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Author: globalist2013 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35339  
Subject: Time Premium Date: 3/21/2013 1:44 AM
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In finance, the time value (TV) (extrinsic or instrumental value) of an option is the premium a rational investor would pay over its current exercise value (intrinsic value), based on the probability it will increase in value before expiry. For an American option this value is always greater than zero in a fair market, thus an option is always worth more than its current exercise value. http://en.wikipedia.org/wiki/Option_time_value

Bonds aren’t truly options, though they share many features with them. One of these features is that a bond can trade at a premium to its value at maturity -- assuming it will mature -- and therein lies the rub. When is it better to grab the premium than to wait for maturity, especially a maturity that could be problematic? Well, as always, for every situation there’s a trader’s proverb, and the proverb goes like this. When in doubt, get out.

Here’s the situation. Chesapeake is tendering for their 6-7/8's of ’18, offering an incredible 745 bps over par for them. On a five-lot (which I have) the reorg fee will knock that down to 106.85, which is still a hefty prem. I did my entry just over a year ago at 81.095. If I exit, my YTM over my 1.2 year holding-period bumps to 31.6%, versus an 11.0% YTM over the remaining 5.4 years to maturity. But if I tender, then I face the problem of trying to put that money back to work in a market that is increasingly over-bought.

At 5% inflation, the discounted value of five bonds 5.4 years from maturity is $3,842, right? versus their tendered value right now of $5,342. Also, an income-stream would lost, having a discounted value of approx. $1,627. So the choice is between two fairly comparable, discounted values, $5,342 for the tender and $5,469 for waiting for maturity (assuming no reinvestment of monies in either case). The bond numbers and my instincts tell me to get out.

The stock numbers are even more emphatic. CHK closed at $22.49 on my entry-day, 02/24/12. Today, the stock closed at $20.88. In other words, betting on the stock, rather than the bond, would have lost you money. One of TMF stock touts just happened to recommend CHK in an inane article entitled, Will Chesapeake Energy Help You Retire Rich? http://www.fool.com/investing/general/2012/07/11/will-chesap... That article was a follow-up to an earlier one, Is Chesapeake Energy the Right Stock to Retire With? http://www.fool.com/retirement/general/2011/07/13/is-chesape... I’ll leave it to you to draw your own conclusions as to whether such touts are ever worth reading.

Once, I took the time to go through that person’s recommendations. Predictably, they were no better than a coin-flip. So here’s exactly how you, too, can become a Foolish stock picker. Throw a dart at a page of stock quotes. Wherever it lands, buy lots, then concoct a story about the stock's prospects and hold on to it until the story becomes true. But if you want to buy bonds, dart-throwing isn’t going to cut it. You’ve gotta be able to do credible research, as well as size positions and time entries/exits. But those are just minor details, right? hardly even worth mentioning.

Why those who can’t make a living from their own investing want to tell others how to invest is beyond me. Worse, why anyone would act on the recommendations of those amateurs is even harder to understand. The spelling of those articles is impeccable, as it their grammar and punctuation. Too bad so little else about them is correct or of value.

Charlie
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