How to think about options?

[ItsAValueTrap]

My point is that massive share repurchases dramatically increase per share value on a level that is wholly unaccounted for by route option pricing and especially stabbing at implied vol for multiple years.

 

I'm not sure that repurchases should affect the options pricing that much.

 

A company can do a few things with its profits:

A- Buy back shares.

B- Re-invest the capital.

C- Issue dividends.

D- Pull an Apple and sit on a big stack of cash.  (Apple is essentially the world's biggest hedge fund.)

 

A and B will cause more volatility in the business than D.  C will reduce the value of the call options, unless the company dividends it out all at once and the options get adjusted (in which case C is almost the same as D).

 

I think the big picture is that 1-2 years of profits don't make that big a difference.

 

Where DTV is unique is that it takes on very high amounts of leverage (and continues to increase it).  Lots of leverage should make the business highly volatile.  If you think that stock prices will track fundamentals over time, then high leverage should make the stock volatile.

[compoundinglife]

You guys are debating the stock/company again, not discussing using options.

 

Thanks for bringing this up. I started this thread so the discussion of options did not consume the AAPL thread, but the AAPL debate has manifested over here. Perhaps we can swing it back over to the AAPL thread.

 

 

I have some experience with options and have thought a bit about the Apple situation in this regard.

 

Some thoughts and experiences:

 

Successes:

a)FFH leaps - We, collective we (this message board) knew the issues with FFH as much as anyone.  We knew that the issues were getting behind them when we first initiated Leap positions.  The Leaps were a way to lever the return to value.  It was not based on FFh actually growing but surviving.

b) AMEX, SB, GE, WFC - all Longest Leaps - As above - a survival story or return to value.  If these turned against me I would have had my house, a little cash, a job, in a severe depression.

c) BAC, WFC, JPM, AIG - return to value in all cases.  Proxy for common to add leverage

 

Failures:

1) Trying to duplicate FFh success with smaller companies - I have done it enough times to know to stay away.

2) Rim - Buying Leaps, Selling puts - I got hammered.  In this case I would call it fighting the tape. 

3) Buying puts in general.  This never seems to work very well.  I still use them, strictly as insurance, accepting ahead of time that I will probably lose, but they serve a purpose.

4) Selling puts.  There are better ways to earn income - buy WFC, or SSW instead.  Unless you really want the stock at the lower price.

5) Buy and hold, either on purpose, or through forced holding (liquidity dries up).  example: MFC options.  Options are for trading.  The only time I have ever exercised them is with FFH.

 

So what can I learn from all this. 

1)Return to value situations work best

2) If an option hasn't moved into the money when the next Leap cycle ensues I get rid of it completely.  For US investors, this will mean waiting your one day plus a year to get your tax loss.  Revisit your situation and buy more leaps or take your losses and stay away. 

3) Lock in my gains as soon as The next cycle comes out, subject to tax issues.  Basically, get rid of buy and hold mentality.  Buy more at the time limit Leaps if upside still exisits on stock. 

4) Dont sell puts unless I want the stock at a new improved price.

5) Only buy puts as insurance, not to make money.

 

To the Apple situation directly:

 

Ask yourself how many times in history you have seen a high flyer regain its value quick enough to make money on your Leaps?  If Apple reports weaker than expected earnings, meets expectations, or even slightly exceeds them the stock will stay down.  What is the chance something will materialize to take it back up to $500.  To get to $500 in 1.6 years you need something big.  Will this happen in that time period?  Are you willing to eat %100 on your position?  If these are all acceptable to you then by all means go ahead.  Otherwise stay with the common, or in my case none at all.  I am not willing to fight the tape, Yet!

 

Thanks. Your perspective makes alot of sense.

[Cardboard]

Regarding options, buy long term ones. I have been tempted and did buy shorter term options so many times only to see the stock finally go up (and sometimes in a major way) after my options had expired or was fed up to renew them. The leverage and low price of short term options along with the thinking of what could go right is like a drug. I have won a few times, but in the majority of cases I was disappointed and it caused me a lot of anguish.

 

On Apple, I think that a major rebound in the short term is a strong possibility. It has been going down for 7 months in a row now in a very defined channel as technicians would say. It is setup almost perfectly for some kind of short squeeze or renewed buying interest on any positive news. I would not bet against a company that has 37% of its market cap in cash, looking to do something positive with this cash and still generating large profits. It is trading at 8.9 times earnings and 5.6 times excluding cash. Despite this, I would still buy 2015 Leaps and maybe sell a higher priced call to lower your premium. You can possibly leverage more this way so that what you lose on the upside is gained from holding more Leaps.

