I am a huge fan of the Walt Disney Corporation’s products. I shudder to think how much money I have dropped on their theme parks alone in the past five years. I think they do a wonderful job, have great assets and seem like a great company. So I should buy their stock, right? Hold Up Right There
I write generally about three topics on this site:
I list them in that order based on what I perceive as the general public’s interest level. Most people are concerned with getting out of debt and maintaining a budget – Personal finance issues. Those who have succeeded at those tasks become more interested in how to put their savings to work for them and become interested in investing. Very few people proceed to an interest in policy and economics, and perhaps rightly so. It’s certainly not immediately clear that an understanding of economics is beneficial to your personal wealth.
The Case for Economics
There are obvious reasons to believe that an understanding of economics should be a great asset in your financial life. Inflation is one of the examples. If I judge accurately what future inflation will look like, this can greatly improve my ability to choose good investments. If I can look at upcoming legislation and see what its effects will be, I should be able to capitalize on that. It seems like a slam dunk that an economic view should be a great boon to my financial freedom.
However…
Sadly, economists have a habit of being spectacularly wrong. Even when they aren’t completely wrong, it’s very difficult to profit off of their decisions. For example, right now treasuries are already priced very low because of a perception that inflation in the future will be high. So even if that perception is correct, the expected price change is already “baked into the cake;” and if they’re wrong, there’s a chance for spectacular loss.
So Why Bother?
Despite all this I have a nasty habit of continuing to write about the big picture, particularly policy. One reason I do this is because I believe that a basic understanding of economics can help you make wise decisions in your day to day life, not just in your investing life. The law of supply and demand may not be useful in deciding whether to buy Microsoft, but it can be useful in starting a business or in deciding what political policies to pursue. While the value of economic understanding may be questionable for investing purposes, its value in life is much less questionable.
The More Things Change
Many sage investing professionals have a saying: The most dangerous words in the English language are this time it’s different. Each time that politicians proudly proclaim that we’ve defeated the boom and bust cycle for example, we know how the story always ends. The more things change, the more things stay the same.
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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 1st. Now suppose I buy 10 call contracts on this stock with a strike price of $37.50 and an expiration date of February 23rd (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 23rd 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 23rd 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. (more…)
As a finance nerd who is very hard to shop for, I thought I might take some time to give some hints to those of you who have to shop for people like me. Here are some clues of gifts you can get for boring folks who only like to talk about the stock market and economics:
A Subscription to the Economist – I have had subscriptions before, but I can’t ever get through them in a week so pretty soon I have a pile in my entryway. That being said it’s SO much cheaper to get a subscription and if you giftee is a frequent reader of the Economist it could be a very appreciated gift.
A copy of Thomas Sowell’s Basic Economics – This is a great read for someone who is interested in economics. While he occasionally dabbles in partisan politics, this book is much less “agenda driven” than many of his other books, particularly Economic Facts and Fallacies.
A Single Share of Stock Cerificate – Most of us trade almost completely electronically anymore and we almost never actually get to hold any physical symbol of our interests. You can get these from OneShare.com. Right now you can get $20 Off Complete Framed Stock: Use code HOLIDAY09.
Gold Coins – Much like the stock certificate, this gives us something physical to represent what we spend so much of our time doing.
Classic Books – Even if they’ve already read them, it can be nice to own a copy of something like one of Peter Lynch’s classics, or the Intelligent Investor.
Stress Relief – Get something to take the edge off during the trading day. I like stress balls, but there are tons of options.
Report or Newsletter Subscriptions – If you’ve ever heard them mention a newletter or a research service they’d like a subscription for, this can be a great gift. I’d never go out and buy one myself, but if I got one as a gift I’d use it.
Of course, in the end we know that we’re hard to shop for and will be happy with whatever you give us. Especially if it’s not depreciating rapidly!
Photo by: stephen.moore
When it comes to investing, is America still the most sensible place to keep your money? This question involves a lot of elements and has no simple answer. There are however, some pieces of conventional wisdom that may deserve a little extra attention.
Listening to the media, you would think the ascendancy of the Chinese is all but assured. They are one of the few economies to truly start enjoying an alleged rebound from the economic crisis and were already becoming a behemoth before the latest financial woes. Surely Asia is where the future lies.
What is often forgotten in all of this is that China is not an open society. In the modern era we assume that the wool can’t be pulled over investors’ eyes. China however can easily give out misleading numbers to investors.1 Moreover, because of the amount of their economy that is centrally planned, they can essentially manipulate their own markets very easily. Their current stimulus may largely consist of creating unused infrastructure to keep their populace employed.2
Another supposed factor in why our money should be fleeing US Dollars is the hyper-inflation that will be driven by all the stimulus spending. The thinking goes that any kind of recovery in the economy will be coupled with inflation from all the money that’s been printed to finance the stimulus. While this seems reasonable, at the same time it’s been suggested that as much as 40 percent of the World’s wealth was destroyed by the financial crisis.3 With a good deal of that being in America, it seems that we may be able to survive some quantitative easing. (more…)
Photo by: Chapek Sergey
Probably the most self-destructive thing that a person can do for their financial future is to pay undue attention to what those around them are doing. Obviously this has limits, but using your friends, family or neighbors as benchmarks for “success” can manifest itself in many ways and almost all of them can sabotage your financial progress. You should always remember that what a person presents as their situation can be very different from their true situation. Let’s look at some ways the Joneses can sabotage you.
Typically when talking about “keeping up with the Joneses” we’re referring to buying status symbols. Maybe your neighbor bought a new BMW, and it sure looks nice. Or maybe you’d like to host the football watching party sometime, but your TV just doesn’t match up to your friends’. These types of situations can inspire us to make purchasing decisions that may provide a short-term high for a lot of pain.
Almost all status symbols are depreciating in nature. Your car and that new TV are going to lose their value over time. The more purchases like that you can avoid the better your financial future is going to be. This isn’t really very tricky, and most of us are aware of this, even if we don’t always follow through.
We believe that personal finance and investing are issues that are incredibly daunting because we are generally not equipped with the basics. This site is designed to help you learn how to make better decisions about how to manage your money.