ERICOPOLY

Here is an easier phrasing: You are prepaying all of this interest, long before it is due, which is effectively an interest-free loan to the very person you are borrowing it from. Thus, you aren't really borrowing as much as you think. Therefore, you have to figure out how much you are really borrowing first, before then calculating what interest rate you are really paying. And that is an easy calculation. Given: BAC stock price $15.60 BAC "A" warrant price $6.54 Strike price $13.30 x= cost of leverage interest rate $15.60 - $6.54 = $9.06 Now you need merely solve the following equation for 'x': $9.06 * 1.x^5 = $13.30. I'm using 5 years in the calculation to keep it simple, even though we're not exactly 5 years from expiry.

Think of an individual with a steady job but not a penny to his name, getting a zero-money-down 5 year term $20,000 car loan that is interest-only and a balloon payment is due at the end of 5 years. I know, I know, suspend your disbelief for a moment. I believe it is a better loan for this consumer to pay the interest monthly as it accrues. That's the whole reason why they wanted a loan in the first place -- they have no immediate cash and need to borrow. They can't prepay it. Instead, suppose they have to prepay all of the interest. Okay, that's $5,000 in future interest that's due immediately before they can drive the car off of the lot. But they don't have $5,000. So they have to borrow it. And you aren't including the cost of borrowing it in your calculation. Borrowing it costs more money! And that's an easy way to see that the loan is more expensive than your (and Greenblatt's) calculation suggests). Back to our options & warrants... you effectively have to "borrow" more because you have less equity with which to purchase the stock after pre-paying all of that interest upfront. Or looked at differently, you are giving the lender an interest-free loan (by prepaying interest long before it's due) and carrying on as if handing out interest-free loans has no economic cost. So anyways, I think Greenblatt is incorrect. The calculation that I make really isn't that hard, and it's accurate at the same time.

I didn't engage because it was getting off track. What interest rate did you use? There is $18 being "borrowed" in the case of the call, but not in the case of the put. Did you omit that expense from the call? You're right, I'm more interested in the other half of the discussion. I was just thinking that since calls don't get the dividend on one side and the puts + stock do, then the puts would necessarily be more expensive than the calls. It would depend on the bond yield, so that's probably why the dividend yield didn't matter that much. Still, though, if one can get double the dividend by margining + puts, it would seem like the puts price should reflect that difference in possibility. I'll focus back on the other conversation though. In November I bought BAC A warrants again in our RothIRA accounts. My thinking was around the 7.5% cost of leverage (waaaayyyyy cheaper than in March), and the prospects for the dividend coming soon, and the relative convenience of "one and done" trading for the next 5 years. Having a Roth account is a trading liability because I run the risk of losing my taxable losses if they wash into a Roth trade - so I am very careful about managing that risk. Anyways, that wash period is over soon (then I can take the taxable loss on my expiring puts). Let's say BAC pays a 60 cent dividend (in 2015 or 2016) -- that would be 4.5% cost of leverage justification in those A warrants. Then let's say 2% cost for the put and 1% cost for the margin loan. That adds up to the cost of leverage in the A warrants at 7.5% rate. So they look like they are attractively price, IMO. I aggressively moved into them in November.

I didn't engage because it was getting off track. What interest rate did you use? There is $18 being "borrowed" in the case of the call, but not in the case of the put. Did you omit that expense from the call?

I agree here, and it makes sense. However, to be equivalent to the call version, you would have to buy puts at $18 right? Wouldn't the puts be more expensive than the calls because of the implied dividend yield? I tried to verify that earlier, but failed. Is that just not right? I was expecting it to work out due to put/call parity. There is no cost to the put. The example, if you recall, is a $36 stock with $18 call strike price. The call is priced at $18. Thus, the embedded put in the call is free. No, this isn't terribly realistic, but I wanted to keep the discussion on just the missing dividend. So I reduced the complexity. It is assumed (apples to apples) that the put is also free on the market (if it's free for the call). Okay, not real-world, but I didn't want to get the discussion off track. Too late! :D It's also the reason why I kept my example to one where the strike price was 1/2 of the stock price. That way the math is very easy. Just keeping complexity out of it so we can do these computations in our heads.

