43 lines
1.7 KiB
Plaintext
43 lines
1.7 KiB
Plaintext
380 Part Ill: Put Option Strategies
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Using Margin. The same prospective initial purchaser of common stock might
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have been contemplating the purchase of the stock on margin. If he used the LEAPS
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instead, he could save the margin interest. Of course, he wouldn't have as much
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money to put in the bank, but he should also compare his costs against those of buy
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ing the LEAPS call instead.
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Example: As before, XYZ is selling at 50; there are 1-year LEAPS with a striking
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price of 40 that sell for $12; XYZ pays an annual dividend of $0.50; and short-term
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interest rates are 5%. Furthermore, assume the margin rate is 8% on borrowed debit
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balances.
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First, calculate the difference in prospective investments:
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Cost of buying the stock:
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$5,000 + $25 commission:
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Amount borrowed (50%)
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Equity required
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Cost of buying LEAPS:
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$1,200 + $15 commission:
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Difference (available to be placed in bank account)
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$5,025
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-2,512
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$2,513
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$1,215
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$1,298
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Now the costs and opportunities can be compared, if it is assumed that he buys
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the LEAPS:
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Costs:
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Time value premium
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Dividend loss
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Savings:
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Interest on $1,298 at 5%
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Margin interest on $2,512 debit balance at 8% for one year
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Net Savings:
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-$200
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- 50
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+$ 65
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+ 201
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+$ 16
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For the prospective margin buyer, there is a real savings in this example. The
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fact that he does not have to pay the margin interest on his debit balance makes the
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purchase of the LEAPS call a cost-saving alternative. Finally, it should be noted that
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current margin rules allow one to purchase a LEAPS option on margin. That can be
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accounted for in the above calculations as well; merely reduce the investment
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required and increase the margin charges on the debit balance. |