As a general rule I think options are a terrible idea for the casual investor.  For those who are simply trying to match the markets without spending a tremendous time watching their investments, options represent a significant danger.  Even for those who have experience with options, understanding all the implications of buying or selling an option can be confusing.  Covered calls however, may have a useful place in the typical investor’s portfolio.

Option Terminology

Options are defined by several values.  For the purposes of discussing options here we will assume we’re talking about an options contract on a stock, which is not always the case.  First of all, be aware that an options contract is for 100 shares of the stock.  Thus you don’t deal in tremendously small lots when dealing with options.

Each option is either a call or a put.  A call option is an option to buy a stock at a particular price on or before a particular date.  A put option is an option to sell a stock at a particular price on or before a particular date.  In both cases the date by which the decision must be made is the expiration date and the price at which you have the option to buy or sell is called the strike price.  These options also have a price which is listed in terms of a price per share.  So for example if you see a price quoted as $0.25, that means twenty-five cents per share, or $25 for the full contract, since contracts are for 100 shares.

If all of this sounds confusing let’s look at an example:

Supposing we have a stock X which is currently trading at $35 per share and it is currently January 1^st.  Now suppose I buy 10 call contracts on this stock with a strike price of $37.50 and an expiration date of February 23^rd (Note that expiration dates are the third Friday of a month).  Let’s suppose I pay a price $1 per share for each of these options ($100 total for each and $1,000 total since I’m buying 10 contracts) and look at what happens depending on how stock X’s price changes in that time.

If stock X does not exceed $37.50 before February 23^rd my options will expire as worthless and I will lose 100 percent of my investment, assuming I do not sell the contracts before then.  If on February 23^rd the price of the stock is higher than $37.50, I will be able to buy the stock at a discount, which will hopefully exceed my $1,000 investment.  So for example if the stock is at $42.00 I will make $4.50 per share on the 100 shares per contract for 10 contracts, thus making $4,500 less my initial $1,000 investment.  This means I made $3,500 on a $1,000 investment.  As you can see, options have a high risk and high reward.

In general, people often close their position before the expiration date, which of course affects the economics as well.  If I have a call option, for example, with some time left before the expiration date and the option is already “in the money” (meaning the share price is higher than the strike price for a call), then I will probably be able to sell it at a premium to the difference in the prices, because of the potential to make more money before the expiration date.

Covered Calls

So now let’s suppose instead that I want to sell a call on stock X.  I can do this without owning one; I simply have to buy it back before the expiration date.  This is very similar to shorting a stock.  Let’s look at the economics of this.  If I sell a $37.50 call for $1 per share then I make $100 per contract.   As long as the stock doesn’t go above $37.50 before the expiration date, I will get to pocket that $100 per contract.  However if the stock goes skyrocketing I will have to pay the difference between the price and my $37.50 strike price.  As you can see, this is very risky.  However, I can make this a much safer bet if I already own the stock.

Suppose I have 1,000 shares of stock X and I do not expect the price to rise significantly.  I might go ahead and sell a call with a strike price a bit above the current price.  Thus if the stock price doesn’t move above that strike price I will pocket a little money.  If the stock price does move I will still make money because of the difference between the current price and the strike price and the premium I was paid when I sold the contract (the contract’s price).

Thus if the stock goes down, I’m better off than I would have been without the call because I get the money for selling the contract.  If the stock stays flat I’m better off for the same reason.  The only time I lose is if the price goes enough above the strike price to exceed the value I was paid for the contract.  Thus I’m limiting my downside, but I’m also limiting my upside.  If stock X doubles, I’m only going to get my strike price for it, which could be thoroughly discouraging.

Why Sell Covered Calls?

There are many reasons you might not be bullish about a stock price in the short term, but not ready to sell the stock.  Tax considerations could be one example.  Another might be that the stock pays a dividend, but you’d like to limit your exposure to the stock going down in the meantime.  In fact, combining covered calls with dividend stocks can be a good way to increase your yield and limit your risk.  You might also simply want to limit your risk when entering a position by reducing your downside and upside at the same time.

Obviously there is much more to understanding the risks and benefits of covered calls, however they represent one of the few options strategies that might make sense for a casual investor.  Be sure that you thoroughly understand them before considering them however.  The vast number of variables and outcomes can confuse even the most seasoned investor.