We are thinking the same way, I just wasn't careful in how I described my example. yes, two shares of upside. two dividends missed. twice we "borrowed" $18. Thus, 1 missed dividend per $18 borrowed. Therefore, the missed dividend of 1.08 (per call) is 6% of the "borrowed" amount of $18 per call. I get that 1.08 / 18 is 6%. I just don't understand why we would think we should get the 1.08 in the first place. If we had bought $18 of shares, we would have got a 3% yield, or .54. If my choice was to buy the common unlevered or to buy the call, or some combination, nothing was going to give me a 6% yield, so why would I be missing that unattainable 6%? Example 1: Using portfolio margin Let's say I only have $18 to my name and I buy 1 share of common stock for $36 using $18 of money borrowed on margin. I get dividend yield both on $18 of my own capital tied up and on $18 of the borrowed money Example 2: Using calls I don't get a damn bit of dividend on my own $18 of equity, neither do I get a dividend on the $18 worth of synthetically "borrowed" money. In Example 2, I not only miss out on dividend yield from the $18 borrowed, but I also miss out on the dividend yield from the $18 of my own equity that I contributed. So that's why it's 6% cost and not 3% cost. Because you synthetically borrowed only 1/2 the price of the stock, but you gave up the dividend on the entire thing! Your own money got no yield. Normally, if you invest your own $18 into the stock you get a 3% yield. But that vanishes when you add $18 of "borrowed" money to the deal. So you multiply it by 2, and thus it becomes a 6% cost of having added $18 of leverage. What yield premium should be applied to the secured liability to get to an apples to apples that you wanted? That's separated out into the price of the put used to secure the portfolio margin liability. It's important, but a separate (related) topic. Another separate but related topic is the risk of moving margin interest rate (another liability that is unsecured). Those are important topics, but the dividend is a distinctly different threat, and it has a cost to the option holder.

We are thinking the same way, I just wasn't careful in how I described my example. yes, two shares of upside. two dividends missed. twice we "borrowed" $18. Thus, 1 missed dividend per $18 borrowed. Therefore, the missed dividend of 1.08 (per call) is 6% of the "borrowed" amount of $18 per call. I get that 1.08 / 18 is 6%. I just don't understand why we would think we should get the 1.08 in the first place. If we had bought $18 of shares, we would have got a 3% yield, or .54. If my choice was to buy the common unlevered or to buy the call, or some combination, nothing was going to give me a 6% yield, so why would I be missing that unattainable 6%? Example 1: Using portfolio margin Let's say I only have $18 to my name and I buy 1 share of common stock for $36 using $18 of money borrowed on margin. I get dividend yield both on $18 of my own capital tied up and on $18 of the borrowed money Example 2: Using calls I don't get a damn bit of dividend on my own $18 of equity, neither do I get a dividend on the $18 worth of synthetically "borrowed" money. In Example 2, I not only miss out on dividend yield from the $18 borrowed, but I also miss out on the dividend yield from the $18 of my own equity that I contributed. So that's why it's 6% cost and not 3% cost. Because you synthetically borrowed only 1/2 the price of the stock, but you gave up the dividend on the entire thing! Your own money got no yield. Normally, if you invest your own $18 into the stock you get a 3% yield. But that vanishes when you add $18 of "borrowed" money to the deal. So you multiply it by 2, and thus it becomes a 6% cost of having added $18 of leverage.

The BAC warrants will get a floor established to support the cost of leverage once a dividend is paid. Imagine if a $1 dividend were paid (it won't be that high, but just imagine). That would be 7.5% of value versus what a regular call option offers. So that large of a dividend, were it to be suddenly announced, would create quite a land grab for the warrants -- the price would spike right away. They would suddenly be the best thing around, with effectively free options volatility premium (free embedded put) -- compared to a regular call options. So for accounts that can't use margin loans (like IRAs), it would be the best game in town and we'd see no more option decay.

We are thinking the same way, I just wasn't careful in how I described my example. yes, two shares of upside. two dividends missed. twice we "borrowed" $18. Thus, 1 missed dividend per $18 borrowed. Therefore, the missed dividend of 1.08 (per call) is 6% of the "borrowed" amount of $18 per call.

