By Justice Litle
Joel Greenblatt has one of the best investment track records in
history. His hedge fund, Gotham Capital, is on record with average
50%-plus annual returns for more than a decade.
Those returns are even more impressive because Greenblatt didn’t earn
them by using fast-paced trading or leverage. Instead, he is a
dyed-in-the-wool value investor.
In his book You Can Be a Stock Market Genius,Greenblatt lays
out some of the strategies he used to generate these extraordinary
returns. One of those strategies is using LEAPS, which stands for
“long-term equity anticipation securities.”
Put simply, LEAPS are a special type of call option with a long-term
shelf life. (Puts are also available.) LEAPS are available on hundreds
of securities and can extend out as far as 30 years.
A big advantage of LEAPS is that they allow you to benefit from price
movements of a large amount of stock with a modest amount of capital.
Instead of buying $10,000 worth of shares, for example, it is possible
to buy just a few hundred dollars worth of LEAPS and still have similar
profit potential.
Better still, this smaller amount becomes the maximum amount of money you can lose if your investment goes against you.
So if investor “A” buys $10,000 worth of stock — tying up a large
portion of capital and exposing himself to downside risk on the entire
amount — investor “B” can use LEAPS to enjoy comparable upside
potential with a fraction of the capital and a fraction of the downside
risk.
Greenblatt describes how he used LEAPS to profit from a bullish
investment situation in the early 1990s. Wells Fargo, the mortgage
behemoth, was trading for $77 per share, having suffered through one of
the worst real estate recessions since the 1930s.
In fact, in 1992, things were so bad in the commercial real estate
market that investors were wondering whether Wells Fargo would survive
the downturn. Even if it could have rebounded modestly, Wells Fargo
stock was so depressed that the share price could have easily doubled
over the course of a year or two.
There was just one problem. What if some hidden risk lurked on the
balance sheet? What if the depressed share price was justified? How
could Greenblatt protect his downside, while still capturing a big
upside move?
Greenblatt decided to invest using LEAPS…
He later described the Wells Fargo LEAPS investment as “a great
chance for a double with a remote possibility of disaster.” LEAPS
allowed him to catch the upside if he were right. But even if he were wrong, the risk of the LEAPS position was limited to the cost of his purchased options.
As it happens, Greenblatt was right about Wells Fargo. And his LEAPS
investment was a home run. Wells Fargo shares more than doubled. But
Greenblatt’s LEAPS did even better. They returned in the neighborhood of
500%.
Not all LEAPS will deliver these kinds of returns. But they are an excellent way to lower your capital costs, reduce your risk and boost profit potential.
In Strategic Wealth Report, this is exactly what we strive
to do. I use the power of LEAPS to exploit compelling investment ideas
and major long-term trends.
If you would like to find out more about LEAPS, look for my special report on the subject (coming soon).
Carpe Divitiae,
Justice
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