Buy 'Em Out- Introduction
Buy 'Em Out
Introduction
What I've hopefully established by now is that selling LEAP puts can be controlled for risk, thus reducing financial exposure to levels well within acceptable limits. So far, the only thing we've done with the premiums generated has been to invest them in money market funds and watch them grow at 6 percent a year. But as the title of this book suggests, I have in mind a better use of the premiums received, which is to use them to acquire additional shares of stock in my favorite companies.
Your list of favorite companies is certainly not going to coincide with my list; in fact, it is safe to say that no two people reading this book will have the same set of pet stocks. In view of this, what I propose to do is to take the premiums generated and use them to cover the costs of any high-quality stocks from among the list of companies that were assigned because the LEAP puts wound up in the money by the expiration date.
Procedure
To be conservative, the premiums generated from the sale of LEAP puts are placed into a money market account until the puts expire out of the money and worthless. This approach has the twofold advantage of terminating any financial obligation associated with the expiring LEAP put and of eliminating the maintenance margin requirement. As the premiums build up in this manner, you can purchase stock and add it to your equity portfolio. You can also use the accumulated premiums to purchase stock that was assigned to you because of option positions that expired in the money.
The procedure consists of accepting the exercise and assignment of any stocks whose far-term LEAP puts expired in the money but rolling out any near-term LEAP puts that did so. The reason the far-term in-the-money LEAP puts are accepted for assignment and the near-term LEAP puts are rolled out (rather than the reverse) is to delay stock purchase long enough for the premiums received to build up ahead of the monetary requirements for stock acquisition. In practice, you would be free to accept exercise and assignment of any stock you believed was worthwhile, assuming you had the dollars to acquire it.
As we want to concentrate on the effects of stock acquisition, the computer runs will be restricted to the universe of 115 stocks rated B+ or better and the universe of 50 stocks rated A- or better. For each universe, three runs will be made, ranging from the conservative sale of at-the-money LEAP puts to the very conservative sale of LEAP puts two steps out of the money. In each instance, any near-term LEAPS that appear to be winding up in the money will be rolled in much the same manner as in the previous chapter. For any far-term LEAPS that expire in the money, the procedure followed is to purchase the assigned stock.
At-the-Money LEAPS on the B+ Minimum Universe
Run No. 15 is the analog of Run No. 3 but where the in-the-money near-term LEAPS are rolled out and the in-the-money far-term LEAPS are accepted for assignment from among the total universe of 115 stocks rated B+ or better and for which the original strike price was at the money. All line items for the near-term LEAPS are identical to those in Run No. 9 (which is Run No. 3 with rollovers). On the other hand, the 1,479 far-term LEAPS that expired in the money are all accepted for assignment. The ITM exposure for the far-term LEAPS is $3,899,612 and represents the funding required to finance the acquisition of the 147,900 shares so assigned.
The realized gain is again the difference between the forward value and ITM exposure. It is a negative $1,470,879 for the far-term LEAPS, because the cost basis of $3.9 million is greater than the $2.4 million available from the far-term premiums alone. However, when the near-term LEAP premiums are used to pay for the acquired stock, the additional capital needed from external sources over the ten-year period is just a little over $168,000, an almost breakeven situation. The account value for the far-term LEAPS includes the close to $7.9 million in the new column marked stock value.
The overall investment account on March 31, 1997, is just shy of $8 million. This sum is close to 150 percent of the $5,345,392 in total premiums collected over the ten-year period and is substantially higher than the 69.7 percent account ratio (without roll-overs) in Run No. 3 or the 80.3 percent account ratio (with rollovers) in Run No. 9. The names these companies were known by are those of March 31, 1997, and do not reflect any mergers, acquisitions or spin-offs that have occurred since then.
At-the-Money LEAPS on the A- Minimum Universe
Run No. 16 is the analog of Run No. 4 but where the in-the-money near-term LEAPS are rolled out and the in-the-money far-term LEAPS are accepted for assignment from among the total universe of 50 stocks rated A- or better and for which the original strike price was at the money. The ITM exposure of $1,241,101 represents the funding required to finance the acquisition of the 51,800 shares of stock resulting from the 518 far-term option contracts that expired in the money and were assigned. The realized gain is $565,464 for the near-term LEAPS and a negative $358,568 for the far-term LEAPS.