I see--I calculate it by figuring out where owning the warrants are better than owning the common and annualizing that number. For example, the point where the warrants make the same as the common is currently $22.94. Thus, my rate is $22.94/$15.56, annualized, which is currently 7.9%, or since this is at parity, it would also be ($22.94-$13.30)/$6.54, or 7.9% annualized. I also usually adjust for missed dividends, which adds be 0.01*remaining number of quarters to the $22.94 number, adjusting to 7.95% per year. I'm not totally sure if that dividend adjustment is strictly the right way to do it, but it makes some sense (those are the raw dividends that were missed). In your calculation, you are calculating how much extra your are paying now for the leverage (strike + warrant price - stock price), which makes sense. Why then divide that by the strike? Seems like you would want to divide by your cost (warrant price)? In any event, it seems like the first approach gives a slightly better indication of cost, since you could have bought the common instead of the option/warrant. Is there an advantage to the second approach I'm missing? Let's compare my method of calculating cost of leverage (over on the BAC Leverage thread) to Packer's method. Packer's method comes out to a lower cost of leverage answer. Why is that one might ask? Simple... well... sort of, anyhow :) You see, we're talking about pre-paying all of the "interest" on the synthetically borrowed money. That's very different from a typical loan where you pay the interest incrementally as time goes by. The difference is significant! There is opportunity cost to settling up your interest costs on day one, versus day by day. It's the time value of money. Anyways, my method of calculating it is what I prefer to use because it compares apples-to-apples with the normal kind of loan where you pay interest on a rolling basis as the payments come due. Make sense? So that's the difference between my method and Packer's method. His is perfectly fine for some things, but I find I can't make use of it for comparing one type of leverage (options) to another (borrowing money with normal interest payment). My purpose was to compare various costs for all manner of leverage -- so it's why I do it that way and don't use Packer's method. Packer's method of course is a lot easier to compute.

Let's use an example where the stock is $36, the strike on the calls is $18, and the premium on the calls is $0. So you can purchase the calls for $18 each (no premium). Now, does it seem like the cost of leverage is 0%? Not so fast! You are basically "borrowing" $18 per share synthetically when the strike is $18, right? You take your $36 in cash and buy two calls for $18 strike instead of purchasing 1 share of common for $36. And you get no dividend, right? So let's say the common is trading at $36, so the strike on the warrant is 50% of the cost of the stock -- just like I said. Okay, 3% of $36 is $1.08 of dividend. That's a dividend that you will miss out on, so it has to be added to the cost of getting that $18 worth of leverage. $1.08 is 6% of $18. Now, if you instead had used portfolio margin and purchased a put with $18 strike, you would not be losing the dividend. So this kind of computation is only important to strategy where you lose the dividend (like with call option or warrant). It's a real cost though. The cost of leverage is not 0%, it's 6% in this example.

What are the anti-dilution provisions on the GM "B" warrant? A 3% dividend on the common would raise the cost of leverage on the warrant by 600 bps if the warrant strike were 50% of the stock price. But that would be if there were no provisions for dividends at all -- don't know if there are.

You rock! Searched on "dollar for lot" and found their form -- and yes, "Option" is one of the types of securities on that form: www.interactivebrokers.com/download/DollarForLotForm.pdf

He puts out John Arrillaga's name in that video. I went to Pinewood School with the children of his business partner, Richard Peery. Funny. Actually, I'm a Facebook friend of one if the Peery kids, for whatever trivia value that has to you :-) Their story is pretty awesome: In the 1960s, Arrillaga and business partner Richard Peery bought California farmland and converted it into office space.[3] They became two of Silicon Valley's biggest commercial landlords with more than 12,000,000 square feet (1,100,000 m2).[4] In 2006, he sold 5,300,000 sq ft (490,000 m2) of his real estate holdings for roughly $1.1 billion http://en.wikipedia.org/wiki/John_Arrillaga

That's probably a good suggestion as well except I don't know how to contact the equity derivatives desk at investment banks. I think this might be the same path that 'Indirect' has more recently put me on to, but I'm not sure. I don't know a lot of the ropes that you guys do.

