Dow Jones Reprints: This copy is for your personal, non-commerical use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool on any article or visit www.djreprints.com
Warren Buffett reportedly thought to invest in Bank of America while soaking in his tub. He then called the bank's chief executive, Brian Moynihan, who probably now believes in divine intervention, if he didn't before.
Buffett got a sweetheart deal. Moynihan, whose credibility was waning as fast as investors were buying puts that would surge in value if the bank's stock fell below 2.50 a share, got the seal of approval for BofA from the world's most successful investor.
Naturally, Bank of America (ticker: BAC) rallied, ending the week at $7.76 a share, after gaining better than 10% on the week. The stock's implied volatility fell to around 90% from 124%, which means the shares now are priced as only twice as risky as the entire financial sector, rather than three times so.
The news of Buffett's latest buy has spread far and wide since breaking Thursday morning. Almost every conceivable story angle has been exploited. The simplest, and truest, is this: Buffett does what terrifies others. Unlike most investors, he acts decisively in the face of fear.
These days, the options market in general is drenched in fear. Many investors have bought bearish puts on stocks to hedge their long positions. As this column has stated before, it is a good time to invest in equities, especially mega-capitalization stocks with hefty dividends. Selling puts is a cost-effective way to buy them. Two weeks ago we even encouraged investors to buy Bank of America, as market sentiment was too pessimistic. Dare we hope that Buffett was reading The Striking Price in his bathtub?
LIKE BUFFETT, INVESTORS WITH multiyear time horizons should use fear to their advantage. Consider two strategies: the half-and-half and the risk reversal.
The half-and-half balances the potential reward of buying stocks with the risk of buying while the market trend is uncertain. If you want to own 200 shares of a stock, buy 100 shares and sell one put. If the stock is put to you, you'll buy more shares, but at a lower price. In addition, you will have earned the premium on the put sale. The risk: The stock races higher and you miss the gains from the shares not bought.
Consider the strategy as applied to AT&T (T), which recently traded at $28.47, with a dividend yield of 6.1%. An investor seeking to own 200 shares could buy 100 shares outright and sell the January $27.50 puts for $1.71.
If the stock is put to that investor because it falls below the put's strike price, the investor will buy an additional 100 shares at $25.79. This effectively lowers the average price of the 200 shares to $27.13 each.
RISK REVERSAL ENTAILS SELLING out-of-the-money puts and buying out-of-the-money calls. The strategy monetizes "skew," or the difference in implied volatility of out-of-the-money puts and calls. Sometimes, high skew makes it possible for investors to profit by speculating on a stock's rise.
Consider NetApp (NTAP), which recently fetched 37.70. At that price, JPMorgan's derivatives strategists recommended that clients buy the stock's December $40 calls and sell December $36 puts. If the stock rallies above 40, those investors will make money. If it falls below 36, they buy the stock at that cheaper price. JPMorgan expects NetApp to hit 55 by December 2012.
The risk reversal is a trader's strategy. It takes advantage of put and call pricing discrepancies. The half-and-half helps investors build positions in particular equities. Though the strategies differ, they both are aimed at nervous buyers.
Still fearful? Take a bath. A better idea might strike you.
Comments: steve.sears@barrons.com; http://twitter.com/sm_sears
This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com
Yahoo! Buzz
MySpace
Digg
del.icio.us
NewsVine
StumbleUpon
Mixx
The producer of key crop nutrients stands to benefit from a growing global population and limited arable land.
With the luxury jewelry retailer posting strong quarterly results and raising its forecast for the year, we expect the stock to shine.
Atmel and Cypress Semi have more opportunity than the market thinks.
Disruption in Nokia leaves an opening for the BlackBerry maker.
Credit Suisse suggests advantaged equities such as Chevron.
The apparel firm will see earnings hurt by oversold accessories.
The market is a snake pit, but a dose of generic-drug giant Teva Pharmaceutical could help rehabilitate your portfolio.
The billionaire's Tracinda Corp. sold 20 million shares of the gaming firm.
Though a Ticonderoga analyst cut his price target on the sector, he sees 25% upside for select stocks.
The communications-equipment vendor may be the overall gainer for the year.
Companies that want to grow their sales in this economy had better be able to steal customers from rivals. (At SmartMoney.com.)
The market obviously was happy to shelve any anxiety for several weeks, anyway, as to what the Fed might or might not do.
America might run on Dunkin', but investors aren't likely to get rich buying Dunkin' Brands' pricey shares. There are better bargains elsewhere in the restaurant sector.
Bank preferreds were given a big vote of confidence last week by Berkshire Hathaway's $5 billion Bank of America investment. Eight to consider.
The Fed chief says fiscal policy, not monetary policy, is needed to insure the nation's long-term economic health.
The price of gold could fall by a third from its recent high, but the long-term case for the metal remains intact.
Our Special Report on Independent Financial Advisors points out that independent financial advisors are coping with major challenges in the market: preserving clients' wealth and also seeking returns. Here, we look at how five are doing it.
Go to The Ranking List
Special Report on Independent Financial Advisors finds advisors seem to love the Web-based service HiddenLevers, which provides some of the best "stress tests'' yet for small portfolios.
Special Report on Independent Financial Advisors finds that despite the free online investment material, financial advisors are still paying for good information. Here's a look at what they pick and why.
U.S. stocks posted their first weekly gain in five weeks, even without the Federal Reserve hinting at more quantitative easing. And, why department stores might be the best place for investors to shop.
Special Report on Independent Financial Advisors discusses how the advisor-client relationship can be planned and planned, and still not cover all contingencies. Some ground rules for the inevitable emergencies.
Read Full Article »