The combined realized gain is this time a relatively large positive amount, signifying that the total premiums received were more than enough to cover the ITM exposure of the near-term LEAPS as well as pay for the stock acquired through assignment of the far-term LEAPS that expired in the money. As a result, the account value of $2,941,554 at the end of the ten-year period includes stock valued at close to $2.5 million. The account value is 154.2 percent of the premiums collected over the ten-year period and is substantially higher than the 95.9 percent account ratio (with rollovers) seen in Run No. 10.
One-Step OTM LEAPS on the B+ Minimum Universe
Run No. 17 is the analog of Run No. 5 but where the in-the-money near-term LEAPS are rolled out and the in-the-money far-term LEAPS are accepted for assignment from among the total universe of 115 stocks rated B+ or better and for which the original strike price was one step out of the money. The ITM exposure of $1,759,423 in the funding required to finance the acquisition of the 73,800 shares of stock resulting from the 738 far-term option contracts that expired in the money and were assigned. The realized gain is $588,590 for the near-term LEAPS and a negative $412,326 for the far-term LEAPS.
The combined realized gain of $176,264 is a positive amount, signifying that the total premiums received are enough to cover the ITM exposure of the near-term LEAPS as well as pay for the stock acquired through assignment of the far-term LEAPS that expired in the money. As a result, the account value of $4,334,794 at the end of the ten-year period includes stock valued at close to $3.9 million. The account value is 149.1 percent of the premiums collected over the ten-year period and is substantially higher than the 77.9 percent account ratio (with rollovers) seen in Run No. 11.
One-Step OTM LEAPS on the A- Minimum Universe
Run No. 18 is the analog of Run No. 6 but where the in-the-money near-term LEAPS are rolled out and the in-the-money far-term LEAPS are accepted for assignment, from among the total universe of 50 stocks rated A- or better and for which the original strike price was one step out of the money. The ITM exposure of $511,671 represents the funding required to finance the acquisition of the 22,400 shares of stock resulting from the 224 far-term option contracts that expired in the money and were assigned. The realized gain is $232,761 for the near-term LEAPS and a negative $77,444 for the far-term LEAPS.
The combined realized gain is again positive, signifying that the total premiums received were enough to cover the ITM exposure of the near-term LEAPS as well as pay for the stock acquired through assignment of the far-term LEAPS that expired in the money. As a result, the account value of $1,326,217 at the end of the ten-year period includes stock valued at just over $1 million. The account value is 144.7 percent of the premiums collected over the ten-year period and is again substantially higher than the 96.8 percent account ratio (with rollovers) seen in Run No. 12.
Two-Step OTM LEAPS on the B+ Minimum Universe
Run No. 19 is the analog of Run No. 7 but where the in-the-money near-term LEAPS are rolled out and the in-the-money far-term LEAPS are accepted for assignment from among the total universe of 115 stocks rated B+ or better and for which the original strike price was two steps out of the money. The ITM exposure of $768,734 represents the funding required to finance the acquisition of the 43,500 shares of stock resulting from the 435 far-term option contracts that expired in the money and were assigned.
The realized gain is $286,682 for the near-term LEAPS and a positive $8,680 for the far-term LEAPS. In this situation, the premiums received from sale of the far-term LEAPS alone were enough to cover the cost of the stock acquired through assignment of the far-term LEAPS that expired in the money. As a result, the account value of $2,522,336 at the end of the ten-year period includes stock valued at close to $2 million. The account value is 153.6 percent of the premiums collected over the ten-year period and is substantially higher than the 77.5 percent account ratio (with rollovers) seen in Run No. 13.
Two-Step OTM LEAPS on the A- Minimum Universe
Run No. 20 is the analog of Run No. 8 but where the in-the-money near-term LEAPS are rolled out and the in-the-money far-term LEAPS are accepted for assignment from among the total universe of 50 stocks rated A- or better and for which the original strike price was two steps out of the money. The ITM exposure of $190,502 in Table 10.27 represents the funding required to finance the acquisition of the 10,600 shares of stock resulting from the 106 far-term option contracts that expired in the money and were assigned.
