Tuesday, January 27, 2009

Covered Calls

I know this is a non-stock blog, but I know most of you are most familiar with stocks. And, you probably have a lot of stocks that are stuck at these low points and are not moving much that you didn't sell when the market crashed. One way to make a little extra money is to sell covered calls. This is only good if you think the stock is not going to go down much or will either stay the same or go up. In order to sell a covered call, you will need level 2 access from your brokerage which is easy to get, most of the time you just have to fill out a form.

Let me give you an example of a covered call.

Say you own the stock TER (Teradyne, a company I used to work for). Say you bought it at $7. On 1/27 the stock was trading at $5.09. Now you are $2 in the hole. You probably don't want to sell it because you think it might go up. Now the stock has not moved much in the last month or so, and you are not sure what to do. So you probably want to sell it the next time it goes up or you could sell a covered call.

If you look at the options for TER, you can see that the February $5 call option is selling for .50. What does this mean? A call option is a contract written by a seller that conveys to the buyer the right — but not the obligation — to buy a stock. So if you buy a $5 call option, you have the right to buy the stock at $5 no matter what the price of the stock is. The option usually expires on the 3rd Friday of the month. Now I have learned that you don't make money buying things, you make money selling things. So, what you should be doing is selling the call option. When you sell the option, you collect the .50, or what is called the "premium."

So if you own 100 shares of TER, you can sell 1 call option (1 option gives the right to buy 100 shares). So say you sell the .50 Feb $5 call. You will get .50 upfront. So let's see what happens:

1) If the price of TER is $5.25 on 2/20 (3rd Friday) the option will execute and the person who bought the option will pay you $5 per share. So you would have gotten the .50 plus $5 for a total of $5.50/share.

2) If the price of TER < $5 on 2/20, the option will expire worthless and you can keep the .50 that was paid upfront. Of course, you would have lost money on your shares. You can always sell the option again for the next month.

3) If the price of TER is $6 on 2/20, the option will execute and you will be selling your shares for $5.50.

Now, once you sell a call, you cannot sell your shares unless you buy back the call. So if your stock is tanking, you need to buy back the option. Of course it will be cheaper than when you bought it. An option will be more valuable if the market thinks that the price will move, this usually happens before earnings come out. Also, you will receive a higher premium if there is a longer time to expiration. There is a lot more to options, but this is a good way to start. If you have questions, let me know.

Sunday, January 25, 2009

Prosper

Prosper is a site that I was skeptical at first. But it's one of the only places that I have made money on. Basically you deposit some money in a Prosper account and you loan it out to people, you are like a bank. People will present their reasons why they need the money (starting a business, paying off other loans, etc.). Prosper also gives their own credit rating to the person based on their credit score and other items. Since I was skeptical, I only put $500 and made 15% which is great. I wouldn't recommend putting a large amount of money, but around $1000 would be good. Prosper isn't accepting new lenders right now since they are doing some type of filing but should be accepting them once the filing is done. Something to try out....I have to give credit to Tony Thomas (my best follower) since he introduced me to this site.

Sunday, January 18, 2009

Some good links

Every now and then I'll find some I'll find some good articles worth posting. Here's 2.

6th Post - Gold

A very tempting choice for a lot of people right now is Gold. Currently gold is selling for $843 an ounce. You will hear a lot of gold salesman coming out right now since gold usually sells well when the economy tanks, because it can be a hedge against inflation. They will start making the argument that the fiat currency such as the US Dollar is going to die and gold will reign supreme and we will go back to the gold standard. Even though I think going back to the gold standard might be a good idea instead of having faith based money as we do now, I don't see it happening since the banks would hate it. I see a lot of analysts saying gold will be going over >$1000. See example here. They will give you lots of reasons why gold will go up. Some of these reasons are valid and some are not.

