This isn't exactly advanced or newbie but specifically for those interested in LEAPS-stock-replacement strategy. I didn't think a new thread was warranted so- putting it here.
I’ve recently had several requests regarding LEAPS (stock replacement) strategy for TSLA. So for what it’s worth, thought I’d post a little experience based tutorial for the method I use. There are many numerous alternatives, so please don’t view this as definitive in any way- but this is what works for my investment profile. I started this kind of thing back in the Apple growth days many years ago taking my lumps with trying different stock only- margin plays and finally moving to a LEAPS based method that seems to work for me. Always refining of course… but here ya’ go:
1) The Warning Label:
Only use LEAPS (over stock) for high growth - capital intensive(=well orchestrated growth pattern) companies
(certainly like Tesla and Solar, Apple for example is more marginal growth now and deserves less use of this method)
2) Set the Stage:
Use LEAPS to lower your risk by aligning the stock level you want rather than a simple dollar level because you are leveraging dollars to achieve a stock risk level- not the other way around- as follows:
Decide given your portfolio and risk tolerance, how much TSLA stock you would like to carry and how long. My current range is 2000-2500(3000 tops) shares for the next 5 years (through Mod E market at least). That aligns with my goals vs capital risk. Use LEAPS to reduce the capital required to carry this investment (not to trade on events etc.)- meaning you must tolerate the swings in the value of your LEAPS as if you own the stock at that level. This seems obvious, but too many people use LEAPS to trade on the swings (that should be relegated to short term options or other methods).
3) Oh My, What to Do:
Now with the net Delta you want to carry decided- you need to select the LEAPS (strike, expiration, # of contracts). I recommend simple spreads both in time and strike. Use 2 spreads for each as follows:
Time spread- about 1 year and more than 1 year- So currently J15 and J16. Think about how the company is expected to grow in proportion to expected development and skew to that arrangement initially starting with a mental 50/50. For example I expect 2014 to be a high growth year for Tesla compared to 2015 due to ModX, SC network, GigaF, J15 intro of GenIII) Next year will be more measured against ModX sales
producing a 60/40 split for me going in (maybe even more skewed).
For each of J15 and J16 use 2 strikes (KISS) as follows:
Take the anticipated TSLA$ value 3-6 months prior to expiration and use that strike(or lower) for lower strike leg;
Take the anticipated TSLA$ at expiration and use that(or higher) for the upper leg strike.
For example my initial setup for TSLA was J15 $250 and $300 (total of 60% by dollar investment) and J16 $300 and $350 (totaling 40% by dollar investment)
Remember with this method you will never carry to expiration (you may choose to accent your investment by keeping something through expiration, but if so that should be considered a conversion to a simply short term option play)
4) Oh My, Why Did I Do That:
The time spreads allow for unexpected timing of anticipated events, capturing value of unanticipated events, capturing value of future roll (explained more below), and capturing long term value before those J16s get too expensive later
The strike spreads allow for capturing value of earlier than expected moves in the stock while provided significant cushion for later than expected moves. For example, the lower leg strike is 3-6 months before expiration, so if not reached you still have plenty of time to let those run or roll them up depending on the events taking shape. The higher leg strike will capture time value if the stock price runs up much quicker than anticipated as follows (and this is the basic tenant behind the strike selection):
5) Oh My, What Do I Do Next or The Roll-Up and Out:
With a high growth company the best LEAPS return will be produced when you RECEIVE the time value in your LEAP. When you first purchase the option you are paying(renting) that time. To illustrate the point I'll use an extreme case. Given TSLA currently at $250, the Time Value of the LEAP is a bell(ish) curve from $150 to $400 always peaking ATM ($250). The goal with the LEAP to is to capture as much of that curve in your strike as possible, meaning let that bell peak at your strike well before the rent is due (bring it to me faster than the rent I'm paying). This is why we chose the lower strike 3-6 months out, when the rent begins to accelerate more (although still low by short term Option standards maintaining our tenant of stock replacement investment). When the peak reaches your strike (ATM), roll up in strike and out in time, by considering the new situation and how much of this year's value you have captured (likely early). For example I'm now rolling all J15 $250 to add some J15 $300 (because my Delta track is now top of range affording cash generation) and to more J16 $350+ (because I believe I have captured significant 2014 value early so adjusting 60%/40% ratio to 40%/60% favoring J16 now)
6) Am I Mental or The Mental Picture:
'swim to where the wave peak WILL BE - wait for the inevitable wave to carry you to it's peak, then move to where the next wave will be'.
