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Technology Stocks : Dell Technologies Inc. -- Ignore unavailable to you. Want to Upgrade?

To: BGR who wrote (83193)	12/3/1998 8:17:00 AM
From: Geoff Nunn	Read Replies (2) \| Respond to of 176387

re: buying stock on margin v. buying call options Apratim, you raise an interesting point. Assuming call options are fairly priced as in B-S, there can be only one reason for speculators to buy them - leverage. So, would speculators not be better off to forget about options and buy stocks on margin instead? Several points: 1. When stocks are purchased on margin, the margin requirement set by the FRB applies. If the legal minimum is 50% - the current rate, then the maximum leverage an investor can obtain is 2/1. Many speculators obviously seek greater leverage than that. During the days before the FRB set the margin requirement much greater leverage was possible. If speculators in the 1920s bought stocks on .05 margin, as historians have reported, then the leverage ratio would have been 20/1. Back then the stock market was able to provide a better substitute for options than it can today. 2. Even if you could legally purchase stocks on low margin, I think it's doubtful your lender would charge you the riskless rate of interest. :-) Presumably, low margin implies greater risk for lenders, so the rate would be adjusted accordingly. Therefore, I guess I'm skeptical of the argument that buying stock on margin would reduce interest costs. 3. The greatest advantage in buying margined stock rather than call options is reduced transactions costs. For most stocks today transactions costs are extremely low. In contrast, the costs in options are among the highest known to man. Take Dell, for example. If you trade the stock you pay a small fixed fee (Schwab charges $29.95) plus one half the spread (assuming you sell at the bid and buy at the asked). The spread on Dell usually seems to be 1/8 point, or .002%. In contrast, the spread on Dell options can run to 6-10% or more. In addition, Schwab will tack on another .003%. This means your total cost on the purchase of Dell options would be a whopping 3.3-5.3%. The seller would pay a similar figure. If you look at the total brokerage cost to buyer and seller of trading options, it is 6.6-10.6%. Even residential real estate transactions don't cost that much!!! If an investor is willing to accept the reduced leverage from margin buying, the benefit is substantially lower transactions costs. So I agree with you that the stock market provides a less costly alternative to options, but only for investors who would find the 2/1 leverage ceiling acceptable. Geoff