ERICOPOLY

Isnt that obvious? Like what happened in Volkswagen. A margin call could turn a 5% exposure shorting Volkswagen into a 100% loss on the whole account. Personally I never use leverage/margin so its simple for me. I also don't think the person who started the thread was thinking about weighting using leverage. Damn right it's obvious that portfolio weightings need to be expressed while taking notional leverage into account. You either have notional leverage, or you don't. The Mohnish system is for unleveraged -- add some leverage through derivatives, and it changes things.

You could have 10 positions (BAC calls, GM calls, KO calls)... etc... where each is at-the-money calls. You actually have a 100% loss potential from the passage of time alone (until expiry). So you need some sort of framework to think about option position sizes if you hold options. I don't think you can use the same rules as you use with common stock. My framework is to think about how much net time decay exposure I have (netting out premiums on options I've purchased against premiums on options I've written). Then I further think about (if I'm dealing with in-the-money calls) how much leverage I have to the downside price movement in the underlying stock. Suppose I have 2x leverage in deep-in-the-money calls -- I think of that more in terms of a 20% position sizing rather than a 10% position sizing. Otherwise, I'd fool myself into believing the position is smaller than it really is (you quickly realize the mistake if the stock drops and your losses look and feel like they are twice as deep compared to the unleveraged common). Now, if you want to grin a bit from the irony of it all, somebody else on this thread urgently wants you to think about it as only 10% exposure (so that you don't suffer unknown/unexpected risk from a complexity-induced bias! LOL, his approach leads to a "simplicity-induced" cognitive bias for the reason mentioned in the second sentence of this paragraph ;)). You don't blindly take rules designed for uncomplicated things (unleveraged strategies) and apply them to complicated things (leveraged strategies).

I don't get why weightings is complicated. Out of 100% of your portfolio how much are you allocating for each security? What has weighting of security in a portfolio got to do with capital at risk? From your example. I can have 10% in SHLD and 10% in BAC and that's my weighting. You can have 10% in SHLD/BAC + Puts at 26% or 10% of strike so your weighting is 12.6% for SHLD and 11% for BAC. My risk for both is I can lose 100% and your risk is you lose 26% and 11% so what. The question asked by the person who started this thread was "How you weight your holdings" ? 1. Equal weight like Mohnish Pabrai 2. Weight by relative Value or upside like Bruce Berkowitz 3. Weight by sector The first option is "equal weight like Mohnish Pabrai". I think you'll find that he doesn't purchase short-term call options in his funds (including LEAPS, although he was able to purchase GM warrants in one of his funds). He has this 10% weighting in order to be able to limit single issue risk. So you are cheating the system if you hike up the single-issue risk by purchasing calls. You still have 10% max exposure, but a much higher amount of risk on that 10%. It's not really the same thing at all as what Mohnish is practicing. You may think you are playing within his framework of rules on position sizing, but not really. You need to go back and think about why position sizing exists in the first place. It could be a system of risk management (for the downside). Right? So doesn't the position sizing change when you use derivatives to hike the risk through the roof? This is why I'm encouraging you to think of position sizing in terms of upside/downside exposure. Look through the derivative and see what it represents on the underlying side. I'm talking about unleveraged downside, so that it's apples-to-apples comparison with the type of unleveraged downside that Mohnish it talking about. You have to ignore another person on this thread who is pleading with you to treat a derivative like it were common stock when you choose position size. You can't just refuse to think about the look-through leverage (and the premiums/costs you pay for it) under the banner of avoiding complexity. The complexity is already there unless you have a rule not to own derivatives -- once the derivative is owned, you don't reduce it's complexity through refusing to think about it. It takes a bias to believe that ignoring something makes it go away -- a false sense of absence of complexity (out of mind, out of reality?). So let's say you have at-the-money position size of 10% in call options. You can lose the entire 10% from time-decay alone! Now, are there other places in the portfolio where you'll have an offsetting profit from time-decay? That's what I'm doing -- I'm netting out my future time-decay risk (I purchased premiums, and I sold premiums), and then asking myself on a net basis, how much time decay exposure do I have?