Don't fight the ocean of event driven peaks 'n troughs, instead let the big waves come to you.
This produces a flow of investment that allows a mental calculation mirroring a stock position
- less emotive-panic allowing a larger hold position;
- intermediate events are tolerated not played, allowing for a bigger mental picture of the ocean.
After all this is your core belief in the company and what those in the company believe to their core;
And THEY are the ones working to create YOUR value- so aligning your investment mission with those wonderful people is the best possible alignment of your decisions as well.
7) Is That All You Got Bro' or Around the Edges:
Around the edges of this for those times the waves seems to get so deep you can't see sky or so tall your nose is bleeding do the following:
Carry a bit of stock position for those troughs:
The stock won't move nearly as much as those LEAPS of course, so when you get those inevitable lows (like Fire induced), you can convert the stock to add LEAP (or any other option for that matter) position providing a rare occasion additional leverage for the inevitable rise again- remember when it does to convert back to your stock hold position (+ cash earned).
Leverage the LEAPS safely for those crests:
On the other side, when at an unexpected scary crest (I can see the whole world from here) and you know damn well you'll have to suffer some sort of sickly air drop, use the LEAPS position for no margin required sell-write of some OTM Calls to cushion-hedge the ride down. This is also why we have a lower leg in our strike spread. You can sell at or above your lower strike (recommend about 10%-20% higher) and at a shorter expiration (recommend no more than month out) covered by your existing LEAPS- safely hedging or adding some cash generation to your portfolio.
(One More Thing):
Enjoy your Life more than your Money
I’ve recently had several requests regarding LEAPS (stock replacement) strategy for TSLA. So for what it’s worth, thought I’d post a little experience based tutorial for the method I use. There are many numerous alternatives, so please don’t view this as definitive in any way- but this is what works for my investment profile. I started this kind of thing back in the Apple growth days many years ago taking my lumps with trying different stock only- margin plays and finally moving to a LEAPS based method that seems to work for me. Always refining of course… but here ya’ go:
1) The Warning Label:
Only use LEAPS (over stock) for high growth - capital intensive(=well orchestrated growth pattern) companies
(certainly like Tesla and Solar, Apple for example is more marginal growth now and deserves less use of this method)
2) Set the Stage:
Use LEAPS to lower your risk by aligning the stock level you want rather than a simple dollar level because you are leveraging dollars to achieve a stock risk level- not the other way around- as follows:
Decide given your portfolio and risk tolerance, how much TSLA stock you would like to carry and how long. My current range is 2000-2500(3000 tops) shares for the next 5 years (through Mod E market at least). That aligns with my goals vs capital risk. Use LEAPS to reduce the capital required to carry this investment (not to trade on events etc.)- meaning you must tolerate the swings in the value of your LEAPS as if you own the stock at that level. This seems obvious, but too many people use LEAPS to trade on the swings (that should be relegated to short term options or other methods).
3) Oh My, What to Do:
Now with the net Delta you want to carry decided- you need to select the LEAPS (strike, expiration, # of contracts). I recommend simple spreads both in time and strike. Use 2 spreads for each as follows:
Time spread- about 1 year and more than 1 year- So currently J15 and J16. Think about how the company is expected to grow in proportion to expected development and skew to that arrangement initially starting with a mental 50/50. For example I expect 2014 to be a high growth year for Tesla compared to 2015 due to ModX, SC network, GigaF, J15 intro of GenIII) Next year will be more measured against ModX sales
producing a 60/40 split for me going in (maybe even more skewed).