Why I don't buy gold.
  • Gold is a speculative investment. It is exactly like a stock, it can go up or down. Gold was $999 in March and $720 in November 2008. There are no dividends associated with gold.
  • Buying gold is not simple. You can buy physical gold, but then you have to store it and keep it safe. You can buy ETFs. ETFs usually store gold as backing, but they might not have enough so if the ETF does go bankrupt, you may or may not get your portion of the gold. One popular ETF is GLD. There are different types of gold also.
  • I don't understand it properly. As I have said in my previous posts, I like to buy hard assets, and I would consider gold a hard asset. However, unlike real estate which I understand, gold is very complicated and there are many ways to buy it, and many different forms of gold to buy. The easiest would be an ETF, and that is what I would recommend since that is the easiest to buy and sell, but if you are thinking that the US govt will go bankrupt, maybe the ETF might not be the best in that case, you may want to actually buy physical gold. Here is a good place to inform yourself about gold. The site is also biased since they are promoting gold, but they do describe the differences in gold. Not understanding something is not a good excuse not to buy, since you can always educate yourself, but for me I find it just too speculative for myself.
If you feel gold will go up and decide to buy it, just make sure you educate yourself before buying it. One word of advice: Be weary of buying it when it is the "hot" product as it is right now.

Update on Gold 2/20/09. Gold hit $1000 an ounce today. I don't know if it is too late to buy, be careful if you do. In the short term, it does seem that it will go higher as the economy keeps tanking.

Sunday, January 11, 2009

5th Post - Future of Stocks

Here are my thoughts on the future of stocks. Now, like I have stated before, nobody knows what is going to happen in the future, so my guesses are as good as a monkey guessing what is going to happen in the future. I normally would not put credence into many of the theories about the future of the market, especially ones that say everything is going to crash. But it seems that everything that had less than 1% of happening are now happening. Who would have thought last year that Lehman Brothers and Bear Stearns would no longer exist. I had never checked to see if a bank was FDIC insured before, but now I do. I just want to point out a couple things that I have read about.

  • Baby boomers retiring - This one comes from Robert Kiyosaki. He believes that as more people retire, they will take out money from the market. He says the law says that 401k have required distributions and when you sell the market goes down. He says that after 2016 (I think) more people will be taking out money than putting money in, causing the market to fall. Now, this makes sense to me. The only problem I have is that he assumes that all the money that comes out will not go back into the market once it is distributed. Another reason this may not come true is that we now have a large amount of international money coming in the market from sovereign wealth funds. I don't know if that will blunt the effect of the required distributions but it is something to think about. Also, I have heard rumors that with the recent downturn they may be changing the rules requiring distributions and it is possible the government might let people keep money in their retirement accounts.
  • 40 Year Cycle - This one is a little out there, but it seems to have come true in the past. It seems every 40 years the market crashes. And it looks like from year 36-40 of the cycle is the worst part. The last crash was 1974, so that makes 2010-2014 the worst of the next 40 year cycle. If this is true, Obama is going to have a tough time. I like the 3rd chart that the link shows. Click here for chart.
  • The Obvious - There are also the obvious reasons why the market will go down. I have heard that we still have a commercial real estate crash and a credit card crash coming. And then there is the inflation that is coming with printing all this money. We'll see what happens.

4th Post - My views on Stocks continued

I want to make a couple other points about stocks that I want to continue from my last point.

  • Timing. Another point I want to make about picking stocks is that you may know that a stock is going up, but you don't know when. A lot of people knew that housing and banks would crash, but the problem is they did not know when. There were a lot of hedge funds who shorted the market in 2006 and 2007. They foresaw the crash but instead the market went up to an all time high in Oct 2007 and the shorts got killed. Of course, it crashed after that. Another variable that makes it hard to predict stocks.
  • Wall Street likes to sell. I read an article (see link below) that made remember that even when times are bad, wall street needs trades to happen in order to survive. That is why you should be very weary of analysts saying there is a 2nd half recovery. They need money back in the market in order to survive. They could be right, but you should remember that nobody knows what is going to happen. Take a look at the quotes in this article.
  • Fraud. Another reason why it is dangerous to pick stocks. Just now, Satyam Computer Systems got caught for fraud. I don't know how this got past the PWC, a big 4 accounting firm. The company added $1Billion dollars to their financial statements. Now, auditing cash is very easy, you look at the bank statement and you see if they match. How that got past the auditors I do not know. Now, from an investment point of view, say you did your analysis and looked at their financial statements, and picked Satyam. Now, if you cannot trust a company's financial statements, especially something as simple as cash, I am not sure how you can invest in any stock. Now, this also goes against my argument for bonds, since fraud can also affect bonds. This is true, you could lose your money investing in bonds in the case of fraud, but you do have a chance of getting some money back, unlike stocks which you will probably lose all your money. Now, for bonds you can also invest in high yield bond ETFs or funds, that way you can diversify your risk. Here's an article that makes some suggestions.