I don`t think that a bank would be allowed to do what Eric is doing. When you look at the risk profile Eric has just a big LEAP call position in BAC and is long in JPM,C and SHLD. If this risk profile is further levered up or not does he only know himself, but from what i read its further levered up. So when a 100% stock portfolio will suffer a 50% drawdown he is on the edge of losing everything. I don`t think that is something worth copying, especially with this combination of securities. Let argentina blow up and he is probably in trouble. But as always thats my understanding of his situation, i can be wrong. :) The BAC puts are $15 strike. As the stock drops below that point, the portfolio is no longer leveraged to the downside. I no longer feel any additional pain from BAC dropping at that point -- instead, the only further pain I can experience is from the amount of notional exposure I write on the other names. It works like this... First, I figure out how much I have left when BAC drops to $15. Second, I restrict the notional amounts of C/JPM/SHLD puts that I write to that "$15 is worst case" BAC scenario. There is no chance of total wipeout from the leverage itself. A "magnified drop", let's call it. So let's say I have 2x leveraged BAC common position (notional value is 2x the value of the portfolio). Okay, so at $15 I've lost approximately 20% of account value instead of 10%. All I can say to that is "big fucking deal". I can live with a 10% permanent loss.

I'll decide what path to follow when we get there. I expect to get around a 3% dividend yield, which will take out a nice chunk of the margin costs. Then there is the potential to write covered calls. Initially the boost from higher short term rates will positively impact the bank earnings, and with it I expect the stock price. That will have an (at least partially) offsetting positive impact on the cost of rolling puts.

I agree. It just is what it is. Perhaps there is a cognitive bias but it's not coming from me? Richard said a few things above that cast a "very bad thing" characterization about "introducing complexity". Compare that to when Rabbitisrich dispassionately describes it in the terms of the actual economic position of the portfolio.

Nobody said or implied that you don't understand any part of this. That said, you've made my point and my goal isn't to convince you of anything -- I've read almost every post on this board for 12 years and I think nobody's done that before. You've read my posts, but you haven't understood what I am saying. Every time you argue "against" me, you are setting up straw men that you knock down. Then you arrogantly claim that you have defeated me and that I have not offered you a rebuttal. The problem is, of course, that you are not arguing with me, but rather with your straw man. Another quality misrepresentation Richard! I am used to this from you by now. The truth is that, I present it very humbly, the complete opposite of any sort of "breakthrough". I claim it to be nothing special at all, nor do I claim it to be "good" in any moral sense, just using derivatives for what they were originally designed for, the swapping of risk. In my own words, where I explicitly downplay it as any sort of "breakthrough": Nice! I "misunderstand" what I am doing when I use derivatives for swapping risk! Of course, that's just another of your assertions, claiming that out in the field my use of derivatives is causing me to suffer cognitive biases and therefore I misunderstand what I am doing. You have absolutely no clue if that's true! None! Just another of your assertions you pull out of thin air and then attribute to me. Yet you arrogantly present it to be the case, with no cause to say so. That's good timing in fact because you just said the following: There you go. When somebody misrepresents me, I'm being "refuted". I am the one who can clearly see when the things you say do not match up with the things I understand and believe. However, you don't expect me to realize that! How arrogant is all I can say.

I believe if I talked about the great, inexpensive campout I had with the kids, roasting marshmallows over an open fire, you guys would first state that I don't understand the risks of a campfire, and from there expound on the cognitive bias I am suffering from. Of course, the fact that I mentioned "FIRE" in the story would be overlooked and soon you would be warning me that campfires are hot, that they contain a fire, that a fire can spread, that my bias is causing me to overlook this danger, etc.. etc.. etc.. etc.. I'm then sitting here wondering... do these guys really believe I am totally unaware of this? When did I tell them that I thought fires could not spread, that they were not hot, etc.. etc... After all, I roasted something in the fire.

Yep, but let me ask you something. Where in the hell are you getting the notion that I don't understand any part of that? The BAC idea "standalone" is the same as one where you hold the BAC common, then write a BAC call, then buy the BAC call back. The legs are there, implicitly. You have that cash from writing the covered call, and from there you can choose what upside you want to hold. Perhaps you choose to hold the BAC upside -- fair enough. It doesn't add any new "legs" if you choose to invest it in the calls of a different company instead. There were already legs, you've just swapped them for different legs. There is still risk, you've merely traded your risk for some other trader's risk. This is why I call it "swapping risk back and forth". This is merely a method of diversifying the risk of a concentrated position. You can initiate a 10% position in the common of 10 different companies. You are familiar with that of course as a tactic of reducing single-issue risk -- it's called diversification of course (your downside in any single issue is only 10%). So I can utilize this time-tested approach of diversifying the downside -- meanwhile selling the upside (covered calls) in all those names and using the proceeds to purchase the upside just on one name. So I can achieve 100% concentration without ANY downside concentration. It's diversified across all the names I swapped risk with. There is no concentration on the downside. So given that this is a topic about position sizing, I am claiming that you don't have to worry about your position sizing on the upside -- you just have to find enough diversification on the downside. You can start first by: 1) building the diversified portfolio of common 2) writing covered calls on each 3) using the proceeds to purchase a concentrated position in your top pick Or do it the tax-preferred way that I mentioned -- buying the concentrated position in the common, and then writing puts on other names to pay for the puts on the concentrated name. Well, excuse me if I say... and no personal offense to you... "no SHIT Sherlock!". That's just a colorful phrase that I find humorous and I don't mean any disrespect. Didn't I make myself clear enough when I said I'm taking the upside of BAC and the downside of others (C, JPM, SHLD)? Or perhaps it wasn't clear when I talked about the COST of non-recourse leverage? Or that I'm deducting an expense (the depreciating puts). And the margin interest?

