198  •   The Intelligent Option Investor
time to take a larger position and to use more leverage is when the market is 
pricing a stock as if it were almost certain that a company will face a worst-case 
future when you consider this worst-case scenario to be relatively unlikely. In 
this illustration, if the stock price were to fall by 50 percent—to the $8 per share 
level—while my assessment of the value of the company remained unchanged 
(worst, likely, and best case of $6, $25, and $37, respectively), I would think I 
had the margin of safety necessary to commit a larger proportion of my portfo-
lio to the investment and add more investment leverage. With the stock sitting 
at $8 per share, my risk ($8 − $6 = $2) is low and unlikely to be realized while 
my potential return is large and much closer to being assured. With the stock’s 
present price of $16 per share, my risk ($16 − $6 = $10) is large and when bad-
case scenarios are factored in along with the worst-case scenario, more likely 
to occur.
Thinking of margins of safety from this perspective, it is obvious that 
one should not frame them in terms of arbitrary levels (e.g., “I have a rule 
to only buy stocks that are 30% or lower than my fair value estimate. ”), but 
rather in terms informed by an intelligent valuation range. In this example, 
a 36 percent margin of safety is sufficient for me to commit a small 
proportion of my portfolio to an unlevered investment, but not to go “all 
in. ” For a concentrated, levered position in this investment, I would need a 
margin of safety approaching 76 percent (= ($25 − $6)/$25) and at least over  
60 percent (= ($25 - $10)/$25).
When might such a large margin of safety present itself? Just when 
the market has lost all hope and is pricing in disaster for the company. 
This is where the contrarianism comes into play. The best time to make 
a levered investment in a company with high levels of operational lever -
age is when the rest of the market is mainly concerned about the possible 
negative effects of that operational leverage. For example, during a reces-
sion, consumer demand drops and idle time at factories increases. This 
has a quick and often very negative effect on profitability for companies 
that own the idle factories, and if conditions are bad enough or look to 
have no near-term (i.e., within about six months) resolution, the price of 
those companies’ stocks can plummet. Market prices often fall so low as to 
imply, from a valuation perspective, that the factories are likely to remain 
idled forever. In these cases, I believe that not using investment leverage in 
this case may carry with it more real risk than using  investment leverage