First Quarter Earnings Options Logbook 2012

It was a few hours before Apple's [AAPL:NSD] first quarter earnings report for 2012 and I wrote on my Facebook status suggesting option traders consider writing a 495 put and 630 call on the weekly option; it was the April 27, 2012 expiration at the time. The stock was trading around $560 pre-earnings report and the trade implied the stock would move less than 11.5 per cent at the most in any direction by Friday. My colleagues and friends recognized the risk of the trade which prompted a short debate.

It was pointed out that writing naked calls as an investment strategy will not always work in your favour. That person is correct, but no investment strategy will either. Buy-and-hold strategies have failed for many investors and 95 per cent of day traders don't make money either. Mutual funds have been ripping people off for decades and other instruments are yielding a return less than inflation. So, I thought it was unfair to single out naked options as an unfavourable investment style. Fortunately for me, the Apple options expired worthless and I was able to reap the monetary reward and some bragging rights.

Following Apple's earnings, I decided to disclose all trades dealing directly with earnings and post them here. The point is to show that writing options with proper risk management can and will always work in your favour 9 times out of 10. It's not for everyone and if you miscalculate your break-evens and ranges, you could easily lose the shirt off your back, along with the rest of the closet. Statistically speaking, 93 per cent of options expire worthless, according to the Chicago Board of Options Exchange (CBOE); those are very good odds in the writer's favour. Below are the trades in chronological order starting on April 10, 2012 (Alcoa earnings typically kicks off earnings seasons) and ending May 25, 2012 (six weeks later). Green indicates a profit at expiration and red indicates a loss at expiration. I will in this instance use my real dollar figures to provide better insight on cash flow.

JPMorgan & Chase (JPM)
Trade Date: April 10, 2012	Reporting Date: April 13, 2012 BMO
Closing Price Pre-Earnings: $44.84	Closing Price Post-Earnings: $43.21
Sold 5 45.00 calls at $0.25, sold 5 40.00 puts at $0.11; expiring April 13, 2012
JPM finishes week at $43.21
Net profit of $147.50 on $6,670 margin or 2.21% return

Intel (INTC)
Trade Date: April 16, 2012	Reporting Date: April 17, 2012 AMC
Closing Price Pre-Earnings: $28.47	Closing Price Post-Earnings: $27.95
Sold 10 30.00 calls at $0.29, sold 10 27.00 puts at $0.12; expiring April 21, 2012
INTC finishes week at $27.60
Net profit of $365.00 on $6,630 margin or 5.51% return

Qualcomm (QCOM)
Trade Date: April 18, 2012	Reporting Date: April 18, 2012 AMC
Closing Price Pre-Earnings: $66.99	Closing Price Post-Earnings: $62.57
Sold 5 70.00 calls at $0.38, sold 5 62.50 puts at $0.19; expiring April 21, 2012
QCOM finishes week at $62.25
Net profit of $111.26 on $8,995 margin or 1.24% return*
*Note: In-the-money put closed on April 21 at $0.25

Apple (AAPL)
Trade Date: April 24, 2012	Reporting Date: April 24, 2012 AMC
Closing Price Pre-Earnings: $560.28	Closing Price Post-Earnings: $610.00
Sold 1 630.00 calls at $1.14, sold 1 495.00 put at $1.25; expiring April 27, 2012
AAPL finishes week at $603.00
Net profit of $112.26 on $10,280 margin or 1.09% return*
*Note: Closed call on April 25 at $0.83 to free margin for other trades, profit would have been $216.50 or 2.11%

Las Vegas Sands (LVS)
Trade Date: April 25, 2012	Reporting Date: April 25, 2012 AMC
Closing Price Pre-Earnings: $58.78	Closing Price Post-Earnings: $56.97
Sold 3 62.50 calls at $0.35, sold 3 55.00 puts at $0.55; expiring April 27, 2012
LVS finishes week at $55.87
Net profit of $242.50 on $3,816 margin or 6.35% return

Amazon (AMZN)
Trade Date: April 26, 2012	Reporting Date: April 26, 2012 AMC
Closing Price Pre-Earnings: $195.99	Closing Price Post-Earnings: $226.85
Sold 2 215.00 calls at $0.60, sold 2 175.00 puts at $0.80; expiring April 27, 2012
AMZN finishes week at $226.85
Net profit of $1,534.05 on $9,098 margin or 16.86% return*
*Note: I took assignment and shorted the stock and closed it several weeks later.

