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Northern Trust – NTRS Sep10 55 Call – Long

February 14, 2011 By Jared G. Leave a Comment

In 2010, after much paper trading, I finally embarked on a campaign to trade options on my cash account. Over the next several weeks, I plan to report my trades, their results and what lessons, if any, I learned. Whether or not you accept the veracity of these reports does not concern me — these trades illustrate a lot of the things I did wrong, and should be instructive.

My mother used to have a Bouviers named Sebastian; he was a good dog, but he never gave me trading advice ...

August 5, 2010 – At Options Profits, Mark Sebastian suggested his readers buy September calls of Northern Trust Bank (NTRS) with a strike of 55 at .30 or better. His justifications? At around $49, it was trading near its lows (upside move more likely…); the implied volatility for NTRS was relatively low, making the options cheap; following the paper, Mark noticed someone buying a lot of 50 and 55 calls on NTRS; and finally Mark likes NTRS, knows people who work there and likes the institution. Personally, I’ve worked with people from Northern Trust, and also like the institution, but I don’t consider that a great insight on which to base a trading or investment decision. Then again, I’m a computer programmer, not a professional investor/trader.

August 6, 2010 - This was my first trade based on a suggestion from Options Profits. I bought 3 Sep 10 55 calls on NTRS at $0.35. The most I could lose was what I paid for the calls plus the commission for opening the trade, about $120.

August 11, 2010 - I sold my calls for $0.65. After commissions, I netted a profit of $60.03, about 44% in a week.

This was my second trade, and my second “success”. I think I was getting cocky.

What I did wrong:

I seem to remember doing this trade on the day before NTRS announced earnings, and the price going down a bit the next day to $0.25. The point of the trade was not a catalyst-induced price action, so I should have waited to see what happened after the earnings announcement.
I also jumped the gun because I had just gotten my trial subscription to Options Profits and was anxious to let the rubber meet the road. I bought in at $0.35 even though Mark said $0.30 or better.
I was too timid in position sizing for this trade; in retrospect, I should have bought five calls, rather three — the larger a position, the less impact commissions have on profitability.

What I did right:

I set up an exit strategy as soon as the buy order was filled — a limit sell at $0.65. I set it up to cover commissions and still give me a good profit cushion.

I probably left some money on the table for this trade too, but I’m happy with it.

Looking at the price action for NTRS between 08/05/2010 and 09/17/2010 (the expiration date on these calls), the highest that NTRS got was $50.50. The action on this out-of-the-money call was all based on increasing volatility and premium — it never got close to the strike, so there was no intrinsic value to the call, ever.

Sometimes, the paper is wrong.

Filed Under: Trading

My First Option Trade – AAPL Jan’11 270/280 Bull Call Spread

January 31, 2011 By Jared G. Leave a Comment

Apple Dollars In 2010, after much paper trading, I finally embarked on a campaign to trade options on my cash account. Over the next several weeks, I plan to report my trades, their results and what lessons, if any, I learned. Whether or not you accept the veracity of these reports does not concern me — these trades illustrate a lot of the things I did wrong, and should be instructive.

June 29, 2010 – Jim Cramer was projecting a price target of $300 for AAPL, while other analysts were raising their targets to levels like $325. Things looked pretty bullish for Apple, and I thought the back-to-school and the holiday season would bring good news to the company. Apple stock was hovering around $256. Out of the money calls are cheaper than in the money calls, and I wanted to give the trade enough time to develop. Hence I chose call strikes above the then current bid, and the first expiration after the holidays. I paid 29.44 for the Jan 11 270 call on AAPL, and I sold the Jan 11 280 call for 24.94. My debit was 4.5.

I bought ONE spread, and was charged about $15 in commission. Assuming I’d get charged another $15 to close out the spread, I calculated my break-even to be 4.8.

In other words, on June 29, 2010, I committed $480 for this trade, and my profit and loss graph looked like this:

P&L Graph Courtesy OptionsXpress.com

The most I could lose was $450 + $30 round-trip commissions. If AAPL were to close at $274.50 on expiration, I would break even. And if it closed at $280 or better, I would realize the maximum possible profit on the trade $550.

July and August were tough – AAPL price dipped below $240, and the bid on this spread suffered too. But, as I anticipated, September proved to be pretty good for AAPL.

September 20, 2010 – With AAPL climbing, and the bid on this spread at 5.8, I decided to sell on the morning of the 20th. AAPL did close above 280 that day, and in the end I did probably leave about $450 on the table. But I made a tidy profit of $100 on a $480 investment in three months, so I was happy.

I attribute the “success” of this trade to beginner’s luck.

What I did wrong:

I was way too cautious with choosing a spread that would expire in almost 6 months. There were two premises to this trade: the back-to-school season would be good to AAPL and the holiday season would be good. That should have translated to two trades: one that would expire in October 2010; and another that would start in October or November and expire in January 2011.
I sold too soon. With a ten dollar spread between strikes, and AAPL on an upswing (through the short strike of 280 on the day I sold, as it turns out), I realize I lost out on this trade — I made $100 profit, when I could have made four or five times that.
I traded this in the morning. In “Trading for a Living”, Elder says that amateurs tend to trade at the open while professionals trade near the close. By trading in the morning, or even setting limit orders after the close, I am reacting to the previous day’s developments and trends; by trading near the close, pros are one step ahead of amateurs and reacting to that day’s developments and trends. In addition, pros actually set themselves up to take advantage of amateurs’ reactions the next day. By trading in the morning, I am clearly an amateur.
I did NOT do a thorough analysis of “the Greeks” on this trade. Had I done that, I might have found a trade that stacked the deck more in my favor.

What I did right:

I had a good thesis (AAPL would do well during the back-to-school season …) that was substantiated both by fundamentals (low PEG, good cash-flow, high book value, etc.) and by analysts.

On the whole, I am happy with this trade. The lesson I learned from it, “Trade at the close, not the open”, is one I wish I had learned back in June 2010, rather than now upon review, because it would have prevented some of my later losses. I donated the profit earned to a friend who was running for State Representative but … that’s another story.

