Gaining Exposure 	 	•	 195
by using relatively less leverage when I want to commit a significant amount 
of capital to an idea constitute, I have found, given my risk tolerance and 
experience, the best path for me for a general investment.
In contrast, we all have special investment loves or wild hares or 
whatever, and sometimes we must express ourselves with a commitment 
of capital. For example, “If XYZ really can pull it off and come up with a 
cure for AIDS, its stock will soar. ” In instances such as these, I would rather 
commit less capital and express my doubt in the outcome with a smaller 
but more highly levered bet. If, on average, my investment wild hares come 
true every once in a while and, when they do, the options I’ve bought on 
them pay off big enough to more than cover my realized losses on all those 
that did not, I am net further ahead in the end.
These rules of thumb are my own for general investments. In the spe-
cial situation of investing in a possible takeover target, there are a few extra 
considerations. A company is likely to be acquired in one of two situations: 
(1) it is a sound business with customers, product lines, or geographic 
exposure that another company wants, or (2) it is a bad business, either 
because of management incompetence, a secular decline in the business, or 
something else, but it has some valuable asset(s) such as intellectual prop-
erty that a company might want to have.
If you think that a company of the first sort may be acquired, I be-
lieve that it is best to buy ITM call options to attempt to minimize the time 
value spent on the investment (you could also sell puts, and I will discuss 
this approach in Chapter 10). In this case, you want to minimize the time 
value spent because you know that the time value you buy will drain away 
when a takeover is announced and accepted. By buying an ITM contract, 
you are mainly buying intrinsic value, so you lose little time value if and 
when the takeover goes through. If you think that a company of the second 
sort (a bad company in decline) may be acquired, I believe that it is best to 
minimize the time value spent on the investment by not buying a lot of call 
contracts and by buying them OTM. In this case, you want to minimize the 
time value spent using OTM options by limiting the number of contracts 
bought because you do not want to get stuck losing too much capital if 
and when the bad company’s stock loses value while you are holding the 
options. Typical buyout premiums are in the 30 percent range, so buy-
ing call options 20 percent OTM or so should generate a decent profit if