▶ Full Post Text
I’ve copy-pasted it from word:
LEAPS (long term ITM calls) investment strategy
Step 1: acquire a list of 50-60 undervalued/fairly valued but above average stocks
Important filters/aspects aside from obvious P/E, P/B, EPS, Current, D/E AND a certain amount of qualitative research:
1. Various sectors, a larger allocation to Cyclicals, be they consumer or materials or energy or shipping or who knows what
2. Option availability, especially as not many companies have long term options
3. A nameable, dependable Catalyst: Sector rebound (commodities), M&A, product launch, also sector recovery but for i. e. shipping cycles, temp/short term mispricing/overreaction to small underperformance (see KROS dec 2024)
Step 2: Check option availability and pricing:
Use following criteria in addition to the option being 15-30% ITM:
1. Delta 0.6-0/8
2. Theta in accordance with ideal values in PK Definitions – so less than 11.8% compounded over 6mo, 22.2 over 12mo, 31.4 over 18mo
3. Vega less than 1 percent of premium – max 2 if option seems otherwise very attractive
4. Gamma should be 3% or less (see PK Definitions for how to calculate Gamma percentage)
5. Expiry, as said before, in after 18-30 months of issuing date; partially also as to keep the maximum amount of extrinsic value one wants to sell 6-9 months before expiry
6. Intrinsic and extrinsic value should be min. 65 and max. 35% respectively (int.>ext.)
7. Premium equal or smaller than one 5th of your option Portfolio which shouldn’t be in turn more than 30% of your common-stock part of your Portfolio
8. IV (Implied Volatility) should be below either a) that specific Calls past average or b) below or at that of other options of same maturities’ (moneyness doesn’t matter here)
Final note for step 2: **It is extremely important to remain in net compliance with these filters, which serve to reduce risk but do not remove it entirely. Even when employed by investors, LEAPS are inherently speculative instruments; although generally less so than aggressive out-of-the-money strategies, which are often stereotyped on Wall Street, LEAPS nonetheless carry risks that the lay investor may not fully appreciate. For example, our two-percent upper limit for Vega is deliberately aggressive and should be applied only by those who are highly confident in all other factors of the transaction. An investor who relies upon liquidity, or whose financial position is highly dependent on such instruments, is best served first by refraining from these transactions altogether; and if one chooses to engage, by applying the filters conservatively and exercising disciplined skepticism in all potential transactions. This guidance is not intended to discourage capable investors, but rather to limit potential losses for those who could otherwise incur substantial harm through participation in these by nature speculative transactions.**
**Here we refrain from saying “trades” and instead use the word “transactions” as “trades” may give the investor false expectations from his undertakings as they are not purely speculative, but have an investment-type factor in them**
Step 3: Execution, monitoring and in the exceptional case, shortlisting
Execution: For a last check, give the options found by you to your financial analyst for a second (qualitative and in-depth) opinion. If it/they check out, buy all (or the best 5-6 if capital for more is missing, see step 2 – premium) and now
Monitor: their Premium and Share Price. Also keep a look out for steep Gamma increase/Delta decrease and the Catalysts current stage and whether it is invalidated
Reconsider (negatively) if a) **stock price** goes down 20% from date of buying option, b) catalyst is in light of current events vague/cancelled/delayed further than 12 months before expiry (in case of M&A), c) any of the Greeks break through our thresholds (here we emphasize that the ones in step 2 are meant as they are in themselves extremely aggressive), d) **company’s financial situation** degrades, which implies a deteriorating business, e) **the option’s moneyness** transitions to near-ATM or even OTM through substantial stock decline or other factors or f) liquidity detoriation in option chain – this may make exiting your position difficult and may remove profits as bid/ask spread widens
We shall refine points a) and b) here:
For a), the option should not get sold instantly, instead, the investor will reevaluate following points: 1. Catalyst still relevant; 2. Financial position identical or better than it when transaction to buy was made; 3. Decline is sector-wide or driven by short-term volatility which **the investor can explain,** additionally, the investor, for 1., 2. and 3. must do some research as to whether the conditions are to stay favourable until catalyst “happens”
For b), the investor must make sure that the catalyst is 1) not delayed further than option expiry – 12mo and 2) the catalyst has already “happened” without substantial/predicted (relatively) stock growth
Note: **all these points are** ***in addition*** **to the standard valuation, balance-sheet, and business-risk assessments on a “standard” basis employed in common-stock investments**
As for positive reconsiderations: Some are quite obvious, say, a) the catalyst being priced in with a substantial return on the premium of the contract or b) the option’s intrinsic value has reached a **predefined** threshold (say, 80-120%, depending on the investors confidence or attractiveness of issue at time of buying) but then there are reasons such as c) the extrinsic value of the premium being too high for the transaction to remain even half investor-ish, in the case that this increase increased the premium or d) the last 9-12mo before expiry await and possible further gain is not justified through the increased Theta risk in this period. Also, e) the possible further upside is not justified through possible downside (especially for the share price), even if thesis remains intact and finally f) if the valuation of the company as stock or mkt cap becomes unattractive.
As a whole, the investor has inherently more discretion for positive decisions than for the negatives, as he already has substantial gain in a positive LEAPS compared to common stock and will not mind a decline from e. g. +250% to +170% compared to from 80% to 10%
In the exceptional case that the investor doesn’t find \~5 options suiting his needs **perfectly** (here we use the word “perfect” as if the investor is marching right into such by nature speculative transactions (again, I cannot emphasize this more) he shall make sure the conditions are favourable and he has like the Graham-Newman Corp. disclosed in the 1950s a “4 in 5 chance” of succeeding at his quest. This is said very vaguely, but we believe the reader understands what we mean and why we mean it when we say “perfect”), he shall make a list of options that are best suited, but not yet priced quite as attractively as he would like and monitor these closely.
so yeah that’s it
I’m 13 by the way, made this after a week of learning about options
I know that the greeks‘ thresholds are very narrow and finding stocks that comply with all my requests are difficult, that’s why I say „net-compliance“
i made this with my fellow friend ChatGPT but ideas were mine and I wrote it