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Selling Covered Calls

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I often hear people tell me that they’ve stopped contributing to their retirement account because they don’t think the stock market is going to go up.  It seems many of these people assume that a retirement account and the stock market are one and the same.  Most plans have many options, and nearly 64% have actively managed bond funds as an alternative.^[1]

The fact that many people don’t even know what their options are in their retirement accounts suggests to me that they probably shouldn’t have been in the stock market in the first place.  Many people were initially sold on stock market-based retirement account options by claims that the stock market returned 8%, or 11%, or whatever their advisor was telling them. They put their finances on autopilot and never looked back.  At least they never looked back until 2008.

The Risk Premium

The philosophical rationale for why stocks should outperform “safe” investments, like government treasuries, is something called the risk premium.  In theory, if equities did not outperform safe investments, then rational actors would cease to buy the equities. The prices would decrease to a level where there would be an adequate risk premium.

This theory was put to the test during the recent financial crisis when, at the nadir of stock prices, there essentially was no risk premium for the previous thirty years.^[2]  Since then, stocks have rebounded a good deal and the risk premium has returned. However, it points out an important fact: the risk premium is only likely in the long term and is not guaranteed.

Risk Tolerance

Because of the wild variability of the risk premium, the value proposition of equities decreases as you get closer to an expected retirement date.  Once you have a near-term window for beginning withdrawals, the amount of time your returns have to “average out” decreases, and your exposure increases.  As you get closer and closer to retirement, equities should become a smaller and smaller portion of your portfolio.

The Macroeconomic Picture

The final, and most important, question is:  Do you still believe in the American Economy in the long term?

Ultimately there are many other fish in the sea and there’s no reason you have to be invested in American stocks, or even in stocks at all.  In an era of declining stock prices, being flat is better than losing less than others.  The macroeconomic picture can be conflicting and confusing right now, so it can be hard to decide; but there are plenty of things to fear.  If you haven’t measured your thoughts on these subjects or discussed them with your advisors, the sooner the better.

You should never approach the stock market as your only investment option.  Think about your position in life and whether your goals are the same as when you started your investment plan.  Automatic investing in the stock market has been a solid choice for many years now, but before you commit any more money to the plan, clarify in your mind why you’re doing so.

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Should You Be In the Stock Market?

1. PSCA.org – 51st Annual Survey of Profit Sharing and 401(k) Plans
2. Bloomberg.com – Bonds Beat Stocks in ‘Earth-Shattering’ Reversal: Chart of Day

Photo by: foxspain

Many people are looking for various ways to invest in foreign companies.  Whether they’ve lost faith in American companies, want to hedge or simply want  some diversity, ETFs can be an easy answer to eachieve this.  I’ve listed 76 ETFs that provide you exposure to the stocks of certain countries, groups of countries or the world as a whole.  Some things to remember:

• Many countries are highly dependent on a particular sector. For example if you’re buying a Russian ETF in many ways you are buying a lot of exposure to energy as that country is highly dependent on energy income.
• Many of these funds have run up tremendously in the previous few months.
• Some of these funds are not particularly liquid.
• Many of these funds have high fees associated with them.
• Each of these funds implements their exposure in different ways, be sure to read the prospectus.
• This list is far from exhaustive, although it was exhausting to compile.

My summary of all this is:  Read the Prospectus, Read the Prospectus, Read the Prospectus.  Make sure you know what you’re actually buying if you buy one of these ETFs.  I’m not recommending or endorsing any of them, I’m just compiling some resources to help you start your research.

Single Country ETFs

If you’re looking to roughly match the results of another single country here are some ETFs for some specific countries.  Bear in mind that these don’t all necessarily track just the country’s most popular stock market index.  They can track other indexes or even subsets of those companies and may balance them in a variety of ways so be sure you understand exactly what they invest in before you buy the ETF.  Many of these funds are limited by market capitalization as well as particular country, once again be sure to read the prospectus.