Visa (V)
Trade Date: May 2, 2012	Reporting Date: May 2, 2012 AMC
Closing Price Pre-Earnings: $122.19	Closing Price Post-Earnings: $116.41
Sold 2 125.00 calls at $1.16, sold 2 120.00 puts at $1.25; expiring May 4, 2012
V finishes week at $117.79
Net profit of 18.51$ on $6,938 margin or 0.27% return
Note: In-the-money put was closed at $2.10 prior to expiration

In summary, the net income generated on the nine closed and profitable trades equated to $997.03 over five weeks. That profit is after commissions and SEC Fees, but before taxes. Only one trade generated a loss, a substantial loss of nearly $2,100 in fact, which would have created a loss of roughly $1,100. Fortunately, I had enough margin to take assignment and short the shares. The stock is now in a profitable position of over $400, plus the net option premiums received was $257.00, and I had also written covered puts to hedge the trade. I may consider disclosing future earnings plays to provide a detailed history and log of the potential profits and losses that occur. If this were to happen, it will be available in a future link in the top navigation bar.

Disclaimer: As always, writing naked options is considered a higher risk trading strategy and should not be available to all investors. Please discuss this with a financial professional as it can pose serious financial losses if not managed properly.

Don't Be a Sucker Bro, Stay Away From Zucker's IPO

This is the final warning to my friends and all investors lining up to buy a piece of Facebook [FB:NSD] - don't. Here's where I get blunt, which I rarely ever do here. Buying Facebook is the worst thing you can do. Not only will it prove your lack of reasoning and investment judgment, you will lose thousands of dollars too. It does not make enough money to justify its valuation and it most certainly will not make enough in the coming quarters either. And you would be naive to assume current shareholders are not waiting to sell their shares come May 18 when it hits the frenzy of the stock market. I want to save you from losing your hard-earned money by making you understand that Facebook as an investment is a poor decision. The hype surrounding Facebook is resounding and its prospect as a multi-billion dollar business is valid, but I believe this is another case of overvaluation. If you frequent my blog, you know that valuations are a key topic of mine, so you will know exactly where I'm going with this. You would be crazy to think FB would be a good investment at these prices and here's a few rreasons why.

My personal opinion is just that, an opinion, but fundamentals never lie. Based on current IPO valuations, Zuckerberg's company is worth a staggering $100 billion. This makes Facebook worth as much as McDonald's [MCD:NYSE], twice as much as Starbucks [SBUX:NSD], and four times as much as Dell [DELL:NSD]. McDonald's generated $27 billion in sales in 2011, trumping Facebook's $3.7 billion. And Dell, well it sold $62 billion worth of computers last year alone, and some how the company is worth just a fraction of Facebook.

Of course, Facebook isn't just some company. It's the world's largest social media site with 901 million active users. That's 12.8 per cent of the world's population and some expect this number to reach 3 billion. Strong growing numbers in users and revenue generation makes it a bull case for many, but they are sadly mistaken. With valuations over $100 billion, people have already priced in perfection. No company is perfect.

The first concern would be their inability to make real money. Last night, General Motors [GM:NYSE] cut ties with Facebook citing that advertising on FB was unsuccessful. Don't be surprised if more big businesses make the same decision. Recent polls suggest only 23 per cent of users click on advertising on Facebook. In fact, on advertising, Facebook earns just $3.75 per user. One could argue there's a lot of room to grow here too, but who really clicks on ads? Maybe future share holders trying to prop up the price. The company does not monetize from mobile and tablet users either and this must change as more and more of its users make the transition away from computers.