The realized gain is $112,636 for the near-term LEAPS and a positive $42,107 for the far-term LEAPS. In this situation, the premiums received from sale of the far-term LEAPS was more than enough to cover the cost of the stock acquired through assignment of the far-term LEAPS that expired in the money. As a result, the account value of $730,440 at the end of the ten-year period includes stock valued at $462,413. The account value is 154.1 percent of the premiums collected over the ten-year period and is substantially higher than the 103.2 percent account ratio (with roll-overs) seen in Run No. 14.
RUN NUMBER 15
ATM Strike Price is the High, Low, or Closing Stock Price: C
No. of Steps Near-Term LEAP Put Is below ATM Strike Price: 0
No. of Steps Far-Term LEAP Put Is below ATM Strike Price: 0
Minimum No. of Months till Expiration: 8
ITM Near-Term LEAPS Are Rolled Over: Y
Stocks of ITM Far-Term LEAPS Are Purchased: Y
Premium Reinvestment Rate: 6.0%
Minimum First Call Rating: 1.6
Minimum Standard & Poor's Rating: B+
No. of Stocks Meeting Either Criterion: 11
Table LEAP OTM and ITM Rates
Table Premiums Collected and Realized Gain for Expired LEAPS
Table Premiums Collected and Unrealized Gain on Active LEAPS
Table Premiums Collected and Account Values
Table List of Stocks Purchased
RUN NUMBER 16
ATM Strike Price Is the High, Low, or Closing Stock Price: C
No. of Steps Near-Term LEAP Put Is below ATM Strike Price: 0
No. of Steps Far-Term LEAP Put Is below ATM Strike Price: 0
Minimum 1No. of Months till Expiration: 8
ITM Near-Term LEAPS Are Rolled Over: Y
Stocks of ITM Far-Term LEAPS Are Purchased: Y
Premium Reinvestment Rate: 6.0%
Minimum First Call Rating: 1.2
Minimum Standard & Poor's Rating: A-
No. of Stocks Meeting Either Criterion: 50
Table LEAP OTM and ITM Rates
Table Premiums Collected and Realized Gain for Expired LEAPS
Table Premiums Collected and Unrealized Gain on Active LEAPS
Table Premiums Collected and Account Values
Table List of Stocks Purchased
RUN NUMBER 17
ATM Strike Price Is the High, Low, or Closing Stock Price: C
No. of Steps Near-Term LEAP Put Is below ATM Strike Price: 1
No. of Steps Far-Term LEAP Put is below ATM Strike Price: 1
Minimum No. of Months till Expiration: 8
ITM Near-Term LEAPS Are Rolled Over: Y
Stocks of ITM Far-Term LEAPS Are Purchased: Y
Premium Reinvestment Rate: 6.0%
Minimum First Call Rating: 1.6
Minimum Standard & Poor's Rating: B+
No. of Stocks Meeting Either Criterion: 115
Table LEAP OTM and ITM Rates
Table Premiums Collected and Realized Gain for Expired LEAPS
Table Premiums Collected and Unrealized Gain on Active LEAPS
Table Premiums Collected and Account Values
Table List of Stocks Purchased
Table List of Stocks Purchased (Continued)
RUN NUMBER 18
ATM Strike Price Is the High, Low, or Closing Stock Price: C
No. of Steps Near-Term LEAP Put Is below ATM Strike Price: 1
No. of Steps Far-Term LEAP Put Is below ATM Strike Price: 1
Minimum No. of Months till Expiration: 8
ITM Near-Term LEAPS Are Rolled Over: Y
Stocks of ITM Far-Term LEAPS Are Purchased: Y
Premium Reinvestment Rate: 6.0%
Minimum First Call Rating: 1.2
Minimum Standard & Poor's Rating: A-
No. of Stocks Meeting Either Criterion: 50
Table LEAP OTM and ITM Rates
Table Premiums Collected and Realized Gain for Expired LEAPS
Table Premiums Collected and Unrealized Gain on Active LEAPS
Table Premiums Collected and Account Values
Table List of Stocks Purchased
RUN NUMBER 19
ATM Strike Price Is the High, Low, or Closing Stock Price: C
No. of Steps Near-Term LEAP Put Is below ATM Strike Price: 2