• Austria – EWO
• Australia – EWA
• Belgium – EWK
• Brazil – EWZ, BRF
  
• Canada – EWC
• China – FXI,PGJ, HAO and GXC
• Chile – ECH
• France – EWQ
• Germany - EWG
  
• India - EPI, PIN
• Indonesia – IDX
• Israel - EIS
• Italy – EWI
• Japan – EWJ, PJO, SCJ
  
• Malaysia – EWM
  
• Mexico – EWW
• Netherlands – EWN
• Russia – RSX
• Singapore – EWS
• South Africa – EZA
• South Korea – EWY
• Spain – EWP
• Sweden – EWD
• Switzerland – EWL
• Taiwan – EWT
• Thailand – THD
  
• Turkey – TUR

Regions and Groups

These are not individual countries, but groups of them.

• Africa – AFK
• Asia – AIA, IFAS, AAXJ
• Europe – IFEU, EIV, DFE, PEF
  
• Gulf States – MES, GULF
  
• Latin America – ILF
• North America – IFNA
• United Kingdom – EWU

Emerging Markets

This list is for emerging market specific funds that are not purely regional.

• BRIC (Brazil, Russia, India and China) – BKF, BIK, EEB, DEM
  
• General – GMM, EEM, PXH
  
• Small Cap - EWX, DGS

Global and Non-US Sectors

These are worldwide market sectors, or worldwide market sectors excluding the US.

• Consumer Discretionary – GXI, IPD
• Consumer Staples – KXI, IPS
• Energy – IXC, IPW
• Financials – IXG, IPF
  
• Healthcare – IXJ, IRY
  
• Industrials – EXI, IPN
• Materials – MXI, IRV
• Technology – IXN, IPK
• Utilities - JXI, IPU
• Telecommunications – IXP, IST

Feel free to suggest more and I will keep adding to this list.

Post from: Personal Finance And Investing

76 ETFs For Foreign Stock Exposure

Photo by: Nicholas_T

While I generally advocate against investing in individual stocks for amateur investors, I make some exceptions for ETFs.  Exchange Traded Funds are funds that trade on the stock market like a regular stock, but represent underlying assets like a mutual fund.  These ETFs give you an opportunity to hedge your stock market positions and provide some balance to your portfolio fairly easily.  While I would still recommend a lot of research before buying any of these, each of these ETFs gives you some ability to round out your positions.

GLD: Gold

I’ve been known to make fun of “Gold Bugs” now and again in my days, but you have to admit that with the specter of inflation looming over all of the spending and stimulus, gold becomes a bit more appealing.  The mechanism for this ETF is supposed to be fairly straightforward, and it’s done a good job of duplicating the returns of gold recently.  Because most of the currencies out there are from governments who are in straits just as dire as the USA, it can be appealing to find a “currency” that no government has control over.

TIP:  Inflation Protected Treasuries

Inflation Protected Treasuries are another straightforward inflation hedge.  They are not subject to the same wild fluctuations as gold and can be more appealing for that reason.  At the same time, they are dependent on the government’s calculation of consumer price index (CPI), which may not always reflect real world inflation.  Unfortunately, added inflation-based principle will be taxed immediately, which is a consideration.

TLT: Long-Term Treasuries

Treasuries provide an alternative to stocks, but are not positively correlated with inflation like TIPs or gold.  They are, however, correlated with fear in the market, which has been a pervasive force.  When people aren’t sure what to do with their money many of them flee to treasuries, which has driven up the price recently.

USO: Oil

Oil provides an interesting mix of factors to help provide alternative forces in a portfolio.  The price is very volatile, which can be a considerable concern.  It should move with inflation to some degree and unlike gold actually has some utility.  It could be a good way to participate in any recovery without being entirely exposed to economic downturns.  While oil prices will diminish with the economy, that reduction will bring about reduced production; this will eventually help move the price up.  I would be particularly wary with this fund, however, as we could easily see plunging oil prices in the short term.

DBA: Agriculture

In the same vein as oil, tracking food prices can be a good way to participate in recovery while still participating in a fund that people will use even in a recession.  Much like oil consumption, people will still eat–regardless of how bad things get.  It’s also been seriously beaten up recently, much like oil.