For each of J15 and J16 use 2 strikes (KISS) as follows:
Take the anticipated TSLA$ value 3-6 months prior to expiration and use that strike(or lower) for lower strike leg;
Take the anticipated TSLA$ at expiration and use that(or higher) for the upper leg strike.
For example my initial setup for TSLA was J15 $250 and $300 (total of 60% by dollar investment) and J16 $300 and $350 (totaling 40% by dollar investment)
Remember with this method you will never carry to expiration (you may choose to accent your investment by keeping something through expiration, but if so that should be considered a conversion to a simply short term option play)
4) Oh My, Why Did I Do That:
The time spreads allow for unexpected timing of anticipated events, capturing value of unanticipated events, capturing value of future roll (explained more below), and capturing long term value before those J16s get too expensive later
The strike spreads allow for capturing value of earlier than expected moves in the stock while provided significant cushion for later than expected moves. For example, the lower leg strike is 3-6 months before expiration, so if not reached you still have plenty of time to let those run or roll them up depending on the events taking shape. The higher leg strike will capture time value if the stock price runs up much quicker than anticipated as follows (and this is the basic tenant behind the strike selection):
5) Oh My, What Do I Do Next or The Roll-Up and Out:
With a high growth company the best LEAPS return will be produced when you RECEIVE the time value in your LEAP. When you first purchase the option you are paying(renting) that time. To illustrate the point I'll use an extreme case. Given TSLA currently at $250, the Time Value of the LEAP is a bell(ish) curve from $150 to $400 always peaking ATM ($250). The goal with the LEAP to is to capture as much of that curve in your strike as possible, meaning let that bell peak at your strike well before the rent is due (bring it to me faster than the rent I'm paying). This is why we chose the lower strike 3-6 months out, when the rent begins to accelerate more (although still low by short term Option standards maintaining our tenant of stock replacement investment). When the peak reaches your strike (ATM), roll up in strike and out in time, by considering the new situation and how much of this year's value you have captured (likely early). For example I'm now rolling all J15 $250 to add some J15 $300 (because my Delta track is now top of range affording cash generation) and to more J16 $350+ (because I believe I have captured significant 2014 value early so adjusting 60%/40% ratio to 40%/60% favoring J16 now)
6) Am I Mental or The Mental Picture:
'swim to where the wave peak WILL BE - wait for the inevitable wave to carry you to it's peak, then move to where the next wave will be'.
Don't fight the ocean of event driven peaks 'n troughs, instead let the big waves come to you.
This produces a flow of investment that allows a mental calculation mirroring a stock position
- less emotive-panic allowing a larger hold position;
- intermediate events are tolerated not played, allowing for a bigger mental picture of the ocean.
After all this is your core belief in the company and what those in the company believe to their core;
And THEY are the ones working to create YOUR value- so aligning your investment mission with those wonderful people is the best possible alignment of your decisions as well.
7) Is That All You Got Bro' or Around the Edges:
Around the edges of this for those times the waves seems to get so deep you can't see sky or so tall your nose is bleeding do the following:
Carry a bit of stock position for those troughs:
The stock won't move nearly as much as those LEAPS of course, so when you get those inevitable lows (like Fire induced), you can convert the stock to add LEAP (or any other option for that matter) position providing a rare occasion additional leverage for the inevitable rise again- remember when it does to convert back to your stock hold position (+ cash earned).
Leverage the LEAPS safely for those crests:
On the other side, when at an unexpected scary crest (I can see the whole world from here) and you know damn well you'll have to suffer some sort of sickly air drop, use the LEAPS position for no margin required sell-write of some OTM Calls to cushion-hedge the ride down. This is also why we have a lower leg in our strike spread. You can sell at or above your lower strike (recommend about 10%-20% higher) and at a shorter expiration (recommend no more than month out) covered by your existing LEAPS- safely hedging or adding some cash generation to your portfolio.
(One More Thing):
Enjoy your Life more than your Money
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