No. of Steps Far-Term LEAP Put Is below ATM Strike Price: 2
Minimum No. of Months till Expiration: 8
ITM Near-Term LEAPS Are Rolled Over: Y
Stocks of ITM Far-Term LEAPS Are Purchased: Y
Premium Reinvestment Rate: 6.0%
Minimum First Call Rating: 1.6
Minimum Standard & Poor's Rating: B+
No. of Stocks Meeting Either Criterion: 115
Table LEAP OTM and ITM Rates
Table Premiums Collected and Realized Gain for Expired LEAPS
Table Premiums Collected and Unrealized Gain on Active LEAPS
Table Premiums Collected and Account Values
Table List of Stocks Purchased
Table List of Stocks Purchased (Continued)
RUN NUMBER 20
ATM Strike Price Is the High, Low, or Closing Stock Price: C
No. of Steps Near-Term LEAP Put Is below ATM Strike Price: 2
No. of Steps Far-Term LEAP Put Is below ATM Strike Price: 2
Minimum No. of Months till Expiration: 8
ITM Near-Term LEAPS Are Rolled Over: Y
Stocks of ITM Far-Term LEAPS Are Purchased: Y
Premium Reinvestment Rate: 6.0%
Minimum First Call Rating: 1.2
Minimum Standard & Poor's Rating: A-
No. of Stocks Meeting Either Criterion: 50
Table LEAP OTM and ITM Rates
Table Premiums Collected and Realized Gain for Expired LEAPS
Table Premiums Collected and Unrealized Gain on Active LEAPS
Table Premiums Collected and Account Values
Table List of Stocks Purchased
Summary
The overall ten-year value ratios for the B+ and A- minimum universes for the three independent situations in which LEAPS winding up in the money are not rolled out, are rolled out, and are both rolled out (near-term) and assigned (far-term).
Table Figure of Merit Comparisons
As you can see, adopting the combined rollover and stock acquisition strategy can substantially improve long-term account values.
At-the-Money Results
For the B+ minimum universe of 115 stocks with at-the-money LEAPS, the account ratio progressively increases from 66.7 percent without rollovers in Run No. 3 to 80.3 percent with rollovers in Run No. 9 to 149.6 percent with the combined rollover/acquisition strategy in Run No. 15. For the A- minimum universe of 50 stocks, the account ratio progressively increases from 84.9 percent without rollovers in Run No. 4 to 95.9 percent with rollovers in Run No. 10 to 154.2 percent with the combined rollover/acquisition strategy in Run No. 16.
One-Step Out-of-the-Money Results
For the B+ minimum universe of 115 stocks with one-step out-of-the-money LEAPS, the account ratio progressively increases from 72.6 percent without rollovers in Run No. 5 to 77.9 percent with roll-overs in Run No. 11 to 149.1 percent with the combined rollover/acquisition strategy in Run No. 17. For the A- minimum universe of 50 stocks, the account ratio progressively increases from 91.6 percent without rollovers in Run No. 6 to 96.8 percent with rollovers in Run No. 12 to 144.7 percent with the combined rollover/acquisition strategy in Run No. 18.
Two-Step Out-of-the-Money Results
For the B+ minimum universe of 115 stocks with two-step out-of-the-money LEAPS, the account ratio progressively increases from 73.6 percent without rollovers in Run No. 7 to 77.5 percent with roll-overs in Run No. 13 to 153.6 percent with the combined rollover/acquisition strategy in Run No. 19. For the A- minimum universe of 50 stocks, the account ratio progressively increases from 98.3 percent without rollovers in Run No. 8 to 103.2 percent with rollovers in Run No. 14 to 154.1 percent with the combined rollover/acquisition strategy in Run No. 20.
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