Having said all that, I'll now reverse my self and tell
you that you're both right. Based on the two different
premises you are using, both of you are right. However,
both of your premises are wrong.
The person who said 100% is right. Time value of money
affects the rationality of the decision, but not the
potential return.
The fact is, I can enter into a transaction today where I
pay $10, and receive $20 in X years if the stock is priced
at > 20. That's a 100% gain, if that happens.
The reason this may not be a no-brainer is you lose money
if you intend to sell in X years willy-nilly, and the stock
declines below $10. In that case, the stock wouldn't get
called, and I'd receive < $10 for my initial investment.
For instance, today I could do the following:
Buy 100 shares of RMBS for $1656
Write 1 RMBS Jan '03 20 LEAP call for $1100.
Net cost: $556.
Here is the potential payoffs in Jan '03 (I'm assuming that
I will not sell before then, and will thus either sell or
have the call exercised):
Stock Receive Return
1 100 -82%
2 200 -64%
3 300 -46%
4 400 -28%
5 500 -10%
6 600 8%
7 700 26%
8 800 44%
9 900 62%
10 1000 80%
11 1100 98%
12 1200 116%
13 1300 134%
14 1400 152%
15 1500 170%
16 1600 188%
17 1700 206%
18 1800 224%
19 1900 242%
20 2000 260%
Those are some amazing figures. A few days ago, someone
(who reads this board) PM'ed me to ask for advice about
selling some RMBS, and buy some '03 20 LEAPs instead. I
told him that I didn't know much about LEAPS, but it seemed
like a shrewd strategy. Looks like I was only half-right...
I'm not yet sure that purchasing '03 LEAPS is a bad idea,
but writing them is looking smarter and smarter. The last
couple of days, I've been thinking more about options
theory, trying to figure out what strategies make sense. I
haven't come up with a good answer yet, but when I do, I'll
report back to you. Tentatively, I'm looking into the idea
of writing OTM covered calls and OTM covered puts.
I've also looked at the Kelly criterion, which helps to
explain why purchasing calls is nowhere near as
smart as it looks. |
