35 lines
1.4 KiB
Plaintext
35 lines
1.4 KiB
Plaintext
Understanding and Managing Leverage • 181
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02468 10 12 14 16 18 20 22 24
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Stock Price
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Levered Strategy Overview
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Gain (Loss) on Allocation
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26 28 30 32 34 36 38 40 42 44 46 48 50(5,000)
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-
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15,000
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10,000
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20,000
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25,000
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30,000
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5,000
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Unrealized Gain
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Unrealized Loss
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Cash Value
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Net Gain (Loss) - Levered
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Realized Loss
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Instrument Maximum-Loss Price Net Profit at Fair Value Estimate
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Stock $0 $1,472
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Option $22 (11 × stock loss) $4,833 (5.1 × stock profit)
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The 11 times loss figure was calculated in the following way: there is a
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total of 47.3 percent of my allocation to this investment that is lost if the price
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of the stock goes down by 4.3 percent, so −47.3 percent/4.3 percent = −11.0.
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Obviously, this policy of keeping some cash in reserve represents a sensible ap-
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proach to portfolio management when leverage is used. An investor in straight
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stock who makes 20 investments that do not hit his or her expected fair value
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within the investment horizon might have a few bad years of performance, but
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an investor who uses maximum option leverage and allocates 5 percent to 20
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ideas will end up bankrupt if these don’t work out by expiration time!
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Similar to setting a cash reserve, you also might decide to make an
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investment that combines cash, stock, and options. For example, I might
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buy 100 shares of Intel, three ITM option contracts, and leave the rest of
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my 5 percent allocation in cash. Here is what that profit and loss profile
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would look like: |