Secondly, the company's growth is decelerating. At December-end, its profit fell 12 per cent and revenue grew at 45 per cent, down from 55 per cent. Falling revenue and rising costs (strangely it doubled its marketing costs, but I've never seen an ad ever for the site) points to a falling stock in the future. This is evidence that margins are peaking or have peaked in the last 12 months. And its decreasing user count in North America is not a good sign either. Its global user growth rate has stalled to a trickling 1.5 per cent. There are only so many people in the world, and the laws of big businesses are starting to set in.

Thirdly, the CEO shows very little Wall Street prowess. Yes, he built a $100 billion company, but pleasing millions of shareholders is an entirely new realm of business Zuckerberg has yet to endure. His recent actions indicate he still acts like the boss and not the CEO of a publicly traded company, but that may change with time. Why does that matter? Because when you're a public company, shareholders with 100 shares or 100,000 shares care mainly about the stock price.

Some will argue that Facebook is the next Google [GOOG:NSD] and Amazon [AMZN:NSD] and truthfully, I agree in many senses. The company has already grown and become a big part of our lives and culture that it can not escape any aspect of our society. Businesses love it, people love it, politicians, well they're learning to love it. But therein lies its own demise. Its size is immense, and as such, it has little room to grow. Its expectations as a company are so ridiculously high that any hiccup could send these shares tumbling. Some believe that Facebook or Apple will be the first company to be worth $1 trillion. To those investors buying on Friday that believe that the shares will grow much like Google's and Amazon's, it appears your wishful thinking is misplaced and your numbers miscalculated.

When Google went public in 2004, it was valued at $30 billion. And Amazon was worth just $500 million. Today, they are worth about $200 billion and $100 billion respectively in market capitalization. Facebook might be the next Amazon in more ways than one, but I must stress that going public and already being worth $100 billion is not the same as going public at $500 million and growing to $100 billion. Facebook is at its pinnacle, its peak, its zenith if you will. Unless the company makes radical changes to its business model, the prospect that these shares will make you millions is slim. You are better off betting $10,000 on black. At least you won't have to pay a commission at the casino.

Understanding a Rights Offering

I received an email from one of my good friends moments after Ivanhoe Mines [IVN:TSE] released news that a rights offering was made to all shareholders. The company announced a US$1.8 billion rights offer allowing shareholders to subscribe to new shares at C$8.34, a discount of 26 per cent from the previous day's price. As would be the case, my friend had many questions and wanted to know if he should exercise his rights. I told him that a financial theory suggests an investor exercising their rights will not profit or lose. Here's why.

Ivanhoe Mines issued a rights offer at $8.34 to raise funds for a mining project. Prior to the news, the stock closed at around C$11.50 on the Toronto Stock Exchange. It seems like a great arbitrage deal for an investor, therefore, a profit must occur, but that is not true. Let us examine the reason with a very basic example.

If Mr. Jones bought 100 shares of Company ABC at $20 and exercises his rights, thus purchasing another 100 at $16, he would have spent $2000 + $1600 on 200 shares, bringing his average cost base down to $18/share. The market would also push the shares down to $18 as well because of market efficiency. Nobody would be willing to overpay for the stock if it is fairly valued at $18.

Now, Company ABC is trading at $20 with 1,000,000 shares outstanding; that means ABC is worth $20 million. The company issues a rights offer at 1:1 with a subscription price of $16 per share. If all share holders exercised their rights, the company would now have 2,000,000 shares and its new market capitalization would be the sum of the old market capitalization ($20 m) and the new cash received ($16m), which equates to $36 million. But that $36 million is divided evenly amongst 2 million shares, creating a share price of $18.

Assuming no change in company valuation, Mr. Jones would see his shares slowly fall to $18 creating no loss or gain following the completion of the issue.

So, with that basic lesson done, how do we understand Ivanhoe's second rights offer in under two years? The first important thing is determining the amount of rights an investor will receive. Although we are uncertain, it appears that an investor will receive about 20 to 22 rights for every board lot owned, determined by dividing $1.8 billion into the value of the company of $8.52 billion at the time of the news. The rights will not be trading on a secondary market, so holders will only have a few days to exercise their rights. Now, finding the fair market value of Ivanhoe will take a little more work. The company is looking to raise about $1.8 billion by offering shares at $8.34. That creates up to 215 million shares. The company's new market value would be $10.32 billion with 956,348,000 outstanding shares equaling a fair market value of $10.79. And where is that stock today? $10.88.

