There is almost no other area of the stock market (with the possible exception of stub stocks) where careful research can be hugely rewarded. But be careful in your total commitment on LEAPs so as to protect your capital. If you study the mechanics of options well and apply their use to stable franchises, you can carve out precise risk/reward investments. Editor: Be aware that when LEAPS work, you will feel like you are on crack cocaine. Who doesn’t want 200% to 400% returns on your capital, but you must use discretion so you don’t “over-invest” in this instrument. Pick your spots.
Investing more than 10% to 20% of your portfolio in these instruments at any one time would be ill-advised due to their leveraged nature.
Professor’s Option Trading Days at Bear Stearns
Options were not as efficient back then as they are now1. If I could create a situation if our borrowing cost was 10% and make 12%–it was a risk-less spread at 2%. I was doing forward conversions.
I spent the whole summer trading options.
Another way to look at a Call is it is similar to owning 100 shares and 1 put (one put controls 100 shares of underlying stock). The put price is expressed on a per share basis. A put price of $3.70 costs $370.
The equivalent of owning a Call is like buying a stock and a put. Why is that? Once I own a put at $50 strike price, I can’t lose money below $50. I have to lay out $$ for the interest cost of owning the stock at $50. That is the same as owning the Call at $9. The economics are exactly the same other than the interest difference.
Dividend Issue: You have to adjust for dividends because if you own the stock you are getting dividends and if you own the Call you are not getting dividends.
The Call gives you the right to own stock at $50 and the right not to lose money below $50. So here I own the stock and I bought the put.