General Category > Strategies

BAC leverage

**CleverLongboat**:

First of all, apologies for bringing up a buried topic again. I've been spending the past two days going through all the threads and subthreads where this strategy has been discussed, as well as staring down the various spreadsheets posted. It was extremely educating. Nevertheless, as the debate raged on for a couple of years, and people's viewpoints seem to have changed over time, I had trouble following some details of the discussions. Is there any possibility maybe, that someone who has followed this debate from the beginning to the end, and feels he/she understands it could provide a summary of what exactly Eric did at what point in time to gain BAC leverage (i.e. leaps, commons, warrants, in which ratio, at what point in time, why)

Another side-question I had was about the cost of leverage. What is the exact definition / formula for this? At some points I found that I had understood the concept, but couldn't calculate it. Again, sorry for bringing this all up again, I realize from reading the logs that a lot of people were very emotionally invested in this, but I think a sort of 'grand summary' would benefit everyone.

**Sunrider**:

Subtract the option premium from current stock price, then divided strike price by the amount this yields. Annualise the resulting return. That's the cost of leverage as Eirc calls it.

**TwoCitiesCapital**:

--- Quote from: Sunrider on November 22, 2015, 12:46:03 PM ---Subtract the option premium from current stock price, then divided strike price by the amount this yields. Annualise the resulting return. That's the cost of leverage as Eirc calls it.

--- End quote ---

Also, important distinction to note, this is only the case you're buying an at-the-money option. You would need to make adjustments for in-the-money and out-of-the money options which can further complicate it.

For in the money options, you would use the time value of the option instead of the whole premium in the calculation, but this ignores the opportunity cost of the money that is tied up in the "fundamental value" portion of the option premium so you would need to bump up your total cost by some weighted amount of a given, fixed return expectation for your capital to adjust for this. Obviously, this is a "softer" calculation and will be different for every individual who does the calculation on the same option. It's probably best to think of the result as a rough-average cost as opposed to a number with decimal point precision.

Out of the money options require to consider the price appreciation required to get you to the option strike as a "cost" too, even though this isn't money you're paying. It's upside you're foregoing in the name of getting a cheaper option so it still has to be calculated into the cost, but it's also not sucking up your capital that requires the fixed return expectation from above. Again, hard to make exact adjustments for all of these inputs, but if you think of the result as a rough average, or as a range, it probably gets you close enough to compare general forms of leveraged exposure to determine which one comes cheapest.

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