Author Topic: Options vs. Stock  (Read 9528 times)

arbitragr

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Re: Options vs. Stock
« Reply #20 on: July 28, 2009, 04:59:22 PM »
Hi Arbitragr,

You can use options either for leverage or to manage risk.

To use options for leverage, you need to get both the direction of the move and the timing right. Get both right and you make a great % return; get it wrong and you lose a high %. I am not competent enough to time markets so I avoid using options this way.

My thoughts exactly. The timing part is hard, that's why I'm less inclined to make big bets with LEAPS.
I do hedge however, I use predominantly futures to hedge but.

And even if you do have a long-dated contract, there will in most cases be some liquidity problems down the track, which means if you sell you might sell at a discount to your expected price, or else wait for liquidity to come into the markets ... which means more time decay.


"worry top down, invest bottom up ..."


arbitragr

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Re: Options vs. Stock
« Reply #21 on: July 28, 2009, 05:03:00 PM »

We use options exclusively for hedging purposes,
& almost always as the option writer.

As a put writer we generally prefer shorter term options at the money, & write with a view to acquiring the underlying. Greeks are important to us, & the premium is the consolation prize if we fail.


I like this strategy in the current environment. Have been investigating ways to enter an options trade and this is one of them.
"worry top down, invest bottom up ..."

Cardboard

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Re: Options vs. Stock
« Reply #22 on: July 29, 2009, 12:36:30 PM »
IMO, the expiration risk perceived here is way over-rated with the following.

If you own long term, in or at the money calls and the underlying has stayed flat or went down and your thesis is still valid then all you have to do is to reload with new calls at expiration. It is like selling and buying back the stock right away. What is the economic loss other than paying the premium again? At least with the option, you will be allowed to book your loss for tax purposes while with the stock (if it is down) you will have to wait 30 days before buying it back. It could go up in the meantime.

It is also wrong to believe that because you have bought a stock and 18 months after it is still flat that you are even. You lost money. There is a cost to dormant capital. There is also a high likelihood that your thesis is wrong. Liquid options are typically available only for decent size companies. This means that these stocks are followed by analysts and others and if they still don't see what you are seeing after 12 to 18 months, then there is a chance that they will never see what you are seeing. That is why I like them for large caps and using them won't force you to go on margin or to displace small caps with more punch in your portfolio if you are fully invested.

With options, you know your cost going in: it is the premium paid and the loss of dividends. When you buy the common outright, your cost could end up being 50% or more of invested capital if your thesis turns totally wrong. With margin this has pretty nasty implications. The debt has not gone away and it could result in forced selling if your other positions are also down. People also often ignore the risk of rising interest rate.

However like anything else, you have to understand what you hold. If you were thinking to put 10% of your capital into a stock and then you decide instead to put 10% of your capital into at the money calls of the same stock, you don't hold the same kind of weapon. You have to control your greed with options.

Out of the money calls and a short duration options are also totally different animals.

Cardboard
« Last Edit: July 29, 2009, 12:41:05 PM by Cardboard »

arbitragr

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Re: Options vs. Stock
« Reply #23 on: July 29, 2009, 05:38:40 PM »
IMO, the expiration risk perceived here is way over-rated with the following.

If you own long term, in or at the money calls and the underlying has stayed flat or went down and your thesis is still valid then all you have to do is to reload with new calls at expiration. It is like selling and buying back the stock right away. What is the economic loss other than paying the premium again? At least with the option, you will be allowed to book your loss for tax purposes while with the stock (if it is down) you will have to wait 30 days before buying it back. It could go up in the meantime.

With options, you know your cost going in: it is the premium paid and the loss of dividends.
Cardboard

However the thing with the premium, is that in most cases it is often quite large if you're trying to replicate stock-like returns.

Let's take an example;

Strike price = $25
Leap/call price = $4
Qty purchase = 100

So premium cost = 4 x 100 x 100 = $40,000
If the stock stays flat, and you exercise at $25 near the end of the contract, you lose 40K, assuming the leap expires worthless. In most cases the option price will decay in value due to time, so it might be about $2-$3 by the time you roll it over (or before the expiration date), so that's probably a loss of 10-K-20K.

Of course you could gain alot too, but your exercise price has to be above $29 first. So the stock in this case, must increase in value by at least 16% first, or else you'll make a loss.

I remember going through this argument/exercise last time on the old Berkshire board, with regards to FFH.
And same thing came up: if you held stock (not the option) for $40K and it stayed flat forever, your only cost is broker commission. If the stock price went up to $29 you'd make 16% i.e. 6.4K, on the option you would only break even.

Correct me if I'm wrong here, please. (sorry I'm at work, so I'm in a rush, and haven't thought it through totally and trying to watch over my shoulder if my boss is seeing me type this  ;D)



« Last Edit: July 29, 2009, 05:40:59 PM by arbitragr »
"worry top down, invest bottom up ..."