Filed Under: Trading

Let’s Put An Export Tariff On Natural Gas

December 4, 2010 By Jared G. Leave a Comment

Natural Gas

Jim Cramer is continuing to bang the natural gas drum — I would link here, but the blog entry is on the premium side of “TheStreet.com”. Sorry.

In a nutshell, though, Cramer talks about how South America is becoming a net importer of natural gas and how it’s making sense for places like Argentina to look to the United States for its vast reserves of cheap natural gas to fuel their vehicles. And this could potentially put the U.S. in the almost absurd position of importing expensive oil to fuel our cars and exporting cheap natural gas to fuel other nations’ cars.

Not only will foreign countries be sucking our hard-earned (and now hard-borrowed …) cash as they have for decades, but they will also be sucking away our valuable natural resources, cheaply.

Am I the only one who sees this as a losing proposition for American citizens? In the long-run, this can only leave the U.S. as an impoverished gas-less phantom state. We’re on the losing end of an essentially mercantile relationship.

We need an export tariff on natural gas.

If places like Argentina really start beating on our (the United States’) door for our cheap natural gas, I think the wise thing to do would be to slap an export tariff on it.

There are several reasons for this.

First, the export of no-value add raw materials like natural gas without encouraging local productive value-add and consumption first is how you end up on the losing side of a mercantile relationship. Think about the relationship the colonies had with Great Britain — they exported cotton and wool to the mother country cheaply and were forced to import clothing at expense.

Second, the United States needs the money in order to create the regulatory structure that should keep natural gas extraction safe, and fix things should they go wrong. If we cannot place the cost of such preventative measures squarely on foreigners who want us to risk our quality of life, environment etc, to supply them with cheap natural gas, who would get to shoulder such burdens? The American taxpayer?

And third, not only can we use the proceeds from export tariffs on natural gas to build our own natural gas infrastructure and ultimately also a green tech infrastructure, the relative cheapness of local natural gas without any sort of tax versus the expense of imported energy would work its market magic to hasten our conversion from oil to natural gas. By putting an export tariff on natural gas, we can show that we put American citizens first and will not cheaply sell our natural resources.

Our great natural gas resources present an opportunity to set things right, but only if we use it strategically. Let’s not mess it up this time.

Filed Under: Economic Policy

Two Options Letters: The Street’s Options Profits vs Motley Fool Options

September 2, 2010 By Jared G.

MF Options vs. Options Profits head-to-head

Which is better, MF Options or Options Profits?

I’ve already gone into some detail about the Motley Fool Options service (see Motley Fool’s “4 Proven Options Strategies”). I’ve been subscribed to the service since January now, and am unimpressed. They pretty much have restricted themselves to writing puts and, if the puts are exercised, writing covered calls on the underlying stock. If you have the capital to create large enough positions to make this worthwhile, it’s a good way to get steady returns. There is the occasional bull put/call spread but … where’s the excitement? In addition, the trades are few and far between. Admittedly, it’s been a tough environment so far this year, but sometimes I get the feeling the MF guys are having a hard time finding a bearish or sideways position to take advantage of prevailing market conditions.

In my never-ending search for more excitement (wheeeeeeee!), I came across The Street-dot-com’s Options Profits service, which advertises at least “40 trades a week.” Forty trades a week … yowza! What kinds of trades are they? You name it, I think I’ve seen it at Options Profits — Condors, Iron Condors, Butterflies, Iron Butterflies, Strangles, etc. And I swear they have like nine analysts promulgating options trades throughout the day. Some are better than others.

When evaluating an investment letter, I think there are three criteria that matter:

Tracking/Performance
Initial trade conditions
Follow-through

Tracking/Performance – Why do we read these investment letters anyway? To improve performance? In order to do that, then, we need some way to know how the letters’ recommendations perform. Motley Fool Options has two separate hypothetical (I assume …) portfolios where they follow every recommendation they make. The process is quite transparent.

On the other hand, the fifteen or so analysts at Options Profits are held to no account except, perhaps, reader comments and when (or if …) they report on closing their positions. And rightly so — can you imagine how difficult it would be to track 40+ trades/week? Still, it doesn’t make for a very transparent or accountable site. Here’s hoping that Options Profits institutes some sort of performance tracking, preferably on an analyst-by-analyst basis, in the near future.

Initial Trade Conditions – Some services come up with some really sweet sounding trades. Sweet, that is, until you actually go and try to fill them. Either the spread is too wide or the right conditions for the trade existed for only a split second as the analyst wrote the recommendation. On the whole, the initial conditions for Motley Fool Options trades are easily fulfilled if you’re patient because of the more long term character of the trades — to show how much of a long-term bias the analysts at the Motley Fool have, they recently sent me an update that breathlessly anticipated the upcoming batch of 2013 LEAPS.

As for Options Profits, some of the analysts are very clear on entry conditions while others are a bit cagey. With Options Profits, you have to pick and choose which analysts to follow — one of the analysts there, for example, recently put together a spread and suggested it be bought at $0.10. A couple of days later, the spread was selling for $0.50 and the analyst posted an update saying that people should sell the spread for a profit of $0.30. In the update, the analyst also mentioned, by the way, that he made a mistake in the original post — he said that he should have said to buy the spread for $0.20, not $0.10. With this sort of revisionist trading, it’s hard not to win. This underlines the need to parse everything the analysts say at Options Profits.

Follow-Through or Closing The Trade – It’s great to open a trade. It fills you with optimism that you’re doing something to make money and you buy into the story an analyst has told about the trade. Then things start going sour, and you can wait days, weeks, or months, sometimes in futility, for an update from the analyst to take action. With the transparency and tracking at MF Options, this isn’t really a problem, unless your subscription lapses while you wait for instructions to close. The trades may take a few months to mature, but MF Options does follow-through.

The analysts at Options Profits run the gamut on follow-through, but I have noticed things improving recently. The better analysts there will tell you under what conditions to enter a trade and under what conditions to exit on both the profit and the stop-loss side. This information can be easily entered as limit or contingency orders at your brokerage.