http://ibkb.interactivebrokers.com/article/1718#What_if_I_have_a_long_option_which_I_do_not_want_exercised_ ^^I'm almost positive that they cancel the contracts as soon as you enter the instruction (during market hours), but I canceled mine within 3 days of expiration so it could be different if you're a month away. Thank you very much for relaying that anecdote. I had just ended a chat a few minutes ago where I asked the IB representative if I could pay them a fee to buy my position from me. He said "I believe what you are referring to is Cabinet Trades. We do not offer that service at IB". So I was bummed out. You have given me a different question to ask of them now. However I'm afraid it's a different situation. I need it cancelled about 17 days before expiry -- the link you showed me merely talks about forcing them not to exercise under any circumstance. Well, I have 2 more days to go to wait out the wash sale period. The bid is still 2 cents. Probably will be there still. Eric, That is strange, IB makes reference to Cabinet Trades in the footnotes of this page. https://www.interactivebrokers.com/en/index.php?f=commission&p=options1 I wonder if this page is out of date, or if you were provided with incorrect information? 'indirect' had a good suggestion and provided me with a contact number to pursue with the IBPrime services. Thanks for finding this reference to Cabinet Trades -- that would of course be the simplest avenue, and it is a bit shocking that something so useful isn't clearly offered (if at all). I've now chatted with two of their representatives who claim there is nothing they can do for me -- one of them explicitly stating that IB does not offer Cabinet Trades. Maybe I should push them harder showing them the page you showed me.

This is one of the people in my mental list that I would never allow to manage a dollar of my money. I don't like his recent comments about wanting to be in things that are trending -- and mentioned bitcoin. That pretty much did it for me. Did he start his professional investing record before the .Dot Com bubble, or after?

It's already in the price of the stock. The general consensus is for $1.80 per share of earning in two years. That's a $21.60 stock price at 12x earnings -- that's 38.4% higher than today's price. You get to that price even if every dollar of capital generated between now and then goes towards loan losses -- that's more than $20 billion per year of capital generation, multiplied by two years... in addition to their loan loss reserves! That's a tremendous amount of safety discounted in the price.

I thought of something creative so it's probably wrong... What if I buy a bunch of additional cheap BAC puts for a penny each that actually do expire this calendar year? There is a series expiring December 21st. Then after buying the new puts, I then sell these pre-existing Jan 2014 puts that I've been trying to unload. The point of this trade is to create a new, more recent purchase for the wash sale cost basis to attach to. Did I create a wash sale that moved the cost basis to the ones that are expiring this year? So instead of the cost basis moving over to the shares that I purchased on November 7th, it would move over to these new puts that I purchased (the ones that will soon expire this year)? I guess the gist of my question is about wash sales -- does the cost basis move to the most recently purchased shares in the 30 day window, or the oldest (first) purchase of shares within the 30 day window? EDIT: This is more of a question for future strategy -- if this works, I could have done this a week ago and not had to worry

See, I may be overly paranoid but I've been worrying about the optics of something like that. Perhaps I make an arrangement with a buddy that whenever he needs a tax loss (and I don't), I have him bid above market for one of my worthless assets (a deliberate loss for him). This allows me to sell the asset at little tax hit to me, and allows him to take a big useful tax loss. Between us, if this goes on for years and years, we can cheat the taxes a bit -- he uses my low tax bracket when convenient, and vice versa. It could be abused as a tax-bracket arbitrage thing. So I just figured it would be best to avoid that kind of thing if at all possible, simply because I don't want to do anything that might be annoying (and potentially costly) to defend against accusations.

Write puts on blue-chip non-insurance companies (like KO) and use the proceeds to purchase BRK puts. That way, you have the upside of Berkshire, the tax-deferral of not getting paid a dividend, and the downside profile of a secure, non-insurance company. It keeps the concentrated upside in Berkshire, while shifting the downside to a diversified basket of non-insurance risk.

