33 lines
2.1 KiB
Plaintext
33 lines
2.1 KiB
Plaintext
Appendix A: Choose Your Battles Wisely • 277
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very little money to buy a cheap call. It may happen that the money we
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receive for selling the put actually may be greater than the money we
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pay for the call, so we actually get paid a net fee when we make this
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transaction!
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We can sell the put confidently because we know that our worst-case
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valuation is $70 per share; as long as we are confident in our valuation—a
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topic covered in Part II of this book—we need not worry about the price
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declining. We do not mind spending money on the call because we think
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that the chance is very good that at expiration or before the call will be
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worth much, much more than we paid for it.
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Truly, the realization that the BSM is pricing options on inefficiently
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priced stocks as if they were efficiently priced is the most profound and
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compelling source of profits for intelligent investors. Furthermore, finding
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grossly mispriced stocks and exploiting the mispricing using options rep-
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resents the most compelling method for tilting the risk-reward equation in
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our direction.
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The wonderful thing about investing is that it does not require you to
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swing at all the pitches. Individual investors have a great advantage in that
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they may swing at only the pitches they know they can hit. The process of
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intelligent investing is simply one of finding the right pitches, and intel-
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ligent option investing simply uses an extremely powerful bat to hit that
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sweet pitch.
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Bimodal Outcomes
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Some companies are speculative by nature—for instance, a drug company
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doing cancer research. The company has nothing but some intangible as-
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sets (the ideas of the scientists working there) and a great deal of costs
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(the salaries going to those scientists, the payments going to patent attor -
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neys, and the considerable costs of paying for clinical trials). If the research
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proves fruitful, the company’s value is great—let’s say $500 per share. If
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the clinical trials show low efficacy or dangerous side effects, however, the
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company’s worth goes to virtually nil. What’s more, it may take years before
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it is clear which of these alternatives is true. |