Some people also think education and social interactivity are important, but I don’t see it that way. If you need education, take a class or read a book. Don’t pay for some service to “educate” you — it just should not be a selling point. The people at Motley Fool Options make a big deal about the options education available at their site. Here’s how they answer the education question at Options Profits: http://www.optionseducation.org. That, and also a series of Options Profits TV instructional videos.

How interactive or social are the two services? The Motley Fool of course made their name by establishing an online community of “fools” in the 90′s on AOL, so the forum is an integral part of Motley Fool Options. Unless I have a few hours to kill, though, the forum is invisible to me. Just for the purposes of comparison, I looked for a forum attached to the Options Profits service, but didn’t find one. The thing is, I didn’t miss it. The extent of interactivity, discussion, social discourse etc. at OP is pretty much the comments section to each post. Since it’s a newer service, I think they’re still getting some of the kinks out and they lost most of their comment history a couple of days ago when they switched to the Disqus comment management platform.

The Guys At Motley Fool Options

For its options service, the Motley Fool claims to pick and choose the best stock ideas and theses from among all the other Motley Fool services, and put an options oriented spin on them for the purposes of leverage and hedging. They tend to come up with perhaps one trade a week and there are two analysts whose approaches appear similar. I haven’t seen any sort of option market insiders commentary from these guys, like I’ve seen from some of the Options Profits guys — no “playing the skew” or “following the paper” here.

To tell you the truth, I couldn’t tell the difference in trading style between Jim Gillies and Jeff Fischer, but MF does keep a scorecard on the success/failure of each columnist’s activity.

Jim Gillies – As of August 25, 2010, Jim’s total returns since the inception of MF Options in September 2009 is -5.4%. That’s right, negative 5.4%. Over the same period, the S&P 500 went up 6.1%.
Jeff Fischer – As of August 25, 2010, Jeff’s total returns since inception have been +22.2%.

I think I know whose emails I ‘m going to be reading and whose will end up getting filtered into my garbage folder …

The Analysts At Options Profits

Options Profits has a whole slew of analysts that run the gamut. And each one is apparently contracted to supply at least one trade a day, so you end up with more than forty trades a week stuffing your inbox.

There are a couple of problems with this. First, trying to read all these trades and keep up with them can be akin to drinking from a fire hose. And second, many of the trades are very short-term (sometimes they’re closed within hours, and these guys are not afraid to buy weeklies…) — if you’re not on top of your email and also have your brokerage’s website open, you could miss a good trade or the suggestion to close a position.

My suggestion? Look at the list of analysts and figure out which one(s) fit your sentiment and capital/margin situation.

Skip Raschke – Skip likes to set up limited risk positions that work for traders with limited capital — I don’t recall seeing any significant credit positions coming from him. Just buying some straight calls and puts with the occasional bull call spread or bear put spread. I like his trades; they’re fast, speculative, and based on reasoned technicals and fundamental developments. Although Skip doesn’t necessarily own the trades he describes, he does clearly delineate entry and exit points, and he updates whether or not the trade is possible according to his conditions by posting “The current ask is x. The trade is a go.” type comments a few hours after the post. This means that he is not one of these analysts who creates sweet but impossible trades that can never be executed because the spread is too wide. Skip Raschke is one of the keepers at “Options Profits”.
Terry Bradford - Terry leans to the bear side of things (at least during the month of August 2010, when I had my free trial with Options Profits …), and trades options on the indices. He does have some skin in the game as evidenced by the disclosures at the end of his posts and his updates in the comments. Terry’s trades, entrance and exit points are well-defined and realistic. Sometimes a trade won’t materialize because it doesn’t meet Terry’s conditions, but Terry almost always re-evaluates the situation and adjusts accordingly. Good follow-through and follow-up on trades is always appreciated. On a bearish tape at least, Terry offers some good profitable option trades that don’t require much margin or capital outlay.
Paul Price – Here is Dr. Price’s favorite trade: the covered strangle. That is, Dr. Price identifies a stock he would like to buy at current levels, figures out how many shares he would ultimately want to own, and buys half that amount. If he wanted 2000 shares of MSFT (not one of his trades, btw), he would buy 1000. Then he would write a covered call on the shares he bought — if he bought 1000 MSFT at 25, he would sell 10 MSFT calls with a 25 strike. In addition, because he would be comfortable buying another 1000 shares of MSFT at a lower price, he would also write 10 puts on MSFT with a 25 strike. This is an interesting strategy that pays off as long as the underlying stock doesn’t fall apart. It’s like writing covered calls except it essentially doubles your income with only a moderate increase in risk. The capital outlay (or margin commitment, if you play that dangerous game …) is high, though, and since Dr. Price’s disclosures reveal that he always has a position in the trade he promulgates, one concludes he is a wealthy man indeed. For most people, I think, his trades are mostly unrealistic as written, but they are food for thought. Note that Motley Fool Options has recently begun making some covered strangle recommendations, which is a departure from their usual covered call strategy. On the whole, I like Dr. Price’s recommendations and his crystal clear explanations.
Phil McDonnell – At first, I found Mr. McDonnell’s recommendations to be in that category of sweet but impossible trades. Lately, however, I think he has taken heed of some of the comments left for him and he now delineates much more clearly the opening and closing conditions of a trade. Phil leans toward multi-legged positions that don’t put much capital on the line but could pay off big. By the way, Phil also wrote “Optimal Portfolio Modeling” published by Wiley Trading, which covers position sizing. This is one of my weak points so I am plan to buy and read Phil’s book. For Options Profits, I think Phil had a bit of a rocky start, but I’m glad to see he’s improving his transparency and follow-through.
Mark Sebastian – Mark keeps an eye on the “paper”, unusual options activity for specific issues, and extrapolates from that the underlying stock’s behavior. Then he sets up a trade that has a significant advantage over the paper in terms of volatility, delta, etc. Mark’s reasoning is crystal clear and his trades are straight-forward, mostly consisting of only one or two legs and they tend not to require much capital or margin. Mark is probably my favorite analyst at OP.

These are only a few of the twenty or so analysts at Options Profits. If I get a chance, I will add my critiques of some of the other analysts at Options Profits.

