37 lines
2.7 KiB
Plaintext
37 lines
2.7 KiB
Plaintext
184 • The Intelligent Option Investor
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combination of stock and ITM call options but also perhaps buying a few
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OTM call options as well. As the investment ages and more data about the
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company’s operations come in, if this information leads me to be more
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bullish about the prospects of the stock, I may again increase my leverage
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using OTM call options—especially when I see implied volatility trading at
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a particularly low level or if the stock price itself is depressed because of a
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generally weak market.
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I used to be of the opinion that if you are confident in your valuation
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and your valuation implies a big enough unlevered return, it is irrational
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not to get exposure to that investment with as much leverage as possible.
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A few large and painful losses of capital have convinced me that where-
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as levering up on high-conviction investments is theoretically a rational
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investment regime, practically, it is a sucker’s game that is more likely to
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deplete your investment capital than it is to allow you to hit home runs.
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Y ounger investors, who still have a long investing career ahead of
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them and plenty of time to make up for mistakes early on, probably can
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feel more comfortable using more leverage, but as you grow closer to the
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time when you need to use your investments (e.g., paying for retirement,
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kids’ college expenses, or whatever), using lower leverage is better.
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Looking back at the preceding tables, one row in one table in particular
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should stand out to you. This is the last row of the last table, where the leverage is
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−1.8/2.6. To me, this is a very attractive leverage ratio because of the asymmetry
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in the risk-reward balance. This position is levered, but the leverage is lopsided
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in the investor’s favor, so the investor stands to win more than he or she loses.
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This asymmetry is the key to successful investing—not only from a
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leverage standpoint but also from an economic standpoint as well. I believe
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an intelligent, valuation-centric method for investing in companies such as
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the ones outlined in this book that allow investors an edge up by allowing
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them to identify cases in which the valuation simply does not line up with
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the market price. This in itself presents an asymmetrical profit opportunity,
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and the real job of an intelligent investor is to find as large an asymmetry
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as possible and courageously invest in that company. If you can also tailor
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your leverage such that your payout is asymmetrical in your favor as well,
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this only adds potential for outsized returns, in my opinion.
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The other reason that the −1.8/2.6 leverage ratio investment interests
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me is because of the similarity it has to the portfolio of Warren Buffett’s |