228  •   The Intelligent Option Investor
With a table like this, you can balance, on the one hand, the degree 
you are reducing your overall exposure in a worst-case scenario (by look-
ing at column a) against how much risk you are taking on for a bad-case 
(intermediary upward move of the stock) scenario (by looking at column 
b) against how much less premium you stand to earn if the stock does go 
down as expected (by looking at column c). 
There are no hard and fast rules for which is the correct covering strike to 
select—that will depend on your confidence in the valuation and timing, your 
risk profile, and the position size—but looking at the table, I tend to be drawn 
to the $215 and $220 strikes. With both of those strikes, you are reducing your 
worst-case exposure by about half, increasing your bad-case exposure just 
marginally, and taking only a small haircut on the premium you are receiving.
6
Now that we have an idea of how to think about the potential risk and 
return on a per-contract basis, let’s turn to leverage in the strategic sense—
figuring out how much capital to commit to a given bearish idea.
Portfolio Management
When we thought about leverage from a call buyer’s perspective, we 
thought about how large of an allocation we wanted to make to the idea 
itself and changed our leverage within that allocation to modify the profits 
we stood to make. Let’s do this again with IBM—again assuming that we are 
willing to allocate 5 percent of our portfolio to an investment in the view 
that this company’s stock price will not go higher. At a price of $196.80, a 
5 percent allocation would mean controlling a little more than 25 shares for 
every $100,000 of portfolio value.
7 Because options have a contract size of 
100 shares, an unlevered 5 percent allocation to this investment would 
require a portfolio size of $400,000.
The equation to calculate the leverage ratio on the basis of notional 
exposure is
× =Notional valueo fo ne contract
Dollarv alue of allocation number of contractsl everager atio
So, for instance, if we had a $100,000 portfolio of which we were willing to 
commit 5 percent to this short-call spread on IBM, our position would have a 
leverage ratio of