32 lines
1.9 KiB
Plaintext
32 lines
1.9 KiB
Plaintext
164 • The Intelligent Option Investor
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because of their lack of appreciation for the fact that the sword of lever -
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age cuts both ways. Certainly an option investor cannot be considered an
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intelligent investor without having an understanding and a deep sense
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of respect for the simultaneous power and danger that leverage conveys.
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New jargon introduced in this chapter includes the following:
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Lambda
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Notional exposure
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Investment Leverage
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Commit the following definition to memory:
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Investment leverage is the boosting of investment returns calcu-
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lated as a percentage by altering the amount of one’s own capital
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at risk in a single investment.
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Investment leverage is inextricably linked to borrowing money—this
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is what I mean by the phrase “altering the amount of one’s own capital at
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risk. ” In this way, it is very similar to financial leverage. In fact, in my mind,
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the difference between financial and investment leverage is that a company
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uses financial leverage to fund projects that will produce goods or provide
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services, whereas in the case of investing leverage, it is used not to produce
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goods or services but to amplify the effects of a speculative position.
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Frequently people think of investing leverage as simply borrowing
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money to invest. However, as I mentioned earlier, you can invest in options
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for a lifetime and never explicitly borrow money in the process. I believe
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that the preceding definition is broad enough to handle both the case of
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investment leverage generated through explicit borrowing and the case of
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leverage generated by options.
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Let’s take a look at a few example investments—unlevered, levered
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using debt, and levered using options.
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Unlevered Investment
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Let’s say that you buy a stock for exactly $50 per share, expecting that its intrinsic
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value is closer to $85 per share. Over the next year, the stock increases by $5,
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or 10 percent in value. Y our unrealized percentage gain on this investment is |