Saturday, January 3, 2009

3rd Post - My views on stocks

I would like to tell you my view on stocks. I used to invest almost exclusively in stocks. Stocks are one of the easiest investments to invest in and also the easiest to lose. I have recently moved from most of my money from stocks to investments that are backed by hard assets or contracts such as real estate or bonds. Stocks I have learned are what I like to call an intangible asset meaning that other than cash, the rest of the value of the stock is based mostly on future cash flows. This makes them hard to give a valuation on and easy to get wrong. I am not saying don't invest in stocks. I am saying do not be a stock picker. If you want to invest in stocks, by an index fund/ETF or a mutual fund. One thing I do not like about funds is that they are trying to beat a benchmark. I would rather have them try to beat a benchmark AND be profitable. Instead of a fund being happy that they only lost 10% instead of the 30% the benchmark that they compare to lost, I would rather have them sell everything and not lose that last 10%.

I would like to make a few comments/observations on stocks and why it is hard to pick stocks.

1. This is what usually happens to me and most investors. You pick a stock that you think is going up for whatever reason. Just by picking the stock you have a 50/50 chance that it will go up or down. Say you pick correctly and it goes up. So you bought it for $100 and now it is $200. What usually happens is you sell it take your $200 and use it to buy another stock. This time however, you guess wrong and the stock goes down and you lose most of your $200. This has happened to many investors and I do not think it is possible for most people to get it right enough times to make money over a period of time. Even the best money managers who were good for the last 10-15 years, eventually got it wrong and lost all the money they had made. Here's an article on Bill Miller.

Its almost like flipping a coin. You can guess right 10 times in a row, but on the 11th you may lose.

2. How to pick a stock. I, like so many have picked stocks that are 5 star rated, picked by Jim Cramer, passed a stock screen, but it still goes down. Why? I have learned that there are just too many variables that make a stock go up or down to keep track of. For example, say you want to buy a solar stock. So you read a bunch of analyst reports, listen to Cramer and buy the best of breed, do a stock screen for a low P/E ratio. So at the end of the day there are 2 stocks left. You pick one and buy it. Now what happened in Oct/Nov 2008 is that because some banks had worthless mortgage back securities, your solar stock goes down because of the credit crisis. Now, in order for you to have forseen this, you would of had to do research on banking and housing stocks. Now, I find that very hard to do and even to know that you need to do it. There seems to be an infinite number of variables when investing in stocks.

3. What is the value of a stock? I kept reading that $2 trillion worth of money was wiped out in 2008.
Now, this is not really true. For example, say the stock price of Apple is $100 and say there are 1 million shares outstanding for example. That would make the market cap $100 Million. Now, if you sell 50,000 shares the price of Apple will probably go down to $99 or $98. This happens because there are not enough buyers at $100. So if you want to sell 50,000 shares, maybe 25,000 will go at 100, 10,000 at $99.5 and 15,000 at $99. So the $100 is really the maximum someone is willing to buy it for which means that the market cap of $100 million is not really true. The only exception is when a company buys another company, they usually pay a premium to the existing market cap.

There was a period from 2003-2007 where the market was up 100%. In the last 10 years, though there is around a 1% return, they call this the "Zero Decade." They say that the first year after a recession is over is the greatest gains for stocks. I moved most of my money out of the market and into bonds. But what I am doing is maximizing my 401k and currently buying stock mutual funds at low levels. This way if there is a rally I am going to take part in it. All my other money is in bonds. I do plan to take it out of the market once it goes up 30% or more, maybe when the DOW is over 10,000 again. My next post will show some theories about the next 10 years.

