36 lines
2.4 KiB
Plaintext
36 lines
2.4 KiB
Plaintext
Gaining Exposure • 191
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Value investors generally like bargains and to buy in bulk, so we
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should also buy our option time value “in bulk” by buying the longest
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tenor available and getting the lowest per-day price for it. It follows that if
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long-term equity anticipation securities (LEAPS) are available on a stock,
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it is usually best to buy one of those. LEAPS are wonderful tools because,
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aside from the pricing of time value illustrated in the preceding table, if
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you find a stock that has undervalued upside potential, you can win from
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two separate effects:
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1. The option market prices options as if underlying stocks were ef-
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ficiently priced when they may not be (e.g., the market thinks that
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the stock is worth $50 when it’s worth $70). This discrepancy gives
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rise to the classic value-investor opportunity.
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2. As long as interest rates are low, the drift term understates the ac-
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tual, probable drift of the stock market of around 10 percent per
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year. This effect tends to work for the benefit of a long-tenor call
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option whether or not the pricing discrepancy is as profound as
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originally thought.
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There are a couple of special cases in which this “buy the longest
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tenor possible” rule of thumb should not be used. First, if you believe
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that a company may be acquired, it is best to spend as little on time value
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as possible. I will discuss this case again when I discuss selecting strike
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prices, but when a company agrees to be acquired by another (and the
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market does not think there will be another offer and regulatory approv-
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als will go through), the time value of an option drops suddenly because
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the expected life of the stock as an independent entity has been short-
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ened by the acquiring company. This situation can get complicated for
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stock-based acquisitions (i.e., those that use stocks as the currency of
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acquisition either partly or completely) because owners of the acquiree’s
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options receive a stake in the acquirer’s options with strike price adjusted
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in proportion to the acquisition terms. In this case, the time value on
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your acquiree options would not disappear after the acquisition but be
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transferred to the acquirer’s company’s options. The real point is that it
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is impossible, as far as I know, to guess whether an acquisition will be
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made in cash or in shares, so the rule of thumb to buy as little time value
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as possible still holds. |