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Joel, anyone who can operate a microkeratome can doubtless get the hang of options <g>. It's a bit confusing at first, but it starts to make sense after a while (especially when you've got money on the line!). I'm no authority, just one who has been learning at the expense of the market thanks to the Q. I think of it as "failing upward". Which is to say, mostly I've bought at the wrong time, sold at the wrong time, etc., etc., but Mr. Magoo's dumb luck and the power of the Q over these past four months have allowed things to turn out OK. As they say, don't confuse brains with a bull market (or a killer stock!). Anyway, the one to really pay attention here in the options discussion the past couple days is edamo, not me. I'm trying to learn more because I can't believe I will always be able to fall back on a stock that shoots up 40% just when you were getting depressed. The normal market (and the rest of the S&P500) is not like that. Therefore, I believe it's time to learn how to do LEAPS the "prudent" way. Along comes edamo and lays out the blueprint. Basically, the idea he is espousing (from what I can tell) is to look at LEAPS not as a speculative tool, but more as a stock replacement that affords you a certain measure of leverage over just regular stock purchases. So, for example, take the case of RMBS (the one that got the LEAPS discussion going). I remarked yesterday that the Jan 2002 100 calls were very expensive. They cost basically $50 when the stock was at 100. What does this mean? Well, let's say you have 10K to invest in RMBS. You could just buy 100 shares and Bob's your uncle. Or, you could try to be more speculative, wanting to own more than just your 10K alone would let you in common. So, you take that 10K and pick up two of those 2002 100 calls (a single call contract represents 100 shares, so even though the price says 50 in this instance, really the price is 50 x 100 (represented shares) = 5K; therefore, you can only buy 2 calls). By buying 2 calls, you have, in exchange for your 10K, purchased the right to buy 200 shares of RMBS at a price of 100, anytime between now and the third Fri. of Jan, 2002. Well, right now, if you used ("exercised") that option, you would have to pay 100 per share x 200 = 20K for the underlying shares (actually, that's the price you pay throughout the contract). Where does that leave you? You just paid 10K for the 2 calls, then you immediately exercised and had to pay 20K more, so you paid 30K for 200 shares that are only worth 20K. Sound idiotic? It is, and that's not what you'd do in the real world (just a "thought" exercise there :). Instead, you will hold onto those contracts, and hope like hell that RMBS rises like yeast, so that your contracts will be "in the money". For example, let's say RMBS goes to 200 by Jan 2002. Now, you still can buy those 200 shares for just 20K, but they're worth 200 (shares) x 200 (price per share) = 40K. The difference betweeen the 2002 price (40K) and the exercise price (20K) is 20K, which is what you net out. So, you invest 10K today, and 2.4 years from now, it's worth double that amount. Great! But you could have accomplished the same thing just by owning the common (i.e., buying 100 shares today), with a lot less volatility and risk. In fact, RMBS stock would need to more than double in the next couple years for you to come out ahead by owning calls instead of common. That seems like a bad risk to me. edamo, in one of his posts, suggests a different play: buy the Jan 2002 call striking at 50 instead of 100. This call is already "in the money", meaning you could right now exercise it to buy the $100 stock for only 50$. Well, that sounds like a better deal! What does it cost? Twice as much? No! Only $19 more (these are Monday's prices). You pay $69, or rather $6900, for the right to buy 100 shares of RMBS at $50 per share in Jan 2002. Subtract the difference between the current price (100) and the strike (50), means you've got $50 in the money (ITM), or rather "deep" in the money (DITM). Lop off that 50 bucks, and you're only paying 19 bucks for the privilege of being able to buy RMBS at 50 in Jan 2002--as opposed to a whopping 50 bucks of time premium when you buy the Jan 2002 100 calls which are currently at the money (ATM). Why would anyone buy ATM then? Well, you only have to shell out 5K for a contract instead of 6.9K. That means, if you had 70K to invest, you could buy 14 of the 100 strikes vs. just 10 of the 50 strikes. You could plot the two on a graph to see how high RMBS would have to get for the 100 strikes to be worth more than the 50's...I guess it's pretty high! Actually, the strategy I've employed with the Q is more akin to buying at the money, or even out of the money (OTM) LEAPS, but fortunately the Q has been kind enough to accommodate my teething phase. (Also, whereas the RMBS ATM LEAPS for 2002 cost 50% of the price of common, Q's LEAPS are more around 37.5%, which is what I was bickering about vis-a-vis RMBS calls originally). Going forward, I'll probably be more conservative :). For more info, I suggest reading edamo's posts here over the past day or two. Once you get used to the shorthands he's using, I think it'll start to make sense. Cheers, Greg |