Continuing to misrepresent what I am saying does not make it true. You did the same thing the last time you argued with me. You are effectively arguing something that implies a common stock holder is getting a "free option". This however is not what I am arguing. So if the assertion is wrong, then I'm not the one who is wrong (because it's not my assertion). You are just claiming it to be mine -- you are just pulling the assertion out of thin air. Example: A person with two accounts buys straight BAC common in one account (the first of two accounts). He then writes a covered call in the first account where he holds the BAC common. Then he takes the proceeds from writing the covered call and moves this cash to the second account. In that second account, he has the choice of investing that cash in absolutely anything. He can buy SHLD calls, JPM calls... anything. But he instead purchases BAC calls. Does this imply that he is getting a free option on BAC? Is this what you call "Zero Sum" bias, because the decay from one will offset the decay from the other? So do all common stock holders (who don't trade options) then implicitly suffer from what you call "Zero Sum" bias? Logically, his position is no different from just being in the straight common at this point. So does this mean that anyone with straight vanilla common is getting a "free option"? After all, you preached about decoupling. Once you start down that decoupling path, the cash in the second account has been decoupled from the first account. So your argument is such that the upside in BAC is claimed to be "free". This is a false assertion because anyone can clearly see that it's not "free" at all. You are just barking up the wrong tree.

See, if you count only net downside exposure, then in December 2011 I had a 0% position in BAC. And if you count only net upside exposure, then my exposure was 100%. 0% notional downside, and 100% notional upside. What do you call that? What is the position weighting? Now, if you count the options premium as the actual position size, then it becomes misleading. A 10% position for one person (if entirely in options) could be another investors 50% position (in the common). Then the two people aren't communicating with each other on equal ground if one guy says he's in a 50% position and the other guy says he won't ever put more than 10% into it. They just aren't speaking the same language. So, basically, I think notional value (upside and downside) is an essential thing to mention when talking about weighting of holdings.

I guess it's harder to grasp than it looks to me. So I'll make it really short: You can have more upside notional exposure than downside exposure, without any net frictional decay from options premium. You can have upside-only positioning in some names (like BAC), which is paid for by taking downside-only positioning in other names (like SHLD). Just swapping risk back and forth. That's it! Nothing fancy, nothing insightful, it just is what it is. Yet how do you phrase your "weighting" of holdings? Are you talking only about net downside exposure from a given name, or are you counting upside exposure? That's all.

In general, this is a bad way to think about options, since it obfuscates the situation and thereby encourages cognitive biases. Typically, decomposing the position is much more useful than mentally co-joining positions. If selling a put on SHLD seems like a good idea, it should be a good idea regardless of whether BAC options exist. If buying puts on BAC seems like a good idea, it should be a good idea regardless of SHLD. If one of these two legs doesn't seem like a good idea on its own, then the aggregate position could be improved by removing the leg that doesn't seem like a good idea on its own. Obfuscating the individual trades is a bad idea because it can make you think, for instance, "that option was free because I got the purchase price from selling SHLD options". The option wasn't free, because you're still spending cash that you could have kept as cash. Decomposing the position lets you better determine whether each leg is good, without the unnecessary additional complexity of the combined position. (Unless, for instance, you believe that the two positions should be relatively correlated, like BAC and JPM. But I'm assuming that you're using SHLD and BAC for examples because you believe that they're relatively uncorrelated.) I don't see how we get from my post to the things you write in yours. You went off topic -- I never talked about a free option, nor did I hint at one (in fact I explicitly explained taking the option premium from SHLD puts to pay for BAC puts). However, you did, and then you offered the helpful suggestion of decomposition, which would be a nice tip if we were talking about free options, which we are not (you might be talking about that, but not me). See, you can have a rule that you'll never go over 10% for a position size. So you might be envisioning a portfolio of 10 equally weighted stocks. Naturally, this is in part to prevent a blowup from single-company risk. Yet you can "cheat" your way into much larger positions by doing what I said -- taking a 36% position in BAC common and hedging it down to a 10% maximum downside using puts (and spending one of your 10% positions on writing SHLD puts). Therefore, you can have a portfolio with much larger than 10% positions in names you have conviction on, without taking the accompanying single-company risk. And your portfolio may wind up with larger than 100% notional upside exposure without suffering any drag from net put options decay. Anyone can just buy a bunch of calls, but there is net decay. So if the stocks go nowhere, you can suffer permanent capital loss. This is not the case in what I describe above because the puts you write merely net out against the puts you purchase.