Does your mother's head explode whenever you explain options to her?

Don't let this happen to your mother

In the end, it may not be fair to compare these two services because of their completely different target audiences. MF Options is really for long-term investors looking to juice their returns through strategies like repeated covered call writing where you try to keep underlying equities over long periods of time. And Options Profits is for somewhat sophisticated traders looking for ideas and/or information they don’t have time to research themselves — OP offers the a panoply of options strategies, so the OP reader needs to know himself in order to choose from the trades offered those that best suit their sentiment, style and circumstances.

Neither service is appropriate for the novice, though — before following either, save your money, read some books, take a class or two, and watch some podcasts/videos about options trading. Watch Fast Money and Options Action. Then, when you can explain a butterfly to you mother without causing her head to explode, and only then, might you be ready to start trading options with these guys’ help.

Filed Under: Featured, Reviews, Trading

Worthless Financial Products

August 23, 2010 By Jared G.

Some financial products belong in the junkyard

This is not a comprehensive list, but here we go:

Annuities

What’s the point? Hey I like the AXA commercials with the gorilla, but the only person who benefits from an an annuity is the agent who collects a hefty commission for selling you this lemon.

Any kind of life insurance that is not term

What is the point in having an insurance policy accumulate a “cash value”? Insurance is supposed to be a safety net. Take the money you save by not getting whole life insurance and put it into a savings account or something — your savings account will accumulate a greater cash value faster than any whole life insurance plan. Plus all your money will be working for you — your life insurance agent may be a nice bloke, but do you really want him to skim ten percent off the top of your premiums? I don’t think so …

401(k) contributions beyond employer matching

There was a time when service was rewarded with a pension. That’s now a rare situation. Instead, you may now have only a limited option with the 401(k) plan, and that’s not even a good option.

Guess what? With a 401(k) plan you get to pay a percentage of your assets to the plan administrator in the form of management and other assorted fees. In addition, if you are investing in mutual funds (and with most 401(k) plans that is your only choice …) you get to pay even more of your assets to every year to the mutual fund company.

That is whether your plan makes or loses money. Yowza.

The best idea, I think, for your 401(k) plan is to simply set it up so that you max out your employer’s matching contribution, and then set up a Roth IRA and contribute the maximum you can to that.

And, if you can borrow from your 401(k), wait until you can borrow the maximum amount you can from it, then do so. Use the proceeds as either a down payment on a house, or to fund a taxable trading account. I like the latter for its flexibility, and for the fact that you can always liquidate to pay back the balance of your loan should you leave your current employer.

Employer stock plans

Ok, you’re already dependent on your employer for your livelihood. Do you really think it’s wise to give money back to your employer and concentrate your financial dependence on them? Contributing to your employer stock plan is the opposite of diversification, and you need to avoid it. Look at what happened to the people at Enron and the Tribune Company.

Hey, if you think this advice is non-conventional and just plain wrong, I suggest you read “Rule #1″ and “Payback Time” by Phil Town. I independently came to these conclusions, especially about the 401(k) situation, and followed through on them many years ago with my wife and my tax accountant asking every year if I was sure I knew what I was doing. Even though they could not poke holes in my arguments, and even though we were doing well financially. I was finally validated when I got around to reading Town’s books this Spring.

Feel free to draw your own conclusions — I know I’m right on this one.

Filed Under: Investing

Evaluating A Covered Call

March 7, 2010 By Jared G. Leave a Comment

Not necessary for evaluating a covered call, but it helps.

So, for whatever reason, I bought 100 shares of NVidia (NVDA) on February 19. I like their technology graphics cards and Christmas 2010 could prove to be a big win for them considering all the pent-up demand there is for new computers.

On the other hand, I think AMD is running away from CPU manufacturing and straight into NVidia’s graphics niche. Also, I know more people are buying notebook computers and most of those do not have dedicated graphics cards, which is where NVidia really shines.

Personally, I would never buy a computer that didn’t have a dedicated graphics card — it frees up the mainboard RAM for other more important jobs — but that’s just me …

Anyhow, I think NVidia could do really well by December, so I bought some. I am probably way ahead of myself on timing this trade, but I don’t want to be late for it either. I also know that most of the stocks I pick pretty much go nowhere — neither up nor down, just sideways. So, I need to work out a way to make some money from my purchase.

Ideally, I would have liked to just write a put on NVDA, set aside the money to purchase it at the strike, and move on. Today (February 19, 2010), for example, I would put $1370 aside and write an NVDA Sep10 15 Put for $1.30. The $130 I get for writing the put would be added to the $1370 already set aside, so that I’d have a total of $1500 set aside, hopefully swept into a money market account. With that money, I would be able to cover the cost of purchasing NVDA at the 15 strike if it goes below that price and the holder of the put I wrote exercises by the third Friday in September.

: Break-even is 13.7, but my profit is capped at $1.30

Writing a put this way is a pretty conservative trade because my downside is limited, and I can always buy back the put if the trade goes south on me. Which makes me wonder why your typical retirement account does not allow you to do this sort of trade — it’s very annoying.

When writing puts, you need to keep in mind that you’re locking up a certain amount of capital for the lifetime of the put. Here at the beginning of March 2010, we’re locking up $1,370 for just under 7 months. If the put expires out of the money, your $1,370 is freed up, and you’ve got $130. That is a 9.49% return in seven months, or 16.26% annualized. Not a bad return.

This is in my Roth account, though, so my only option-oriented choice is writing a covered call. Before this trade, I had put in several different limit orders to buy stock like Altria (MO), Energy Recovery Inc. (ERII), and Gamestop (GME). The one that came through at the price I wanted was NVDA, so that’s what I have to work with. The first thing to remember when writing covered calls (or puts, for that matter…) is that early exercise only makes sense on dividend paying stock — the entity that owns the call you wrote may exercise early in order to capture the dividend., and the owner of a put may exercise early after the ex-dividend date because he has now captured the dividend and feels he can get a better return on the capital tied up in his stock elsewhere. But NVDA doesn’t offer a dividend, so this isn’t an issue. It is highly unlikely that anyone would exercise this call before its expiration — if they do, I consider it a gift of the time premium factored into the price of the call I wrote. Rather than have to wait until September to redeploy my $1800 of capital plus $160 of option writing proceeds, I can take a step back and figure what to do with the money sooner.