 

However for perspective, it is still $230 billion that has to be justified via their earning power. It is a really big number when you consider what has happened over time to companies like Nokia and BlackBerry who both once dominated this field. Although, as long as they keep their products as good as the competition, which I think they can, they will retain higher margins than the rest. I know many who own IPhones and they won't switch to anything else. The difference in cost, especially when you sign up for 3 years with your phone company, makes it not worthwhile to learn a new system even if I know that they are almost identical. The question is that enough to keep sales and profits around current levels for years to come?

 

Cardboard

[no_free_lunch]

Since we are telling option stories, I did have some success with puts on goldman sachs in 2008.  I don't recall the exact numbers, I think they were around $130 for $3-4 but I could be mistaken.  I ended up selling them way too soon after they tripled in price, seemed like a good return at the time.  That was end of august 2008, had I held to expiry I would have made something like 15x my money.  Had I sold in the november trough, I think it would have been 25x.  Oh well.

[Uccmal]

Since we are telling option stories, I did have some success with puts on goldman sachs in 2008.  I don't recall the exact numbers, I think they were around $130 for $3-4 but I could be mistaken.  I ended up selling them way too soon after they tripled in price, seemed like a good return at the time.  That was end of august 2008, had I held to expiry I would have made something like 15x my money.  Had I sold in the november trough, I think it would have been 25x.  Oh well.

 

Therein lies the problem I have with puts.  I entered August 2008 with some SPY puts.  Shortly after they came in the money I sold them, and lost out on the vast amount of gains to be had two months later.  Shorting stocks is extremely difficult to do well and consistently, and becomes even tougher when you handicap yourself with expiry dates. 

[no_free_lunch]

Shortly after they came in the money I sold them, and lost out on the vast amount of gains to be had two months later.  Shorting stocks is extremely difficult to do well and consistently, and becomes even tougher when you handicap yourself with expiry dates. 

 

Maybe the lesson is to wait until they either: a) expire or b) hit some predetermined multiple.  E.g. in my case, I knew it was possible for them to go to 10-20x (by looking at previous cases), so I should have set a 10x target from the get go (back in January 2008 I think).  I guess the point I am trying to make is occasionally, like all assets, puts can be under-priced. 

[twacowfca]

Shortly after they came in the money I sold them, and lost out on the vast amount of gains to be had two months later.  Shorting stocks is extremely difficult to do well and consistently, and becomes even tougher when you handicap yourself with expiry dates. 

 

Maybe the lesson is to wait until they either: a) expire or b) hit some predetermined multiple.  E.g. in my case, I knew it was possible for them to go to 10-20x (by looking at previous cases), so I should have set a 10x target from the get go (back in January 2008 I think).  I guess the point I am trying to make is occasionally, like all assets, puts can be under-priced.

 

Yes. OTM puts didn't exhibit the strong "smile" pattern then and were in fact a bargain in any prospective milieu other than a benign normal distribution.  :)

[Uccmal]

Shortly after they came in the money I sold them, and lost out on the vast amount of gains to be had two months later.  Shorting stocks is extremely difficult to do well and consistently, and becomes even tougher when you handicap yourself with expiry dates. 

 

Maybe the lesson is to wait until they either: a) expire or b) hit some predetermined multiple.  E.g. in my case, I knew it was possible for them to go to 10-20x (by looking at previous cases), so I should have set a 10x target from the get go (back in January 2008 I think).  I guess the point I am trying to make is occasionally, like all assets, puts can be under-priced. 

 

Yeah, easier said than done. 

[GrizzlyRock]

My point is that massive share repurchases dramatically increase per share value on a level that is wholly unaccounted for by route option pricing and especially stabbing at implied vol for multiple years.

 

I'm not sure that repurchases should affect the options pricing that much.

 

A company can do a few things with its profits:

A- Buy back shares.

B- Re-invest the capital.

C- Issue dividends.

D- Pull an Apple and sit on a big stack of cash.  (Apple is essentially the world's biggest hedge fund.)

 

A and B will cause more volatility in the business than D.  C will reduce the value of the call options, unless the company dividends it out all at once and the options get adjusted (in which case C is almost the same as D).

 

I think the big picture is that 1-2 years of profits don't make that big a difference.

 

Where DTV is unique is that it takes on very high amounts of leverage (and continues to increase it).  Lots of leverage should make the business highly volatile.  If you think that stock prices will track fundamentals over time, then high leverage should make the stock volatile.

