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