Like I said, except in cases where a dividend is involved, early exercise of a written option doesn’t make sense and is therefore a highly unlikely event. Should it occur, it is beneficial to the option writer and detrimental to the exerciser.

With that out of the way, let’s look at the actual trade. I bought NVDA on February 19 at 16.55 — here were the calls I considered writing at the time:

Evaluating NVDA Sep10 Calls To Write - Feb 19-22

		NVDA purchased at:	$16.55
NVDA Sep 10 calls
Strike	Feb 22 Quote	NVDA Breakeven	Gains Cap	% Return From Write	% Gains Cap
17	2	$14.55	$2.45	12.08%	14.80%
18	1.6	$14.95	$3.05	9.67%	18.43%
19	1.2	$15.35	$3.65	7.25%	22.05%
20	0.95	$15.60	$4.40	5.74%	26.59%

Now I could go into some technical mumbo-jumbo and tell you how the trade I chose was the optimal trade, but that’s not how I chose my trade. You can already see by my choice of the September expiration when we’re in the end of February/beginning of March that I don’t like to tie up capital for much more than six months. This gives me a chance to watch two quarters and two earnings reports unfold. It also doesn’t lock me into the stock for very long if I don’t find it profitable. In the fast-paced options world though, six months until expiration can be a long time, and people are willing to pay for that. So long as the price I get for writing the call makes it worth the trade and so long as I still make a profit if the call is exercised, then I am willing to take their money. For me, options that expire sooner than six months from now tend not to be worth the effort to write because of their low price.

NVDA 18 Calls	Expiration Comparison
Expiry Date	Feb 22 Quote	NVDA Breakeven	Gains Cap	% Return from Write	% Annualized (approx.)
10-Mar	0.2	$16.35	$1.65	1.21%	14.50%
10-Apr	0.46	$16.09	$1.91	2.78%	16.68%
10-Jun	0.99	$15.56	$2.44	5.98%	17.95%
10-Sep	1.6	$14.95	$3.05	9.67%	16.57%

If you just take a look at the annualized returns on the write, it looks like I would have been better off writing the June call rather than the September. Honestly, this is not a factor I took into account when writing the call — I just thought that $1.66 was significantly better than $0.99. This is especially true if you take into account commissions. A $10 commission on writing a $0.99 call is considerably more expensive than on a $1.66 call, as a percentage of the transaction — 10 % on the first, compared to 6% on the second.

I admit this is in retrospect, but even considering the better return and shorter time horizon on writing the June 18 call rather than the September, I still think the September write is the better move. And this is simply because it has less friction. If we were dealing with 500 shares of NVDA and writing five corresponding contracts, the story would probably be different — the larger the trade the less friction there is.

At expiration, my covered call profile looks like this:

Breakeven at 14.95; Gain capped at 3.05 when NVDA closes above 18

If my written call expires out of the money (i.e., if by the third Friday of September NVDA does not close above 18), then I can choose to either:

Sell my shares of NVDA and move on to something else (this I would do if I thought my capital could be deployed better elsewhere);
Hold on to my shares of NVDA but not write another call on it (in case I think the proceeds from writing the call do not compensate me enough for the risk of capping my gains again); or
Write another covered call contract and pocket the proceeds.

If NVDA does close above 18 and my shares are called away, I will have maxed my gains at $3.05. I now have ($18.00 NVDA sale proceeds + $1.60 Covered Call Write in February) x 100 shares = $1960, whereas I started with only $1655, and that’s better than a sharp stick in your eye. Now I can decide to buy back NVDA, another stock, or just sit tight. If I do decide to buy NVDA or another stock, I would want to do buy writing a put. But that unfortunately, is not always possible.

By writing puts you have these advantages over other investors:

You set your entry-point;
You reduce your cost-basis for stock you eventually do buy;
You profit if the put is not exercised, and that’s more profitable than creating a limit order on a stock that never gets filled.

By writing covered calls, you gain these advantages over other investors:

You set your exit point — people seem to have some difficulty exiting a trade, if your covered call gets exercised this is done automatically for you;
You reduce your cost-basis for stock already in your portfolio;
You profit when your call is not exercised — if you, like me, tend to buy stock that just frustratingly goes sideways, writing calls is a great way to turn this weakness into a a strength. Think of it, if your stock never gets called away, you can just keeping writing calls and collecting the cash.

Whether writing covered calls or writing puts, you have to remember that you’re locking up capital for the life of the contract whether that capital is in the form of underlying stock for covered calls, or in the form of cash for written puts. In return, you can often get handsome returns.

Something to think about.

Note: It took a bit longer than I thought to write this, so the pricing is out of date — go figure, I write my first covered call, and it looks like it’s going to take off. Oh well.

Note also that writing covered calls isn’t going to be nearly as attractive other stocks. For example, I ran similar numbers for some AT&T stock that I’ve owned for ages, and the options I would have felt ok about writing just did not offer enough to be worth it. What’s the point in running the risk of writing a call for anything less than $75? Writing covered calls works best, I think, when the VIX is high and the underlying stock is somewhat volatile. In this case NVDA is volatile enough, even though the VIX wasn’t as high as I would have liked. The VIX was actually a bit too low, but the timing for the NVDA purchase was right.

Aw man, now I have to go look for an entertaining yet apropos photo for this article. Geez, you’d think two tables and two charts would be enough, but no …

When in doubt, grab the shot of whiskey.

Filed Under: Featured, Trading

Motley Fool’s “4 Proven Options Strategies”

March 1, 2010 By Jared G. 4 Comments

What are the Motley Fools up to really?

