Buying the Internet with Calls
When you look at the Internet sector, you are likely to reach the same conclusion that many Wall Street experts have reached: namely, that only about 1/4 to 1/2 of these stocks will survive the next two years. If so and you are unsure about which "dot.coms" will prosper and which will perish, you have probably considered the strategy advocated by Henry Blodget of Merrill Lynch and others. Simply, do as follows: buy a basket of Internet stocks in the belief that relatively few good big hits will more than offset the losses. Looking at the math, three stocks that increase by 300% will offset the losses of nine stocks that go to zero, so if only a quarter survive and prosper, you have still broken even. Using this kind of logic leads you to the conclusion, the higher the volatility, the better your chances.
Still, this can be a very risky game. You don't know your odds. Are they 1 out of 2, 1 out of 3 or 4 or 5. And, of course, you have to consider whether stock prices are already so high that future explosive gains are unlikely. (The past year tells us a different story, of course, but you still might ask yourself whether now is the time to be making these kind of bets.)
One way to mitigate your risk is to use options. If all we are looking for is the upside potential of the stocks and are assuming that they have little or no downside protection, why not just buy calls. True, options are on Internet stocks are expensive due to the fact that the stocks are volatile, but that does not mean that they are overpriced in terms of their potential gains. What you want to consider is future volatility and whether the options are priced so that you have good chance of a pay-off.
¸ 2000 Value Line Publishing, Inc. |
