After reading Joel's earlier book "You Could Be A Stock Market Genius," I came up with another possible way to leverage the MFI (see my post on using margin to turbo-charge your returns below). One could leverage the Magic Formula with LEAPS. As Joel explained in his earlier book, LEAPS are option contracts that typically have very long expiration dates (as long as 2 years). The benefit of LEAPS -- like all options -- is that they are highly leveraged. Leverage, of course, works both ways. Still, I've thought about using the MFI to identify top companies, and then investing in LEAPS.
Any thoughts?
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3 comments:
Good thoughts. One thing: based on my limited experience, this'll probably limit you to the larger-cap side of the magic-formula stocks, for good or ill. I've had a hard time finding options on a lot of smaller-cap stocks.
I have been thinking on the same lines for quite sometime. However, you do realize that if the price of the stock falls below the strike price, you lose 100% of your investment. On the flip side, the ones which are profitable will make lot more money.
One negative with this approach, I believe, is if the market tanks by a big percentage say 20%, ALL the leaps will become worthless. If you have regular stock, your portfolio will only drop in the range of 10-40%, but it will not go to zero.
I was thinking on the lines buying S&P put options to hedge for the potential losses.
- jaysrao@gmail.com
Excellent points. The problems you have identified are the dangers with leverage. LEAPS allow you to more heavily leverage your investment -- far and beyond what you could do with a margin loan. However, you can buy LEAPS that are heavily "in the money" so as to minimize the extent to which you are leveraging your investment.
Thanks again for the great posts.
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