 

WRT buying back shares it doesn't change the volatility of the "business" in terms of core competencies, revenues, operating profit etc.  Rather share buybacks change the volatility of the share price as the EV of the biz is calculated over less shares.  This divergence is precisely what is not captured in option pricing.

 

I'll sign off this thread.

[locatevalue]

You guys are debating the stock/company again, not discussing using options.

 

I have some experience with options and have thought a bit about the Apple situation in this regard.

 

Some thoughts and experiences:

 

Successes:

a)FFH leaps - We, collective we (this message board) knew the issues with FFH as much as anyone.  We knew that the issues were getting behind them when we first initiated Leap positions.  The Leaps were a way to lever the return to value.  It was not based on FFh actually growing but surviving.

b) AMEX, SB, GE, WFC - all Longest Leaps - As above - a survival story or return to value.  If these turned against me I would have had my house, a little cash, a job, in a severe depression.

c) BAC, WFC, JPM, AIG - return to value in all cases.  Proxy for common to add leverage

 

Failures:

1) Trying to duplicate FFh success with smaller companies - I have done it enough times to know to stay away.

2) Rim - Buying Leaps, Selling puts - I got hammered.  In this case I would call it fighting the tape. 

3) Buying puts in general.  This never seems to work very well.  I still use them, strictly as insurance, accepting ahead of time that I will probably lose, but they serve a purpose.

4) Selling puts.  There are better ways to earn income - buy WFC, or SSW instead.  Unless you really want the stock at the lower price.

5) Buy and hold, either on purpose, or through forced holding (liquidity dries up).  example: MFC options.  Options are for trading.  The only time I have ever exercised them is with FFH.

 

So what can I learn from all this. 

1)Return to value situations work best

2) If an option hasn't moved into the money when the next Leap cycle ensues I get rid of it completely.  For US investors, this will mean waiting your one day plus a year to get your tax loss.  Revisit your situation and buy more leaps or take your losses and stay away. 

3) Lock in my gains as soon as The next cycle comes out, subject to tax issues.  Basically, get rid of buy and hold mentality.  Buy more at the time limit Leaps if upside still exisits on stock. 

4) Dont sell puts unless I want the stock at a new improved price.

5) Only buy puts as insurance, not to make money.

 

To the Apple situation directly:

 

Ask yourself how many times in history you have seen a high flyer regain its value quick enough to make money on your Leaps?  If Apple reports weaker than expected earnings, meets expectations, or even slightly exceeds them the stock will stay down.  What is the chance something will materialize to take it back up to $500.  To get to $500 in 1.6 years you need something big.  Will this happen in that time period?  Are you willing to eat %100 on your position?  If these are all acceptable to you then by all means go ahead.  Otherwise stay with the common, or in my case none at all.  I am not willing to fight the tape, Yet!

 

 

Thanks for sharing it, I never bought any options because of my buy and hold framework till it reaches IV and was never sure about timing.With more experience my probablity of predicting timing is improving so want to wet my feet with small percentage in options and this would be really helpful, I leared a lot from Eric on options which got me intrested in it by the way!

[Yours Truly]

I don't know a damn thing about options/leaps but Uccmal, thanks for your candor, much appreciated!

[Yours Truly]

For those discussing DTV, can you advise why you are referring to John Malone? I don't believe he nor Liberty-companies have any ties with the company anymore.. Per CapitalIQ, he does not own any shares nor is on the board.. neither is his #2 man, Greg Maffei

 

He may be gone but the current CEO, Mike White, is definitely using a play from Malone's playbook of leveraging to buyback shares while being undervalued..

[LC]

For those discussing DTV, can you advise why you are referring to John Malone? I don't believe he nor Liberty-companies have any ties with the company anymore.. Per CapitalIQ, he does not own any shares nor is on the board.. neither is his #2 man, Greg Maffei

 

He may be gone but the current CEO, Mike White, is definitely using a play from Malone's playbook of leveraging to buyback shares while being undervalued..

As well as reducing his tax bill.

[scorpioncapital]

I sold some put options today on a stock at a price 24% below the market price. Expiry is in 2 months (!). The premium I asked for shows as an instant profit because. Namely, buyers seem panicky. What does it mean in this kind of situation? Was it a short squeeze and people are covering or they assume an incredibly volatility, or it's a scheme to drive down the price over the next 2 months? The stock had a huge jump in the last 2-3 weeks, something like an increase of 20%....