustment doesn't change cost of leverage.

 

Agreed.  FYI, I have it at 8.95% common appreciation cost of leverage, or 9.13% total cost of leverage, depending on how you want to think of it.  Link to my calculation is:

https://docs.google.com/spreadsheet/ccc?key=0AhTPR9eP5nWedEF1SGVLdllJTnBMSDMzM3lYZ2d0SlE&usp=sharing

 

Your calculation is much more accurate than mine, but you still have either the strike price or the switch over point in all of them.  If the strike price changes it will effect those fields in your spreadsheet.

 

[CorpRaider]

Yeah, I'm probably going to ballpark it by only including the $.01 of foregone dividend in the cost computation (actually, in reality, I will probably just refer to the "cost" figure excluding the dividend for relative compairsons involving all warrants with dividends which have triggered the anti-dilution provisions).

[ERICOPOLY]

I just noticed that the warrants are looking pretty good right now.  I hold 2016 calls in my IRA, but in my wife's Roth IRA I've been trading back and forth between the warrants and the common.  Back at the beginning of May I sold all of her warrants and bought the common, this morning I just went in the other direction selling the common and purchasing the warrants back. She now has >11% more of the warrants than she had in May.  I've done this 3 times in the last year and a half increasing her number of warrants significantly.

 

I've been using this cost of leverage calculation in my spreadsheet here (I've posted this before: BAC Warrants Cost of Leverage)  to gauge how the warrants are priced relative to the common and various calls.  It looks like about 8.7% cost of leverage, but that will be around 8% if you factor in the reduction of the strike price due to the next year or so worth of dividend payments at $0.05/qrtr.

 

Strike adjustment doesn't change cost of leverage.

 

I'm using:  cost of leverage =  ((strike / (common-warrant))^(1 / 4.5 years)) - 1

 

If you change the strike price it changes the answer.  How would you calculate the cost of leverage?  For options the strike can't change (you lose the dividend), but for the warrants it will so that needs to be taken into account somehow.

 

Subtract today's warrant price from today's stock price.  The remainder then compounds to $13.30 at what rate?  That's the cost of leverage.

 

The warrant adjustments are merely a synthetic DRIP plan.  Nothing more.  Now, if you borrow money on margin to buy shares that you then enroll in a DRIP plan, can you then argue for a lower margin rate when dividends are paid? No.

[rkbabang]

Subtract today's warrant price from today's stock price.  The remainder then compounds to $13.30 at what rate?  That's the cost of leverage.

 

The warrant adjustments are merely a synthetic DRIP plan.  Nothing more.  Now, if you borrow money on margin to buy shares that you then enroll in a DRIP plan, can you then argue for a lower margin rate when dividends are paid? No.

 

That makes sense to me.  Thanks for the explanation.  You are correct that you could not argue for a lower margin rate. 

 

I was just looking for someway to account for the lost dividend with the calls and not with the warrants.  I guess that is impossible without knowing before hand exactly how much the strike price will decrease each quarter between now and 2019.

 

 

[ERICOPOLY]

Subtract today's warrant price from today's stock price.  The remainder then compounds to $13.30 at what rate?  That's the cost of leverage.

 

The warrant adjustments are merely a synthetic DRIP plan.  Nothing more.  Now, if you borrow money on margin to buy shares that you then enroll in a DRIP plan, can you then argue for a lower margin rate when dividends are paid? No.

 

That makes sense to me.  Thanks for the explanation.  You are correct that you could not argue for a lower margin rate. 

 

I was just looking for someway to account for the lost dividend with the calls and not with the warrants.  I guess that is impossible without knowing before hand exactly how much the strike price will decrease each quarter between now and 2019.

 

Use coomon+puts+margin instead of calls for comparing with warrants.  This way lost dividends don't come into play.

[racemize]

I just noticed that the warrants are looking pretty good right now.  I hold 2016 calls in my IRA, but in my wife's Roth IRA I've been trading back and forth between the warrants and the common.  Back at the beginning of May I sold all of her warrants and bought the common, this morning I just went in the other direction selling the common and purchasing the warrants back. She now has >11% more of the warrants than she had in May.  I've done this 3 times in the last year and a half increasing her number of warrants significantly.

