34 lines
2.4 KiB
Plaintext
34 lines
2.4 KiB
Plaintext
Understanding and Managing Leverage • 183
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I’ve used for calculation. All OTM options will be marked with an IRL fol-
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lowed by the percentage of the total portfolio used in the option purchase
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(not the percentage of the individual allocation but the total percentage
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amount of your investment capital). On my website, you’ll find an online
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leverage tool that allows you to calculate these numbers yourself.
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Managing Leverage
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A realized loss is, to me, serious business. There are times when an inves-
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tor must take a realized loss—specifically when his or her view of the fair
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value or fair value range of a company changes materially enough that an
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investment position becomes unattractive. However, if you find yourself
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taking realized losses because of material changes in valuation too often,
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you should either figure out where you are going wrong in the valuation
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process or just put your money into a low-load mutual fund and spend
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your time doing something more productive.
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The point is that taking a realized loss is not something you have to do
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too often if you are a good investor, and hopefully, when those losses are taken,
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they are small. As such, I believe that there are two ways to successfully manage
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leverage. First is to use leverage sparingly by investing in combinations of ITM
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options and stocks. ITM option prices mainly represent intrinsic value, and be-
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cause the time-value component is that which represents a realized loss right out
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of the gate, buying ITM options means that you are minimizing realized losses.
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The second method for managing leverage when you cannot resist
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taking a higher leverage position is spending as little as possible of your
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investment capital on it. This means that when you see that there is a com-
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pany that has a material chance of being worth a lot more or a lot less than
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it is traded for at present but that material chance is still much less likely
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than other valuation scenarios, you should invest your capital in the idea
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sparingly. By making smaller investments with higher leverage, you will
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not realize a loss on too much of your capital at one time, and if you are
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right at least some of the time on these low-probability, high-potential-
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reward bets, you will come out ahead in the end.
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Of course, you also can use a combination of these two methods. For
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example, I have found it helpful to take the main part of a position using a |