35 lines
2.2 KiB
Plaintext
35 lines
2.2 KiB
Plaintext
172 • The Intelligent Option Investor
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the option’s value. Although everyone (especially fly-by-night investment
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newsletter editors) likes to tout their percentage returns, we know from
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our earlier investigations of leverage that percentage returns are only part
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of the story of successful investing. Let’s see why using the three invest-
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ments I mentioned earlier—an ITM call struck at $20, an OTM call struck
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at $39, and a long stock position at $31.
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I believe that there is a good chance that this stock is worth north of
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$40—in the $43 range, to be precise (my worst-case valuation was $30, and
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my best-case valuation was in the mid-$50 range). If I am right, and if this
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stock hits the $43 mark just as my options expire,
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2 what do I stand to gain
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from each of these investments?
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Let’s take a look.
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Spent Gross Profit Net Profit Percent Profit
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$39-strike call 0.18 4.00 3.82 2,122
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$20-strike call 11.50 23.00 11.50 100
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Shares 31.25 43.00 11.75 38
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This table means that in the case of the $20-strike call, we spent
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$11.50 to win gross proceeds of $23.00 (= $43 − $20) and a profit net of
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investment of $11.50. Netting $11.50 on an $11.50 investment generates a
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percentage profit of 100 percent.
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Looking at this chart, the first thing you are liable to notice is the
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“Percent Profit” column. That 2,122 percent return looks like something
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you might see advertised on an option tout service, doesn’t it? Y es, that
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percentage return is wonderful, until you realize that the absolute value
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of your dollar winnings will not allow you to buy a latte at Starbuck’s.
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Likewise, the 100 percent return on the $20-strike options looks heads and
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shoulders better than the measly 38 percent on the shares, until you again
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realize that the latter is still giving you more money by a quarter.
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Recall the definition of leverage as a way of “boosting investment re-
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turns calculated as a percentage, ” and recall that in my previous discussion
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of financial leverage, I mentioned that the absolute dollar value is always
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highest in the unlevered case. The fact is that many people get excited about
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stratospheric percentage returns, but stratospheric percentage returns only |