 

I've been using this cost of leverage calculation in my spreadsheet here (I've posted this before: BAC Warrants Cost of Leverage)  to gauge how the warrants are priced relative to the common and various calls.  It looks like about 8.7% cost of leverage, but that will be around 8% if you factor in the reduction of the strike price due to the next year or so worth of dividend payments at $0.05/qrtr.

 

Strike adjustment doesn't change cost of leverage.

 

Agreed.  FYI, I have it at 8.95% common appreciation cost of leverage, or 9.13% total cost of leverage, depending on how you want to think of it.  Link to my calculation is:

https://docs.google.com/spreadsheet/ccc?key=0AhTPR9eP5nWedEF1SGVLdllJTnBMSDMzM3lYZ2d0SlE&usp=sharing

 

Your calculation is much more accurate than mine, but you still have either the strike price or the switch over point in all of them.  If the strike price changes it will effect those fields in your spreadsheet.

 

It calculates the current cost of leverage and so has to take into account the strike price.  The future adjustments do not affect the current cost of leverage, which is what Eric is saying. 

[racemize]

Subtract today's warrant price from today's stock price.  The remainder then compounds to $13.30 at what rate?  That's the cost of leverage.

 

The warrant adjustments are merely a synthetic DRIP plan.  Nothing more.  Now, if you borrow money on margin to buy shares that you then enroll in a DRIP plan, can you then argue for a lower margin rate when dividends are paid? No.

 

That makes sense to me.  Thanks for the explanation.  You are correct that you could not argue for a lower margin rate. 

 

I was just looking for someway to account for the lost dividend with the calls and not with the warrants.  I guess that is impossible without knowing before hand exactly how much the strike price will decrease each quarter between now and 2019.

 

The calculation in my spreadsheet works for both warrants and calls, including the current dividend, so the cost of leverage should be comparable across vehicles.  However, the dividends can change over the lifetime of the option/warrant, which doesn't matter for warrants once the threshold is met, but does for the calls.  In that case, you have to adjust the dividend to what you think will be paid to get a more accurate cost of leverage--the spreadsheet just uses the current dividend, but can be modified based on whatever assumptions you want.

[CorpRaider]

Race, did you already adjust the strike for the WFC warrants?  The copy i have a link to doesn't show a divvy for them, but it looks like they're running $.01 above the trigger now.  Thanks  I'm really warming to the idea of chunking a bunch of these ones that provide for net or cashless exercise into tax advantaged accounts.

[rayfinkle]

eric- do you have updated thoughts on this?

 

Funny, started re-reading this thread from the beginning the other day and it got bumped.

[racemize]

Race, did you already adjust the strike for the WFC warrants?  The copy i have a link to doesn't show a divvy for them, but it looks like they're running $.01 above the trigger now.  Thanks  I'm really warming to the idea of chunking a bunch of these ones that provide for net or cashless exercise into tax advantaged accounts.

 

I just realized the dividends somehow got messed up in the sheet, and fixed it.  However, with WFC, and in general, it pulls the annual amount and divides by 4, and it appears that yahoo uses trailing twelve months for its dividend, so that's a bit of a problem.  I can fix them manually. 

 

Has WFC published a strike price adjustment?  I usually don't modify until the company officially announces it.  Also, I think they have to hit some threshold before it is officially adjusted, iirc.

 

edit: found it: https://www08.wellsfargomedia.com/downloads/pdf/invest_relations/warrant-notice.pdf

[ERICOPOLY]

eric- do you have updated thoughts on this?

 

Funny, started re-reading this thread from the beginning the other day and it got bumped.

 

It's not as worthwhile to obsess about it now.  There are 1.5 fewer years remaining, and the cost is not above 13% annualized any longer.  Originally the warrants were so expensive it was hard to understand why people wanted them.

[ERICOPOLY]

I started this thread when the common was $12 and the warrants were $5.60.

 

The common has appreciated 35% and the warrants only 28%.

 

[ERICOPOLY]

People thought the warrants were the best thing ever, but how fucked up can it get more than being leveraged and doing worse than plain vanilla common after a roaring 35% gain in the common?  I mean, that's like being unable to get laid in a whorehouse.