I’ve been reading the Motley Fool stuff on and off for more than ten years now, since they were just a forum on AOL. I like to think I learned a bit of useful information from them like how to evaluate a mutual fund based on its expense ratio rather than its historical performance, or the differences between a 401(k) a traditional IRA and a Roth IRA. Sometimes though, I just have to wonder where their heads are at. I was thoroughly dissatisfied with some of their picks in their Inside Value Investing newsletter a couple of years ago (I am no longer a subscriber), and I think they were just about as badly blind-sided by the events of 2008 as everyone else.

I thought these guys were supposed to protect the interests of us “regular guy” investors out here. Keep on investing in DRIPS, dollar-cost average down (do these guys not know what it’s like to try and catch the proverbial falling knife?) was all I heard. Over the long-term, the market has always gone up (Really? What about sector-rotation?).

That sort of thing.

Then, in early 2009 I think, they started touting and teasing their mailing list with something called “Motley Fool PRO”, some high-priced (I think it’s over $1k/year …) newsletter that advocates, among other things, options trading.

Whoa, hold the bus, Tom and Dave. What?! The supposed advocates of dollar-cost averaging, safe investing for the little guy and railing against the financial professionals who want to line their wallets by managing your money — yes, these Motley Fools — are planning to charge readers a not insubstantial sum to “advise” them how to play the options market.

Now, I’ve been growing more and more skeptical of the whole Motley Fool enterprise since they quietly disappeared their “real money” portfolio and started over-emphasizing their wins like Marvel and Iomega long after the train left the station — hey what have you done for me lately, guys? Well, they’ve come with another newsletter and they’re calling it “Motley Fool Pro”.

Gee, now how does that make all the dopes who already fronted cash for the other Motley Fool publications like Stock Advisor, Hidden Gems, Global Gains, Inside Value, Rule Breakers, Income Investor, Champion Funds, Rule Your Retirement, Ready-Made Millionaire and Million Dollar Portfolio feel? Like non-pros, maybe? Or how about chumps?

How are they selling this new service, and how do I know it’s so heavily tilted towards options? As part of the newsletter promotion, the Fools sent out an email blitz offering the usual “Special Report” teaser in exchange for signing up on their notification list. Curious as always, I signed up , thinking the special report would contain some insight to the options market. After all, it is supposed to cover “4 Proven Options Strategies to Profit in 2009 and Beyond”.

At a certain point apparently, it turned out the “Pro” offering wasn’t good enough … Tom and Dave decided to sell another service called “Motley Fool Options” in December. I think it’s supposed to have the same options trades as “Pro” but none of the other stuff like ETFs. Ostensibly, the cost for “MF Options” I think is the same as that for “MF Pro”, $1000/year, but their final offer to me was 2 years for about $800. Eh, it’s worth a shot. I’ve been subscribed to it for a couple of months and I’ll let you know what I think later.

First though, if you do not have a basic understanding of options, the greeks, and strategies with funny names like bull put spread, condor, and strangle, you have no business signing up for either newsletter and following these fools’ advice — not for $1000+ a year for “MF Pro” and not for the $800 two year plan I got for “MF Options” — because either they’re going give you a lot of hand-holding you can get for next to free by watching “Options Action” on CNBC and reading an introductory book like Guy Cohen’s Options Made Easy, or they’re going to recommend trades you won’t understand.

And trading without understanding, my friends, can only lead to tears. In the special report, David Gardner and fellow fool Jeff Fischer, introduce the concept of options to their readers and prospective subscribers. They claim that options “can generate returns in flat markets, [and] cushion the blow of down markets.”

I agree, if you know what you are doing.

Again, if you want to learn about options trading buy a couple of books from Amazon (or borrow them from the library), and open up a virtual trading account at OptionsXpress.com — don’t give these fools $1000! Oy. Not only are options part of the Motley Fool Pro strategy, but also “short positions and exchange-trade funds (ETFs).” All well and good, but you have to understand how to short and what an ETF is. I have a friend whose broker was shorting the ProShares UltraShort S&P500 ETF for her right through October 2008. She received the dreaded margin call, asked “What is a margin call?” and now has to file for bankruptcy. Now, I know that overhead, the bid-ask spread and management fees will make any leveraged ETF into a dependably losing proposition, so shorting a short as my friend’s broker did is not necessarily stupid, but you have to understand the risk you’re taking on this sort of trade — the market could tank (it did) causing this ETF to temporarily spike and increase your margin requirement. In the long run, shorting leveraged ETFs like SDS seems like a good idea, but in the short-run you could be forced to close the short at the most inopportune time. You have to understand the risk you’re taking and be prepared to cover for whenever the situation goes against you.

So, what are the four foolish option strategies? Here they are:

