Options and risk
For those of you that understand options, have certainty of IDCCs buyout or hate for a pompous, self appointed investment advisor (even if well intentioned) trying to save people from themselves, don’t waste your time reading on. However if you are tempted by options and are not experienced in trading them, you may find some thoughts that help you make a better informed decision. If you don’t understand how calls and puts work, how option leverage works, the affect of time and volatility on premiums, you should do some basic research before jumping in.
I suggest you exercise caution when looking at options. I’m not saying they are a bad idea or that you shouldn’t buy options, just make sure you understand the transaction and the potential results. I personally am not going to buy any options. In my situation, it doesn’t make sense. If IDCC goes to the prices needed to make a killing on them, my stock holdings will bring me to retirement wealth, or pretty darn close. So picking up some additional profits, while always nice, wouldn’t have much effect on my lifestyle. However if the prices don’t go to those levels, then I would lose the premiums, and that would be money I need. In addition, I would have to sell some of my stock to make any significant purchase, which I feel would be converting an investment into speculation, which is not for me. For others with different financial situations buying an option “lottery ticket”, or just increasing leverage, might be a rational thing to do.
Be clear on what you need the stock price to do and over what time period. For the far out of the money calls, you are looking IDCC’s share price zooming well over 50% in a limited time period for your options to not expire worthless. This would be on the heels of a run-up of over 50% already. That would be a spectacular performance. If you own the stock, a 50% gain will be a 50% gain, whether it comes next week or next year. With the far out of the money options, a 50% gain in stock price might be a 100% loss. And a 100% gain in stock price could be a 100% loss if it doesn’t come in time. Another issue is that your gains will be short term, taxed at your marginal tax rate, not the capital gains rate, so instead of keeping 85% after federal tax, you may only keep at 65%. So look at your after tax return when considering buying options or stock.
Of course, the upside is huge, and that’s the attraction. So if you have some speculative funds that you want use to try to make a lot of money in a short period, and you feel strongly that IDCC will be bought out at a high price and it will happen soon, then options will provide a huge return and you should go for it. Trust me, I will be rooting for you to make a bundle.
When looking at options investment alternatives, look at the % gain or loss when you do your analysis, not the dollars. If you compare two options with at strike prices $5 apart, the lower strike price will not give you more gain just because you will get $5 more on each share. You have to look at your expectation for the buyout price and then compute your percentage gain or loss based on your expectations. It doesn’t matter what the dollar gain per option is, it is the percentage return. You need to compare investing a fixed amount of dollars, regardless of the number of shares or options, when looking at alternatives. If you are looking for $200 plus share price, the higher your strike price, the better percentage return you will get.
