Why would you buy ETFs that don't pay dividends vs LEAPs?

[murray t turtle]

It's the wholesale swap rate - so the embedded carry in an option is a bit cheaper than you could actually borrow. All expected dividends, if any, are reflected in the Leap value. If the dividend were to change both instruments will reflect it.

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Glad to hear that on dividends;
i like mine actually paid, unless its some tech stocks/ETFs-they pay none.

 

[newwurldmn]

The ETF's might actually be superior. Dividends are reflected in both and the erosion in the leap is the optionality and the carry. Think about it this way - buy the stock and for two years and it does nothing. Pays no dividends and it doesn't move - have you lost money? Of course, you have the lost the carry - few ever count it, but it more visible in the Leap. The optionality(Stock+Put+Net Carry=Call Option. The Leap call has an embedded put and the net carry in the price. So the Leap cost a bit more but has an embedded put.

That only holds if you finance better than the OCC. ie you can put the extra cash to work at a higher rate than libor.

 

[ETJ]

Not a lot to do with OCC. It's a comparison of the swap rate embedded in the option and that's a pricing issue - as opposed to what you could have earned on the money if you hadn't bought the stock. Let's say you buy a non-dividend paying stock and hold it for two years and it doesn't move. You can't compare to bills or swaps on that side, because you can't borrow at those rate except via an option purchase. Your opportunity loss if the stock does nothing ain't zero. What return would you require to lend against a risky asset? One could argue it would be the rate of the companies two-year paper if it exists. Two year swap is about 2.35% right now - a stock with a great balance sheet - remember you are looking at the opportunity cost of the entire purchase price - at best is 200bps over and it's locked in with the option.

 

[newwurldmn]

Not a lot to do with OCC. It's a comparison of the swap rate embedded in the option and that's a pricing issue - as opposed to what you could have earned on the money if you hadn't bought the stock. Let's say you buy a non-dividend paying stock and hold it for two years and it doesn't move. You can't compare to bills or swaps on that side, because you can't borrow at those rate except via an option purchase. Your opportunity loss if the stock does nothing ain't zero. What return would you require to lend against a risky asset? One could argue it would be the rate of the companies two-year paper if it exists. Two year swap is about 2.35% right now - a stock with a great balance sheet - remember you are looking at the opportunity cost of the entire purchase price - at best is 200bps over and it's locked in with the option.

When I said OCC, I was meaning the financing rate implied by the option which is like an average of the good banks financing.

The option is going to assume you earn interest on the cash saved (the strike price). If you can’t earn that rate you will be slightly worse off.

 

[ETJ]

I understood the comment. The financing rate is embedded in the option price and as I mentioned it's superior to any rate I - as a user can finance at. Therefore the option is almost always superior as long as I'm willing to pay for the hedge of the embedded put. Plus opportunity cost isn't deductible whereas loss by erosion is if it's a taxable account.

 

[newwurldmn]

I understood the comment. The financing rate is embedded in the option price and as I mentioned it's superior to any rate I - as a user can finance at. Therefore the option is almost always superior as long as I'm willing to pay for the hedge of the embedded put. Plus opportunity cost isn't deductible whereas loss by erosion is if it's a taxable account.

The call price is higher because you are expected to earn interest on the capital savings. If you can’t lend at the implied interest rate then the call is worse. A typical retailer can’t lend nor borrow at the implied rate. Not that these are normally significant issues.