The last BAC trade I made was on November 7th. So the wash sale period is indeed up soon. I may have needlessly freaked out simply because the bid on the Feb $11 strike put is already "no bid". And the one that I own, the Jan $12 was already at 2 cents and perhaps a very short ride to "no bid" as well. But even if no bid, perhaps it will execute at some tiny price with a "market" order? Is it ever the case that a market order doesn't fill? Surely Nassim Taleb would like a chunk of BAC puts for a fraction of a penny?

Here is what I got from their Trader Chat a few minutes ago: Aimee: Hello, this is 'Aimee'. How may I help you? me: In the "Option Exerccise" window. me: There is a "Lapse (Don't Exercise)" button. What is this for? me: I want to take a tax loss this year on options with no bid. They are out-of-the-money puts. me: They don't expire until Jan 17th, 2014. me: Does the "Lapse" button help me accomplish this? Aimee: no, lapse is for when you have an in the money option and you do not want it exercised me: Is it revocable once "lapse" is designated? I have a theory that if it's irrevocable, then the option is thus worthless. Aimee: Let me get you over to our trade group, as I am not certain. Hold please ChatSys: Transferring chat from room 'General Assistance' to 'Trade Problems'. A Customer Service Rep will join the chat shortly. ChatSys: User 'Daniel F' has joined the chat. Daniel F: Hello, this is 'Daniel F'. Please allow me a moment to read the transcript of your chat thus far and I'll assist you shortly. Daniel F: You're correct with your theory...When you lapse an option it is irrevocable me: Is a record created in my financial statement showing that I lapsed the option in 2013? me: I am rather stressed about this because my $12 strike BAC puts are down to a bid of just 2 cents. They might go no-bid very soon. me: I need very badly to be able to claim them as a loss in 2013. me: I can't sell them quite yet because of wash sale rules. Daniel F: Unfortunately, the lapse will only take affect on expiration date, so it won't show up on your 2013 tax forms me: What can I do if they go no-bid? Daniel F: There really isn't anything that we can do for you in that case

http://ibkb.interactivebrokers.com/article/1718#What_if_I_have_a_long_option_which_I_do_not_want_exercised_ ^^I'm almost positive that they cancel the contracts as soon as you enter the instruction (during market hours), but I canceled mine within 3 days of expiration so it could be different if you're a month away. Thank you very much for relaying that anecdote. I had just ended a chat a few minutes ago where I asked the IB representative if I could pay them a fee to buy my position from me. He said "I believe what you are referring to is Cabinet Trades. We do not offer that service at IB". So I was bummed out. You have given me a different question to ask of them now. However I'm afraid it's a different situation. I need it cancelled about 17 days before expiry -- the link you showed me merely talks about forcing them not to exercise under any circumstance. Well, I have 2 more days to go to wait out the wash sale period. The bid is still 2 cents. Probably will be there still. Have you tried logging into Trader Workstation and looking around in the Option Exercise window? I'll take a look this afternoon if I have time to recover my password (for some reason there's no obvious way to do this), but I was able to find it before just by looking around. I think it was simply 'do not exercise,' but the contracts were 'sold' for 0 immediately after I entered the (irrevocable) instruction. There is a button there that says: "Lapse (don't exercise)". Presumably this is the one you were thinking of. I need to read more about it.

Look, my idea is very simple (and maybe very wrong! ;D ;D): it is not that Keynesian policies are ineffective in stimulating growth and the economy… because they most certainly are! The problem, instead, is the discrepancy between their effectiveness in increasing values and their effectiveness in increasing prices. Specifically, of course, I think they are much better tools for increasing prices than values. Therefore, the longer they go on, the larger the overvaluation becomes. And overvaluation always ends the same way: deflation. Gio I'm more concerned about a recession than an inflated stock market. I don't own an inflated stock (actually, it's an already deflated one) but the value of the stock would be impacted if the economy were to get significantly worse. In part because of defaults, in part because of loan growth, and in part because of yield curve. So I might be more interested in the macro picture of the economy (it's feeds back into value of the companies) rather than the price picture of the S&P500 (which I don't own). You could say that undervaluation always ends in the same way -- inflation. I'm not sure if that's accurate, but it's the flip side of your claim that overvaluation always leads to deflation.