Uncle Frank, re: LEAPs
Let me preface this by saying I'm NO EXPERT on options, so I'm probably not the best person to explain them to you. This is more just my personal "experiment in progress" and should not be taken for anything else. Precisely because I'm no options expert, I consider LEAPs to be the best "option among options" since their pricing will ultimately behave more like the underlying stock than a bunch of delta-beta-phi mumbo jumbo.
You will note that I say "conservative" a bit tongue in cheek as LEAPs are conservative relative to other options (due to their later expiry), but are riskier than common or limited margining. The LEAP premiums vary from stock to stock, presumably due to perceived volatility. In the case of QCOM, Jan 01 calls striking at the money are priced around a third the price of the common. So at our recent (and hopefully never-again-to-be-seen) price of $150, contracts would cost you about $50 each (like all stock options, they trade in lots of 100, so 1 contract represents 100 shares and $50 actually means $5000 for interest in $15,000 of common). While a third may seem expensive, and spreads are large (up to 2 dollars per contract on the Q), you are leveraging your money threefold. The "price" for that leverage (ignoring the spread and assuming the stock goes up) is the erosion of the time premium over (what else?) time. Once the options are "in the money" (i.e., the share price is solidly above 150 in this case), the option price will start to move dollar for dollar with the underlying stock over short term moves, with long term erosion of the aforementioned time premium. What that means, obviously, is that if the underlying stock price doubles, the value of your in-the-money options should sextuple, minus the decrease in the value of the time premium. To me, there are several advantages to LEAPs over other investing plays:
1. They are a way to leverage cash in a retirement account (where you can't margin).
2. In a nonretirement account where margining is possible, you may think that you could just take a 50% margin position (with a 35% house call), but many brokers balk at letting you have more than 75% of margined assets in one security, or they might up the house call from 35% to 60% (in which case you might be screwed if they let you margin to 50% equity, then an internal auditor reviews your "concentrated portfolio" and decides to sell you out to 60%). Options let you circumvent this difficulty since you can only use cash.
3. The leverage factor (at least in the case of the Q, which is all I'm interested in right now :) is about 3:1 with LEAPs, compared to 2:1 w/margin (assuming you go 50% margin which I couldn't do anyway with my broker), which means you have a potential bigger bang for the buck (or bigger loss, of course!). On the one hand, you'll never get a margin call if the market tanks 30%, but your options could expire worthless, which would be very, very unpleasant.
4. Assuming you think 1-3 above make sense, what about LEAPs vs. other, shorter-term options? I have played other options on the Q and done well. As they are shorter term, the time premium is less, so naturally you can buy more contracts for the same money. The drawback is that you end up with a different argument than the original investment argument.
What do I mean by that? I thought it through for myself (in deciding to go to all LEAPs) and my conclusion was: a. The "original argument" is "Making a big bet on the Q", which I voted YES for based on many of the considerations articulated on this board and the Q board. b. That argument is a belief that the Q will rise substantially over SOME LENGTH OF TIME. c. The question is then: WHAT LENGTH OF TIME? This is of course difficult to nail down, but I would generally feel comfortable with the idea of some measure of appreciation over a period of a YEAR OR EIGHTEEN MONTHS. D. The mental trap that I fell into originally in being in many shorter term options was based on a consideration of A above but not B and C. In other words, I thought: "If the Q is going to go up, and I believe that, and I'm willing to bet all my marbles on that, well then, I should gobble up as many short-term options as possible!" Well, I did that and it worked, but now I think what I experienced is politely known as DUMB LUCK, since who knows what can happen in the short term (another Chinese Embassy bombing, NOrth Korea lobs a few more Nodong missles over Japan, Green$pan gets the jitters, etc.). Therefore, I decided short-term options were TOO CRAZY 4 ME. But LEAPs seemed like a good "middle ground", mixing a goodish amount of time buffer into an aggressive pot of Q stew. This choice seemed to me to be consistent with A through C above, and something I could sleep with at night.
I think the Q still has room to grow in price, and if there is enough appreciation over the next 18 months, I will probably just exercise my options and hold some margin. On the other hand, if some tremendous news comes out (like ATT switching to CDMA and total worldwide capitulation to the Q monster), then I'd probably sell my current holdings and buy more contracts with a high strike. Of course, things might not work out so well. I have a buddy that bought mucho DELL Jan 00 LEAPs in January, and he now has about an 80% paper loss. So I will keep a close watch on QCOM (and these boards :), and either head for the hills or switch to common if unforeseen "challenges" emerge. Please note that the foregoing is just my personal impressions and experience!
Best, Greg "not Geoffrey" Moore |