Cardboard

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Re: Options vs. Stock
« Reply #24 on: July 29, 2009, 06:27:36 PM »
"I remember going through this argument/exercise last time on the old Berkshire board, with regards to FFH.
And same thing came up: if you held stock (not the option) for $40K and it stayed flat forever, your only cost is broker commission. If the stock price went up to $29 you'd make 16% i.e. 6.4K, on the option you would only break even."

This goes to the heart of what I briefly mentioned in my previous post. Investors are complacent with stocks. If they stay flat, they don't care too much.

I prefer to see things with a greater sense of urgency. I like Dengyu's term of being "at war". I don't want to take this too far and to expect all my stocks to go up every day, but I would say that if a stock has not moved in my direction within 2 years that there is likely a problem. Some small caps are so unknown that 2 years may not be enough, but a $5 billion or more company? No way!

I can't recall too many cases where I made good returns and it did not happen quite quickly. If it is undervalued (50% or more) and attractive others will notice quite quickly enough.

It may be another benefit of options with their built-in cost and expiration: they force you to really do your homework on the underlying before entering the trade.

Cardboard

ERICOPOLY

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Re: Options vs. Stock
« Reply #25 on: July 29, 2009, 06:42:43 PM »
Of course you could gain alot too, but your exercise price has to be above $29 first. So the stock in this case, must increase in value by at least 16% first, or else you'll make a loss.

I remember going through this argument/exercise last time on the old Berkshire board, with regards to FFH.
And same thing came up: if you held stock (not the option) for $40K and it stayed flat forever, your only cost is broker commission. If the stock price went up to $29 you'd make 16% i.e. 6.4K, on the option you would only break even.

Correct me if I'm wrong here, please. (sorry I'm at work, so I'm in a rush, and haven't thought it through totally and trying to watch over my shoulder if my boss is seeing me type this  ;D)

Yes, but it depends on when it moves up to the "break even" point.  Let's say that I paid $50 for the Jan 2011 $250 strike FFH call 3 weeks ago, and yes, if the stock is only at $300 in 2011 at expiration then the option holder makes no money.

However, yesterday the option holder could have written the 2011 $300 strike call for $50.  In that situation, the gain is 100% in 2011 if the stock is still at $300.  No tax is paid until 2011, and you have a return of capital of $50 which can be reinvested today to boost that return beyond 100%.

Anyways, that's if you are concerned about taxation.  I have to keep a lid on my gains this year because I'm doing another Roth IRA conversion.  So I have a different perspective.


QLEAP

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Re: Options vs. Stock
« Reply #26 on: August 01, 2009, 04:32:44 AM »
Sharp,

"There is a place for options (ie: hedging your employment with puts on a competitor of the company that you work for) but it should be a fairly rare event".

I wish I had come across this post a year ago :( Better late than never I guess.

thanks for the informative post,
Qleap

scorpioncapital

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Re: Options vs. Stock
« Reply #27 on: August 01, 2009, 09:24:54 AM »
Hi all,

I know some of you like to allocate capital via options. I just wanted to get the scoop on the pros and cons of each.
I'm thinking about taking an options position. In the past I've never had the courage to, because the capital that I put up is quite large and would only want to make absolute sure things will work out, and also that options relates to three things: time, volatility, and price. I might get the last one right, but I don't know anything about the former two variables.
I've tried options in the past but haven't been successful b/c as time wears on, the option value would diminish (this is for a LEAP position).

Options is just like buying stock with leverage, only a bit cheaper ... is it not?

Please enlighten me.

Why only stocks and options? What about SSF's, single stock futures? In my view, that product is superior to options and ma even be a better way to establish a long position in an equity than buyign the equity on any given date.

rranjan

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Re: Options vs. Stock
« Reply #28 on: August 01, 2009, 02:53:28 PM »
SSF provides the option to build position cheaply but its available for only couple of quarters but again you can roll over to continue having same exposure level. Interesting way to build position but I havn't used it.

arbitragr

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Re: Options vs. Stock
« Reply #29 on: August 05, 2009, 04:35:18 AM »

We use options exclusively for hedging purposes,
& almost always as the option writer.

As a put writer we generally prefer shorter term options at the money, & write with a view to acquiring the underlying. Greeks are important to us, & the premium is the consolation prize if we fail.

We will occassionally sell a position & hold the T-Bill +long call equivalent. Allmost always around binary events where there is an upward bias, but the outcome could go either way. The premium is insurance.

We find the biggest advantage of being long the underlying is the flexibility. Certainty, today, every time we do a buy/sell. More secure lending vs premium income. Borrow capacity every time we need it. No forest of potentially adverse forward obligations.

We also snore very soundly every night  ;D

SD

Okay, so continuing on ... let's say if we wrote a put and the market price is above the strike and the written put enters profitability ... what happens when
1. you exercise early and take the profit and
2. leave it to expire whilst the mkt value of stock is above strike/exercise price?

I assume for situation 2 that you earn the premium originally written. But I'd like to know the mechanics of it ... does the put buyer exercise/sell it back or something?

Thanks.
"worry top down, invest bottom up ..."