So you can be levered 2.6x on the upside, while having no leverage on the downside. Or you can be invested on the downside only 38.46%, while being invested on the upside at 100%. So this is why I'm saying it makes no sense to say "I'm 50% invested, or I'm 30% invested, or I'm 100% invested" without giving a lot more information to what you are doing and what companies you are invested in. After all, being 38.46% invested in high volatility companies like SHLD is exactly the same very similar to being 100% invested in companies with the implied volatility of BAC. You can swap the risk back and forth until they are logically equivalent position sizes. So implied volatility quantifies a price for risk -- then you can use that quantity of risk to "raise cash" if you use it to purchase puts on stocks that have lower implied volatility. Then you are effectively in cash (partially) while perhaps not being at all in cash.

You can write the at-the-money SHLD put and use the premium/proceeds to purchase the at-the-money BAC put (thus hedging your BAC common). You now have 10% downside risk in SHLD, 0% downside risk in BAC, and 26% upside concentration in BAC. That's what I meant. So if you can accept a 10% downside in BAC, and a 10% downside in SHLD, then you can go 36% into the BAC common and only have a 10% downside in BAC (plus a 10% downside in SHLD). You are really only 20% exposed to the downside (10% BAC + 10% SHLD = 20%), but you have 36% allocated to BAC. So do you call this 10% position weighting in BAC, or 36%? Are you 80% in "cash", or 64%? So quite literally, volatility and risk (even tail risk) are in the real world market closely connected. There is quite literally a market for volatility, and you can use that market to swap risk, so you can't say volatility and risk are strictly disconnected. Only if you refuse to use the tools readily available is that true.

It would be interesting to divert your shower water into a tank to be reused in the toilet bowl. We are literally flushing our drinking water down the toilet.

I think weightings is more complicated than it looks on the surface. You could have a 10% weighting in Sears, or a 26% weighting in BAC. For the same amount of capital at risk. Reason? The at-the-money $35 strike SHLD put trades at 26% of strike, and the $17 strike at-the-money BAC put trades at roughly 10% of strike. I think without looking at the options, it can be a bit misleading to announce what your limitations are for weightings. It is much more nuanced than it looks. Saying you have a 10% weighting limitation doesn't take into account reality. It doesn't really make sense. I don't understand fund managers who claim they have this limit of 5% to holdings, or 10% to holdings. You can see that 10% in one holding equates to 26% in another. Get it?

For my last 3 years of working, I commuted in a vanpool (about 7 riders). That was the best option I could find. Biking was too dangerous, and very unpleasant in Seattle weather. Public transit... ditto (no seat-belts in buses, standing in the aisles while (crowded) bus is moving, getting soaked in the rain when walking between bus stops).

Seems like they didn't spend much effort on this. Look at what they said for 2013 BoA -- $4.27 billion in 2013?

Or I suppose just clip a piece off of every green pepper -- then sell chopped green peppers by the pound. That might be easier. I think you'd want to ask what type of scissors -- some have wiggly edges for cutting irregular "lines". Some are better for cutting herbs versus crust. Some have rounded tips and aren't suitable for combat.

I would take a slice out of every pizza, cutting the remaining slices so that they fit back together in a perfect circular shape. Then I'd reassemble those slices I stole into new pizzas and sell them for money on the side. Or just sell pizza by the slice out of the back of the car.

Wow, and to think I waited for two years just to break that level.

True, but the argument Siegel presented is that the younger generations won't be investing in the same assets as they are sold fast enough, meaning the stock prices, which have been, to a degree, artificially propped up as a result of forced investment in retirement vehicles, may drop. This makes sense to me. Think of the number of people with Masters and Doctorates working as baristas with massive educational debt. Unless asset flows come from overseas, the largest companies may have a problem asset-price wise. Companies also repurchase their own shares, the buyers don't have to be baristas with debt.

Can you flesh this out in an example? Sure, just buy some $10 strike BAC puts and then put in a $10 limit order to purchase a corresponding number of common stock. Then you know that if the stock crashes to that level, you'll own the stock without any risk of further price decline. I know the puts cost money, but only 2/3 of it is mine -- the other 1/3 "belongs" to the IRS and California (the puts offset taxable dividends).

Buffett appears to be quite the fan of options, actually. BAC GS etc...