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
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…)
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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 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.
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. (more…)
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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:
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. (more…)
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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
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