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Long LEAP Calls, why this YOLO strategy can actually make a lot of sense.
2) Options 101:
Whenever you buy a vanilla option, you buy both a call AND a put:
Stock = + Call - Put
By buying or selling stock with an option you can see that
+Call = Stock + Put
+Put = - stock + Call
A put is a call and a call is a put folks!
Whenever you buy a vanilla option, you buy both a call AND a put:
Stock = + Call - Put
By buying or selling stock with an option you can see that
+Call = Stock + Put
+Put = - stock + Call
A put is a call and a call is a put folks!
3) Options are priced using a derivative of the Black scholes Merton equation. It's not exactly BSM but the inputs are the same for most MMs (at least the one I worked for)
The inputs are:
Time to expiry
Volatility
PV (Divs)
Risk free rate
Moneyness of the option
The inputs are:
Time to expiry
Volatility
PV (Divs)
Risk free rate
Moneyness of the option
4) No cash flows, no earnings, no fundamentals go into pricing options.
The price of an option is determined by Maths and an implied distribution.
The longer the time frame, the lesser the accuracy of this assumption
The price of an option is determined by Maths and an implied distribution.
The longer the time frame, the lesser the accuracy of this assumption
5) So, back to YOLO leaps.
Options normally have a 100x multiplier meaning 1 contract is for 100 shares. Lots of Leverage!
So, if you're long term bullish stock the disadvantage of buying long term calls is you're also buying long term puts.
How do we mitigate this?
Options normally have a 100x multiplier meaning 1 contract is for 100 shares. Lots of Leverage!
So, if you're long term bullish stock the disadvantage of buying long term calls is you're also buying long term puts.
How do we mitigate this?
6) Buy deep ITM calls as the more ITM the call is, the more OTM the put is.
Let's use an example.
$LMT long dated calls
Current stock price : ~$350
Jan 23 300 (ITM) call : ~72
Jan 22 300 (ITM) call: ~63
Let's use an example.
$LMT long dated calls
Current stock price : ~$350
Jan 23 300 (ITM) call : ~72
Jan 22 300 (ITM) call: ~63
7) The breakeven for the Jan 23 call:
$300 +$72= $372
~7% uplift in 2 years needed to break even. But here's the kicker:
Say stock is $400 (+15%) in one years time.
You will own a one year option $100 ITM.
This option will be worth ~ $103. That's 40%+ ROI on a 15% uplift!
$300 +$72= $372
~7% uplift in 2 years needed to break even. But here's the kicker:
Say stock is $400 (+15%) in one years time.
You will own a one year option $100 ITM.
This option will be worth ~ $103. That's 40%+ ROI on a 15% uplift!
8) If stock is flat, you lose the difference between a 2 year option and a 1 year option.
In this case $9 or 12%. Not good but it won't kill you.
In this case $9 or 12%. Not good but it won't kill you.
9) So why buy ITM calls? The more ITM an option is, the higher the price of the option and thus the lower the leverage. 100x is an awful lot of leverage.
The key takeaway is that by varying the strike, you can vary the amount of leverage you are using.
The key takeaway is that by varying the strike, you can vary the amount of leverage you are using.
10) Long dated ATM or OTM options typically have a very high break-even price. You're buying a negative EV (because of skew) lottery ticket. People still win the lottery, but not very often.
11) As always, your equity is at risk, but ITM LEAPs give you access to huge, v cheap leverage w/o the fear of getting margin called in a crash.
I would not advocate having a portfolio of 100% LEAPs, but as a 5-10% weight in a very high conviction name, that makes sense to me.
I would not advocate having a portfolio of 100% LEAPs, but as a 5-10% weight in a very high conviction name, that makes sense to me.