Buy Calls – Well, ok. If you think a stock is going to pop why tie up capital by buying it? Just buy some cheap calls and multiply your leverage by 100. For example, if I think T, at 26.59 is headed for 30, rather than commit $2,659 for 100 shares and hope for the best, I could buy one May 09 25 call for $214. If T makes it to 30 by May 15, the call expires with a value of $500. Buying the stock yields a profit of $3000 – $2659 = $341. Buying the call yields a profit of $500 – $214 = $286. Even though the leveraged return on this trade is 133%, vs. 12.8% for the stock trade, there are still problems with just buying calls. First off, since options expire and stocks don’t the underlying stock for your call must make the move you are anticipating within a limited time-frame. Second, to break even on your call purchase, the underlying stock must increase to a value above the strike plus the premium you paid. Jim Cramer goes over a variant of this strategy, using deep-in-the-money calls, in his book “Getting Back To Even”. Also, since subscribing to the “MF Option” service I have noticed that the fools have a penchant for buying in-the-money LEAPS.
Buy Puts – Rather than short a stock that you think will tank, and take on potentially unlimited risk if the opposite happens, you could buy puts on a stock. Stock goes down, you sell the put for profit. To tell the truth, I’d prefer to do a bear call spread than buy a plain old put … At least that way you get some cash rather than laying it out. For example, I could sell March 2010 call on Nucor (NUE) with a strike of 42, and buy one with a strike of 45. For my trouble, I net .85, risk up to 2.15 and don’t start losing money until NUE goes up beyond 42.85. With the way I pick stocks that just go sideways, that’s better than paying 1.20 for a March 2010 NUE put with a strike of 41.
Write Puts – On this one, the fools are essentially pulling rabbits out of a hat — they troll all their other services to identify a stock they would like a position in, they determine a specific entry point, and write a put option such that the put strike minus the put price is that entry point. For example, let’s say I want to buy NVidia at a significant discount to its current price of around $16.40. I could write a September 2010 put at 15 for $1.30. Now, if NVidia goes down below 15 by the third Friday of September, it will be exercised and I will have to buy it for $15 … even if it goes down to $1. Here’s the deal, though: 1) If the stock is put to me at 15, my real cost for the stock is 15-1.30= $13.70; 2) I have to maintain funds ($1500 for 1 contract) in my account to cover the put until it expires. By September, I’m happy so long as Nvidia closes above $13.70. If the stock is not put to me, I’ve made $130 per put; and if the stock is put to me I own 100 shares of a stock I’ve already decided I like. Yay. And, if the Nvidia situation changes any time before expiration, I can always buy back the put to close the transaction.
Write Covered Calls - If you have 100 shares of some stock in your portfolio, you can write a covered call on those shares. I actually did this in my Roth the other day, although I would have preferred to write a put — unfortunately, writing puts are considered “too risky” for retirement accounts, which is very frustrating. Anyhow, I bought 100 shares of Nvidia at $16.50, and my intent was to immediately turn around and write a September 2010 call on NVDA with an 18 strike. I was able to sell the call for something like $1.55 — that’s an extra $155 of cash that went into my account. Now if by September NVDA goes above $18, my shares will be called away … I am obligated to sell them at $18 even if NVDA goes to $100. But you know, I am okay with that because I will have made $155 by writing the call and I will have made $18 – 16.55 x 100 = $145 by selling the stock. That’s a profit of $300 or 18% on $1650 in less than a year. And if NVDA remains unchanged, I can write another call on my shares in September and perhaps add another $150 or so to my cash balance. And if NVDA goes down to 14.95, I still haven’t lost anything. I think the fools call writing covered calls creating a supplemental dividend stream.

Like I said, I have a subscription to he Motley Fool Option newsletter. The underlying stocks are uninspired, and the fools are rather conservative in their strategies as you can see from the Write Put/Buy Stock/Write Covered Calls stream I describe above. The most sophisticated trade I saw involved maintaining a diagonal spread position. E.g., they sold April $25 call and covered it by buying a December $20 call. I think they’re definitely figuring out ways to make theta-decay work for them …

MF Options does have an “Options University”, but come on, do you really need to be paying mondo-bucks for access to it? Before you even consider following these “4 Proven Options Strategies” or getting a subscription to the MF Options service, do yourself a favor — read a couple of good books on options and make sure you understand what you’re getting into. If you got lost reading this post, you’re not ready.

Jared’s Books On Options (I’ve read these, honest):

Options For The Beginner And Beyond by W. Edward Olmstead

Options Made Easy by Guy Cohen

Option Volatility & Pricing by Sheldon Natenberg – This one gets way more technical than the other two, but is rigorous and assigned reading for newly hired professional options traders. Though the math you need for the other two books is nothing to sneeze at, this one is going to be over your head unless you majored in math. And even then, it’s a tough slog.

Once you’ve read these, you’ll be ready to open up an account, and follow some of the free webinars offered by places like OptionMonster and OptionsXpress. Until then, you most likely will lose money and not understand why. At least after you read these books, you’ll understand why you’re losing money. What you do about it at that point is up to you.

Now, go away and leave me alone. I’ve got shit to do man.

Filed Under: Reviews

If You Can’t Beat ‘Em … Jared’s Portfolio Of Evil

February 25, 2010 By Jared G. Leave a Comment

There is profit in evil

Would you invest in a company that peddled death, took advantage of the sick, polluted the environment or abrogated workers’ rights? Or are you one of those goody-two-shoe “ethical” investors who wouldn’t touch a company like Altria (MO) with a ten-foot pole?

Yeah, right. Cry me a river. I’m in it for the money, and if some people’s toes are going to get stepped on because my company knows the quickest way to make money and doesn’t hesitate to do so for the sake of some mamby-pamby “business-ethics”, so be it. I’ll be the one collecting dividends and profiting, and maybe just maybe, I’ll throw some of my ill-gotten gains to the Sierra Club and the American Lung Association along the way … in order to salve my conscience.

Seriously though, the purpose of a corporation is profit its shareholders. Corporations do not exist to employ people; they don’t exist to contribute to society; and they do not exist to innovate. These are all just possible means to the single corporate end: make money. Whether the means are ethical or not, does not matter. It doesn’t even matter whether the means are legal. So long as the defense lawyers and the consequences of illegal activities don’t impact the bottomline too badly, legality is a non-issue. Corporations exist to make money.

Up until now, I have avoided investing money in companies against which I have been conducting my small inconsequential boycotts. WalMart locks workers in the stores overnight? Hello Costco. Exxon drags its feet cleaning up the mess left behind by the Exxon Valdez? I think I’ll ride my bike to work today. Cigarettes will kill you? I’ve never smoked in my life.

But you have to admit, these companies make money despite my efforts. And I’m thinking if you can’t beat ‘em, join ‘em — let’s create a portfolio of evil and ride this highway to Hell, profiting all the way. And maybe my proxy votes will have an effect on how these companies conduct their business.

So far, I have identified 6 corporations whose businesses I would never frequent — I might even picket them — but that I wouldn’t mind owning stock in them:

Goldman Sachs (GS) (02/20/2010 – $156.18) – They advised Greece right into needing a bailout, got the lion’s share of the AIG bailout money, and still gave their people big bonuses. That’s pretty evil.

McDonald’s Corporation (MCD) (02/20/2010 – $64.74) – Bad food that makes you fat. In addition, they sued an Italian food critic for telling the truth about their food and put some protesters in the UK through more than a decade of legal hell (McLibel Case). Not to mention their anti-union activities in Quebec (hiring fifteen lawyers to fight workers at just one restaurant … I gotta say, that’s evil). Well done guys, I want you working for me.

