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an interesting upside to high beta stocks



May 16, 2009 – Comments (6)

my largest holdings include

ASH, TCK, RCL, DOW, GE, USG, XL, WFC, AA and ACAS.  Each of these, particularily the smaller caps among them, are wildly volatile.  Owning this portfolio, bought not all tha tfar from the bottom except for DOW, is an incredible, gut-wrenching, thrilling, horrifying ride.  But that volatility comes with some advantages. 

Option prices are high.  Very high.  And that can be an advantage in one way:  selling far-into-the-future calls can raise relatively large amounts of cash. 

ASH is 24 bucks.  a $40 jan 2011 call brings $4.10.  So thats about 17% of the current value of your holdings and the worst case outcome for you in selling it is that you are forced to sell at 67% above todays price.  You could take that 17% and buy 17% more shares of ash, then sell the call on those and so on.  You would wind up, in essence, with 20% more shares than you could otherwise afford in exchange for agreeing to limit yourself to an additional 67% return.  So, the return if you had to sell for $40 wouldn't be a 67% return (imagine you had 1000 shares worth $24k, you'd make 16k) it would be $19,200 or an 80% return. 

Additionally, say ASH goes to $50 by jan 2011.  If you hadn't sold the calls you'd make $26,000...  but you can always buy the calls back (in this case for $10) and sell the shares for $50.  Now you take a $6 loss on the calls, which gives you (assuming you are in the highest tax bracket) a $2.40 tax benefit.  So it would be BETTER to buy the calls back at a loss and sell the stock if the calls wind up in the money.

Moving beyond my all time favorite stock - ASH - and my biggest regret probably ever in my investing life which is not basically going all in on ASH at 5 bucks, as it was THE cheapest very low risk stock on the market i'll probably ever see - lets look at some of the others.

RCL - no options reported higher than 20, but $20 (a 50% upside from todays prices) pays $3.50 or about 25%.

TCK - options only go out to jan 2010, so the premiums are lower because less time exists between now and then, but you can raise 10% for the $20 call, a 67% premium over today.

GE - you can raise 8% for $20, a 60% premium over todays prices, you can raise 12% for a 50% premium over todays prices

DOW - you can raise almost 15% of current share price for $25 calls (55% above todays prices) or 8% for about twice todays price at $30

ACAS - the worlds wildest card stock, formerly the possibly cheapest stock on the market (but its pretty fairly priced now for its risk/reward ratio), pays you almost 10% of todays price for agreeing to settle for a triple by Jan 2010.  So if you can live with just tripling your money ($10 strike price) you can score a 10% premium up front.  You can raise 15% in just 7 months for $7.50 (well over double todays prices).

XL - you can raise almost 20% of the current price for the $17.40 strike for jan 2011.  Thats roughly double your money.

And so on.  Basically it would be possible for me to raise 10-15% extra funds in exhange for basically agreeing to limit myself to an additional 75% upside by jan 2011.  That extra cash could come in handy if this downturn gets big. 

And remember, thats the values of these options today, they were possibly higher last week before the fairly significant drop in the market this week.

6 Comments – Post Your Own

#1) On May 16, 2009 at 12:30 AM, portefeuille (98.85) wrote:

But that volatility comes with some advantages.  Option prices are high.  Very high.

Volatility is not that high anymore (see for example the volatility index here). If you sell options now (and thus "go short" volatility) that is not so good.

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#2) On May 16, 2009 at 12:51 AM, checklist34 (98.78) wrote:

Porte, I know the VIX is down, but options prices tend to not be based on the volatility of the market as a whole, but on the volatility of individual names. 

For example, WMT jan 2011 options at 67% above todays prices are about 2% of share price.  XL's at 67% above todays price are about 22% of share price, a huge discrepancy.

Its not the VIX that determines options premiums for various stocks, its their beta.  WMT has a beta of 0.23, XL has a beta of 3.16.


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#3) On May 16, 2009 at 1:48 AM, portefeuille (98.85) wrote:

I know the VIX is down, but options prices tend to not be based on the volatility of the market as a whole, but on the volatility of individual names.

I somehow knew you would mention that. That is why I added "for example" in "(see for example the volatility index here)".

I am well aware of the insufficiencies of the VIX. I still believe that the implied volatility for individual stock options (including those on high beta stocks) has somewhat decreased lately and that saying "Option prices are high.  Very high." might thus be a little too strong. I will check that.

Here is some stuff on the vix (for those not that familiar with it):



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#4) On May 16, 2009 at 2:31 AM, checklist34 (98.78) wrote:

porte, thats good insight.  I have been wondering if I should sell some really long term calls to raise cash now while the selling is still good, to plow that cash into the market ...  assuming this dip continues it might bring some good buying opportunities.

good luck

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#5) On May 16, 2009 at 4:03 AM, portefeuille (98.85) wrote:

All I am trying to do with options is to catch some badly priced ones (this fat tails thing, also emphasized by Nassim Taleb).

If I am not mistaken you invest quite a bit of money and do not "believe in diversification" that much. So you have probably more "at stake" than I do.

If you are "up" by a considerable amount you might want to read this about Jesse Livermore ...

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#6) On May 16, 2009 at 5:57 PM, checklist34 (98.78) wrote:

hey porte, I have been almost hyper-diversified among stocks, but more or less concentrated in stocks/cash all year.  I was basically all in to US Equitites by March 6, so I didn't really buy anything on march 9.  I raised cash on the way up.

I am occasionally called insane for going all in on stocks, in fact more or less always called insane, but plain and simple stocks with the S&P at 700 were the only safe investment around.  A bank CD was paying what?  2%?  Gov't bonds paying less than 3 (and you're taxed on those).  Muni bonds weren't a bad investment, 5% tax free, but they aren't without risk... if the economy recovers and interest rates rise and inflation sets in you may well see the principle value of those bonds drop significantly.  Cash in an inflationary environment isn't king.

I don't intend to stay in the stock market for long.  I view this as a periodic things.  When the market crashes, average in.  When it recovers, average out.

Make some interest in bonds in between, because they tend to appreciate a bit as equities collapse. 

Thats my tentative strategy.  I think I have no interest in staying in a bull market for long.  They always tend to end with a crash. 

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