I am not advocating any of these funds in particular, but they are all ways for you to add more dimensions to your portfolio.  This kind of diversity was sorely lacking in a lot of people’s 401(k) accounts when the crash hit last year.  While stocks were plummeting, several of these funds are at recent highs.  Never make any moves without serious research, but these stocks may help you have a more balanced portfolio.

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5 ETFs That Can Help Balance Your Portfolio

This post is step 10 in our Investing Template.

Once you’ve decided how your money should be allocated, it then becomes a matter of execution.  There are many details that can make a tremendous difference in how your returns are realized.  How you get your money into its allocation is nearly as important as what allocation you choose.

Diversification

Diversification is a term you hear a lot.  It basically means making sure all your eggs are not in one basket.  While economic crises can affect all asset classes, in general when one does poorly, another does well.  Thus if you have your money in a variety of areas, you will generally get better returns.  Additionally, this applies to stock and is a compelling reason to buy mutual funds. 

Index Funds

Once you’ve settled on buying mutual funds, index funds are often a very reasonable approach.  Their goal is to roughly match the returns of various well known stock market indexes like the S&P 500 or the Dow Jones Industrial Average.  By buying into an index fund, you have gotten a tremendous amount of diversity in your stocks.  Additionally because they are essentially unmanaged, you are paying low maintenance fees and not subject to your money manager’s strategy becoming outdated.

Dollar Cost Averaging

Fortunately, for many of us this happens naturally due to the way 401(k) contributions are handled, but for the rest of us this can be very important.  Timing the market is a dicey proposition for experts, so for those of us simply trying to get reasonable returns it is a terrible idea to put all our money into a particular investment vehicle at once.  Instead the goal is to buy a fixed dollar amount of each vehicle every so often, maybe every month.  As a result, you will buy more when the price is lower and less when the price is higher.  This should help prevent catastrophic entry points and your average price should be favorable.

Rebalancing

Another technique is rebalancing your asset classes periodically.  Say you had been allocating 50% to stocks and 50% to bonds (not necessarily a good strategy, but easy for our example).  If during the first period of time stocks had done very well and bonds very poorly, your portfolio might now be allocated 65% stocks and 35% bonds.  By rebalancing, you move funds from the over-performing sector to the under-performing sector.  If this is not done too frequently, it can allow you to take part in the recovery of the laggard.

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Investing Step 10: Techniques

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This post is step 9 in our Investing Template.

After all your tax-deferred accounts are being used to their maximum potential, it is time to fund any other accounts.  Once that is done, you need to start deciding how to allocate your funds.  This is the problem that many people did not properly address before the real-estate bubble burst and is the most important step to maximizing your returns.

Time Horizon

As we’ve discussed, the first thing you must decide in each account is how soon you will need access to the money.  You need to create an allocation based on this and adjust it accordingly.  Typically the more risky investments will even out over time and give the best returns, but can give horrible returns in the short run.  Thus the sooner you expect to use the funds, the less risky your choices should be.

For example, many people who were expecting to retire soon are suddenly in a state of confusion, because they left their investments in stocks and had massive negative returns.  This can be crippling for someone who was expecting to retire next year.  If they are expecting to retire in 20 years, there’s a good chance their investments will rebound.  However, if your time window is getting close you should be moving to safer, less risky investments, including cash.

Risk Aversion

In addition to the wisdom of avoiding risk when you are getting close to withdrawing funds, some people are very reluctant to put their money at risk at all.  If you are in this class, you should probably look to maximize your returns with very low or no-risk investments.  There are still many options available, even when capital preservation is a high concern.

The Spectrum

Here is a rough guide of some types of investments to consider, from least risky, to most risky:

•         Short Term Loans to Stable Government Entities
•         Mid and Long Term Loans to Stable Government Entities
•         Short Term Loans To Stable (Blue Chip) Companies
•         Long Term Loans to Stable (Blue Chip) Companies
•         Real Estate
•         High-Yield Debt (junk bonds)
•         Equity (Stocks and Mutual Funds)
•         Futures and Options

Real estate property has long been considered a safe investment, but recently this has been put into question.  Like any investment vehicle it is more easily navigated by experts and it is also very difficult to diversify.

Futures and options are best left to the pros.  In fact I recommend against even investing in individual stocks.  We’ll talk more about this in the next section.

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Investing Step 9: Allocation