Altria Group Inc. (MO) (02/20/2010 – $20.16) – These guys sell “Cancer Sticks”. Need I say more? Definitely evil … and a great opportunity to profit from the misery of others.

Microsoft Corporation (MSFT) (02/20/2010 – $28.77) – Ever see that episode of The Simpsons where Bill Gates “buys out” Homer? Evil. Seriously though, these are the people who got away with creating Vista, lifted the Mac’s look-and-feel to create Windows, and added their own little twist in the form of “The Blue Screen of Death” … not necessarily in that order. Evil? I think so.

Wellpoint (WLP) (02/20/2010 -$58.47) – Dropping people for pre-existing acne conditions and raising Californians’ health insurance rates by some ungodly amount? Hey, it’ll all go to the bottom-line. Too bad they don’t pay their shareholders any dividends out of all their ill-gotten gains. Evil.

Wal-mart Stores (WMT) (02/20/2010 -$56.49) – Hey, I’d like to lock my employees in my store to force them to take inventory too. These guys actually do it. There are even several sites dedicated to showing and documenting WalMart’s mis-deeds like WakeUpWalMart.com. I wouldn’t shop there, but I’ll buy some shares. Evil.

I established a tracking portfolio of these stocks on StockPickr.com, Jared’s Portfolio Of Evil, to see exactly how my premise works out.

To tell the truth, I have invested some money in Altria and am quite happy with the returns over the past year, and that underlines the fundamental problem with corporations — their only conscience lies in the shareholders. If the shareholders are only looking at their own gains there is nothing stopping a corporation from locking people in the store, or suing the pants off individuals who can’t defend themselves. In fact, the corporation is obligated by its duty to its shareholders to maximize profits. So if they can make a few million dollars by breaking the law and getting fined $100,000, they and their shareholders still come out ahead.

Anyhow, since it does bother me that my gains and dividends in Altria are ill-gotten, I do salve my conscience in the knowledge that, when proxy time comes, I vote against what the directors suggest. And in the knowledge that some of my profits go to raising a couple of liberal free-thinkers and supporting the Green Party.

I still refuse to buy cigarettes at Wal-Mart, though.

Filed Under: Investing, Trading

Funding Education – Why 529 Plans Are Bogus

February 17, 2010 By Jared G. 1 Comment

529 Plans Not All They're Cracked Up To Be

Since my children are now 5 years old and 20 months old, and since I just paid the last $4000 on my student loans, I recently looked into my options to help fund the boys’ education.

It seems people are falling for these “pre-paid tuition” 529 plans in droves, so I decided to take a look.

Somehow, these plans are already rubbing me the wrong way and I haven’t even looked at the official literature yet.

First, where can the child go to school with a 529? Apparently, only in one of the schools that is a member of the 529 plan you signed up for.

I have a problem with that. Let’s say you sign your kid up at birth and plan for them to enter college in eighteen years. A lot can happen in those eighteen years: the schools in the plan could decide to step out; their quality could go down the tubes; or they could even go out of business.

For eighteen years you’re paying into this plan, locking up your capital, only to find at the end of the road the school you’ve been paying for isn’t no longer all it’s cracked up to be o isn’t even there. Unless you are wealthy enough to have alternate funding, you have no Plan B because all your money went into Plan 529.

Don’t get me started on the 529 savings plans. I have ranted to my friends about the idiocy of paying mutual fund managers management fees whether or not they beat their benchmarks and I am really pissed about how employers make 401(k) sweetheart deals with brokerages to skim money from their workers’ benefits. 529 savings plans are more of the same.

In Oregon and Illinois for example, 529 savings plan officials looked the other way while Oppenheimer invested money for “conservative” plans in subprime mortgages. When finally called to task, Oppenheimer settled and offered savers half of their losses, take it or leave it. What happened to the other half? I guess it went to pay for Oppenheimer’s lawyers and hefty bonuses for Oppenheimer’s managers.

Also, state officials in charge of overseeing the 529 plans continued “working” in their positions as if nothing happened.

One official, responsible for buying an SUV using 529 plan funds is now a candidate for Senate.

One gets the feeling that little if any of the money put into 529 plans is actually used for education …

Where are the punitive damages? Where are the firings? Heads should roll for this sort of thing.

Get this kid a Coverdell ... not a 529.

This brings us all to Jared’s bad advice for financing your child’s or children’s education: Don’t bother with 529 plans managed by incompetent state officials making sweetheart deals with greedy financial institutions — you’ll only get ripped off. A better alternative, even though the contribution limit is woefully low at $2000 per year per child, is the Coverdell Educational Savings Account. At least there you are managing the money (you can invest in Phillip Morris and Disney if you wanted). If used for qualified educational purposes, withdrawals are untaxed.

And, when the child reaches 30, remaining funds can be transferred to another family member or can be withdrawn with a 10% + the child’s income tax rate tax charged on any earnings in the account — the initial capital outlay has already been taxed before being deposited into the account, so it is not taxed again.

529s suck; Coverdells are ok.

Filed Under: Investing

Hi there.

February 8, 2010 By Jared G. Leave a Comment

What to do while waiting for the disclaimer

While I’m waiting to figure out what kind of disclaimer to put up, I thought I would show you what my inspiration for these financial ideas is.

No wonder the tagline for the site is bad ideas about money.

Anyhow, I just saw an episode of Til Debt Do Us Part on CNBC, and was surprised to hear how much the husband spent on beer — nearly as much as he spent on cigarettes, $300/month. Before the looney/greenback exchange rate went all topsy-turvy, I suppose that didn’t mean much.

But now it does. Either beer is a lot more expensive than I remember or this guy has more problems than just having to ask Gail Vaz-Oxlade for help with his checking account.

I mean, if you convert that to fifths of whiskey at $20, the guy is drinking 15 fifths a month. Almost four fifths of whiskey a week. The man needs to switch from beer to bourbon for economy’s sake, but I doubt Gail would give him that advice.

Of course he needs to also give up the cigs — that’s just disgusting and wasteful.

Filed Under: Shooting The Breeze