Buying Options as a Way to Buy Time

A Call in Financials

Let me walk you through an example, using Marshall & IIsley (MI - commentary - Cramer's Take). This is a banking concern with over 300 offices primarily in the Midwest, although it does have exposure to the troubled Florida and Arizona regions. It has not been hit by the massive write-downs from subprime loans, as it has not made any.

The company has excess capital and is buying back stock. It has the same problems with residential and construction loans that every other bank in the country does, and the shares trade at $25, down form a 52-week high of $50. The shares are cheap at less than seven times earnings and just below book value.

Right now, to buy 1,000 shares I have to put up $25000, or else put up $12,500 and pay interest on a margin loan. If I buy the January 2010 $22.50 call options, I am paying just about $6,000 to control the same 1,000 shares for just over 18 months. I give up the generous dividend to use the LEAPS, but I gain over four times leverage without paying any interest. I have purchased a lot if time for very little money.

Since I used in-the-money options, only about $3.50 a contract is time premium. True, if the stock goes below $22.50 and stays there, I lose the premium I paid. But that is all I can lose. If something goes horribly wrong and the stock goes into the teens, all I can lose is my premium. In the meantime, I have a long time for the price to recover, a takeover to occur or any one of a number of good things that takes the stock over my implied cost of $28.50.

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At the time of publication, Melvin had no positions in stocks mentioned, although positions may change at any time.

Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.