196  •   The Intelligent Option Investor
the company is taken out. Just keep in mind that the buyout premium is 
30 percent over the last price, not 30 percent over the price at which you 
decided to make your investment. If you buy 20 percent OTM call options 
and the stock decreases by 10 percent before a 30 percent premium buyout 
is announced, you will end up with nothing, as shown in the following 
timeline:
$12-Strike Options Bought When the Stock Is Trading for $10
•	Stock falls to $9.
•	Buyout is announced at 30 percent above last price—$11.70.
•	12-strike call owner’s profit = $0.
However, there is absolutely no assurance that an acguirer will pay some-
thing for a prospective acguiree. Depending on how keen the acquirer is to get 
its hands on the assets of the target, it may actually allow the target company 
to go bankrupt and then buy its assets at $0.30 on the dollar or whatever. It is 
precisely this uncertainty that makes it unwise to commit too much capital to 
an idea involving a bad company—even if you think it may be taken out.
Portfolio Management
I like to think of intelligent option investing as a meal. In our investment 
meal, the underlying instrument—the stock—should, in most cases, form 
the main course. 
People have different ideas about diversification in a securities portfolio 
and about the maximum percentage of a portfolio that should be allocated to 
a specific idea. Clearly, most people are more comfortable allocating a greater 
percentage of their portfolio to higher-confidence ideas, but this is normal-
ly framed in terms of relative levels (i.e., for some people, a high-conviction 
idea will make up 5 percent of their portfolio and a lower-conviction one  
2.5 percent; for others, a high-conviction idea will make up 20 percent of their 
portfolio and a lower-conviction one 5 percent). Rather than addressing what 
size of investment meal is best to eat, let’s think about the meal’s composition.
Considering the underlying stock as the main course, I consider the 
leverage as sauces and side dishes. ITM options positions are the main