Leverage: the Good, the Bad and the Ugly

By: Dudley Baker | Thu, May 10, 2007
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In a perfect world all investors would make correct decisions and all leverage would be good leverage. Yea right, none of us are perfect and frequently our investments and the timing thereof maybe off the mark. Therefore, it is necessary for us to evaluate the different choices of leverage to be used (if any) in our investments.

As timing our entry points are essential, the precious metals markets have us waiting, waiting, waiting to learn if this year will once again be another year for the sell in May and go away. We wish we knew but even the best of the best advisors have differing opinions. Therefore, our approach is to consistently seek out value investments as they come our way, whether they are common shares on the precious metals and uranium companies or long-term warrants, leaps or call options on those companies.

Our basic belief is that we are still in the early stages of a long term bull market in the precious metals and yes, we are including the uranium shares in this category. No doubt there will be numerous consolidations before reaching a peak in the coming years and our resolve and your resolve will be tested over and over again. In my gut, I feel there will be at least one incredible shakeout which will scare the hell out of all of us. Will we have the courage, strength and belief to stay the course? Remember, the markets will do their best to shake us out at the bottom and suck us in at the top.

We suggest that investors shy away from the use of margin accounts. Remember last summer?

This game of investing is dicey enough without the use of margin and we put margin accounts in the category of the ugly leverage as the downside risk can be very nasty, i.e. total loss of your investment dollars.

So let's take a look at what we call the good, the bad and the ugly.

Good Leverage

Some investors would believe that investing in the common shares of the precious metals companies or uranium companies would be leverage enough. But we encourage you to explore the use of call options, leaps and warrants, preferably long-term warrants in your investment decisions. This will require you to evaluate your personal time horizon for investing.

If you are a short-term investor, you may prefer to focus on the call options or warrants which are expiring within one year. More risk, but more reward, if you are correct.

For those investors with a minimum of 1 year or more time horizon then leaps and long-term warrants on some of your favorite companies may be the way to go. Now, you have time on your side and in the event of a consolidation you still have time remaining on your leaps or warrants. Some of the leaps have expiration dates out about 2 years and there are now many warrants being issued with a 5 year life.

Of course investors using either call options, leaps or warrants or looking to increase their leverage and thus achieve substantially higher returns on their investment dollars.

Bad Leverage

Have you ever made a bad choice of securities to purchase? Of course, we all have made numerous mistakes in our judgment and timing our entry points. The first consideration in the use of leverage is to ask the question, leverage on what? What companies are you interested in purchasing? You must first make this decision and then look to see if other leverage, call options, leaps or warrants are available on those securities. It's easy enough to understand that if your choice of companies and their common shares do not increase in value neither will any of the choices of leverage.

You have your hard earned investment dollars at risk and if you do not have the potential to earn a substantially higher return through the use of call options, leaps or warrants, then forget it, and just purchase the common shares. This will take doing some good homework on the front end.

Ugly Leverage

Very simply, any use of leverage where we actually lose our entire investment or even 80% thereof is frankly just ugly. We do not like to lose and we do almost anything to avoid being in an ugly situation. When using call options, leaps and warrants, it is always necessary to be aware of the expiration dates and exit your positions well before to avoid a total washout of your investment. As mentioned above, we include margin accounts as ugly leverage for as we all know from experience a winning trade can quickly disappear and turn very ugly.

In conclusion, the use of leverage requires making decisions based upon your personal investment time horizon and the amount of risk you are willing to take.

For more information on the use of warrants, we invite you to visit our website and for information on options and leaps, visit the CBOE.

For subscribers, we furnish a complete listing of all natural resource shares having call options, Leaps and warrants in a simple to read table format.



Dudley Baker

Author: Dudley Baker

Dudley Pierce Baker
Founder/Editor - Guadalajara/Ajijic, Mexico
A Market Data Service for Warrants

Dudley Pierce Baker is the founder and editor of Common Stock Warrants and its predecessor, Precious Metals Warrants and a 1967 graduate of St. Mary’s University in San Antonio, Texas with a major in accounting.

Disclaimer/Disclosure Statement: CommonStockWarrants.com is not an investment advisor and any reference to specific securities does not constitute a recommendation thereof. The opinions expressed herein are the express personal opinions of Dudley Baker. Neither the information, nor the opinions expressed should be construed as a solicitation to buy any securities mentioned in this Service. Examples given are only intended to make investors aware of the potential rewards of investing in Warrants. Investors are recommended to obtain the advice of a qualified investment advisor before entering into any transactions involving stocks or Warrants.

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