Friday, January 2, 2009

2nd Post - Corporate Bonds

Corporate Bonds

This is probably one of the best investments going right now. I have put a majority of my money in corporate bonds. Why do I like them? With the market going down, a lot of corporate bonds of good companies are selling from $500-$800. The coupons on these are >5% and the yield to maturity is from 10-15%. Sometimes you can find the YTM >15%. This is better than any CD you will find. Bonds are better than stocks in that if a company goes bankrupt, there is still a chance that you can still get your money back. Here is the rating of bonds.

Bonds can be bought through any brokerage account (Etrade, TDAmeritrade, etc.)

There is a reason that they are selling cheap in that the company might go bankrupt. I tend to stay away from bank, auto, and housing companies. These are where the greatest gains or losses occur. People who bought Bear Stearns were lucky when JP Morgan Chase bought them. The bonds were selling at or below $500. When it was purchased, Bear Stearns received the credit rating of JP Morgan and are now selling at $800 or higher. People who owned Lehman Brothers were unlucky and were practically wiped out when they went bankrupt. Here are things I look at before buying a bond.

1. Buy a bond below $1000. I like to buy bonds in the $700 range. The bond will go to $1000 when it matures.

2. I try to buy energy companies. They usually are more stable and have real assets so they have a greater chance of getting bought instead of filing for bankruptcy. Telephone and food companies are good also. They are recession proof.

3. Have a market cap of $1 Billion or more. If this is true, the company is probably big enough and will not file bankruptcy before the bond expires.

4. Have a maturity date in the next 10 years or less. I don't like to make long term commitments in companies I am not 100% familiar with.

5. YTM > 7%. You can usually find CDs for 4% so I want more return for the risk I am taking.

6. Buy an investment grade bond, usually BBB or better.

Other things to note: Minimum quantity to buy. Usually most bonds are 5. It is possible to lose all your money since they are not insured.

I have noticed lately that with the market going back up, the bond prices have also gone up, so you may not see the >15% YTM anymore. That is the problem with any investment idea, once everyone knows about it, the profit is squeezed.

Here is an example of a bond that is currently available that I like (not a recommendation).

CUSIP:86722TAA0
Suncor Energy is a $18B energy company. Its bond has a coupon of 6.1 and YTM of 7.6%. It is rated A-. The price is $90.

I hope this helps explain why I like corporate bonds right now. If you have questions/comments please add them to the comments and I will address them.

Thursday, January 1, 2009

First Post!

Welcome to my first blog and the very first post! I hope this blog is useful for you and others.

Purpose

What is the purpose of this blog? This blog is meant to give alternative non-stock investment ideas to the average investor. By average, I mean the average person who has gone through the last 10 years trying to invest money in the market. These are the investors (like me) who have listened to all the analysts on CNBC, read news articles, tried different stock investment strategies, bought and sold stock, and after all that ended up losing money. This year made me realize, more than what I learned in 2000, that even the analysts and experts really have no clue and the market is a gamble. This blog is for people who believe stocks are not for them. I am not recommending not investing in stocks. I want to provide the reader with alternative investments to stock and help with their investing strategy. I read a large amount of financial articles and would like to share what I learn with you. I am not an expert myself, but I want to provide my thoughts on what I believe does WORK and is currently working for me. There is a risk that you may lose some or all of your money, and that is a risk you take with ANY investment. I am not a professional money manager and I am not recommending anything, I am just sharing my viewpoints.

I will try to have a new investment idea, strategy, or viewpoint with each new post. Since new investments do not come everyday, I will not blog every day. I do not want this blog to be a discussion on financial news. I also want to post some interesting links. Also, if you have questions/comments, please feel free to post. I am not sure who will be reading the blog and what their financial expertise is, so if there is something I write about that you don't understand, please let me know.

Basics

Money used on these alternative investments should only be used with your "extra" money. This is the money that is leftover once all the basic expenses listed below have been covered.

1. Have enough money to cover 6-12 months of expenses in Money Market/CD.

2. Have an IRA and make yearly contribution

3. If you have kids, contribute to 529.

4. Maximize 401k or at least get company match.

5. Buy a house to live in if possible.

6. Cover any other obligations you may have (Credit cards, etc.)

So let's start with my first and best alternative investment...corporate bonds. See next post.