On the day of April 18, I told my friend if he did NOT plan to exercise his rights but wants to continue owning Ivanhoe, he should sell them immediately and repurchase them after share dilution. Normally, the rights would be available to sell in an open market, allowing him to capture the "loss" on his share's reduction in value. There was no financial gain in holding them for the next few weeks since the stock did not pay dividends and he did not sell covered calls. He would also partake in the dilution of his shares. I didn't ask what his decision was; that's just rude, but the shares actually rose to $13.50 on other news on the same day, which would have given an investor a good price to sell out.

Be an Amazon Consumer, Not an Investor

Amazon [AMZN:NSD] shareholders may want to sell this week because the good times probably won't last. The world's largest online retailer surged about 15 per cent to over $230 after first-quarter earnings, but carrying that momentum for the remainder of the year will be a tough act with so many storm clouds hovering over the company. And with short sellers licking their fingers at this company, who's left to buy?

For some irrational reason, many analysts upgraded the company, even though the shares are trading at 185 times earnings. Any sane investor would glance at that P/E and know Amazon is extremely over valued. At these valuations, the company would have to be nearly perfect, no wait, better than perfect, to grow their shares. However, this is not the case. Declining profits, declining margins, declining guidance: these are not triggers to buy an expensive stock. No, these are cases to sell a company that appears to be the next Netflix [NFLX:NSD], Research in Motion [RIM:TSE, RIMM:NSD], or Netscape. If this company went private tonight, the new owners would have to wait 185 years to break-even, and that excludes the declining value of money.

Case in point: 2012 Q1 earnings indicated a profit margin of 0.99 per cent. That is, for every $100 I spend on Amazon.com, the company profits 99 cents. With so little room for error and a cut-throat industry that leaves losers in the dust, Amazon has to execute on a very high level. Take a look at the numbers. Revenue rose to $13.18 billion last quarter, a huge increase of 34 per cent but net profit was just $130 million, down 35 per cent by slashing prices to entice buyers. Its strategy of growing revenue may have worked, but it sacrificed its margins too much. Looking forward, the company's second quarter guidance was reduced to a net loss of $240 million. That's right folks. A company that sells more than $10 billion in products every three months will lose $240 million. If that doesn't scream sell, I don't know what else does.

It also doesn't help that the Kindle, their e-reader, is being sold at a loss. It was a strategy Microsoft [MSFT:NSD] and Sony [SNY:NYSE] employed with their video game consoles. The hopes for these two brands was that sales of video games, memberships, accessories, and down-loadable content would cover the losses on the consoles and it has worked. The major difference between Microsoft and Amazon - video games are $60, books are $6.

Add the expected sales tax collection which will eventually be law all across the United States, starting with California and Texas, and you have diminished price-advantage. For the last 18 years or so, with exception of five states, US Amazon customers never paid state sales taxes for purchases online, but this is about to change in 2013, as some customer's will now have to pay taxes like they do at brick-and-mortar shops. In Canada, it would be like never paying GST/HST/PST on Amazon.ca and then finding out that you have to start paying it next year. It will change consumer's behaviour and Amazon could see large-ticket items being left in stock for significantly longer.

What's ultimately problematic for me is the motive of upgrades by 9 analysts the day after earnings. Most traders ignore the noise from analysts. Their estimations and predictions are as educated as sophisticated investors, but their motives are often questionable. Paulo Santos of seekingalpha.com pointed out that Citigroup analyst Mark Mahaney upgraded his price target from $190 to $300 in a single day. But back in 2010, Mahaney predicted the company would earn over $5.32 a share by 2012. Amazon's real EPS: $1.27 (Full article here). How do so many companies change their perception of the company with one report, especially when the report showed that their margins are declining? There has been no significant change in the company's direction and profitability. Are they pumping the shares so they can dump them?

The company's total profit is less than it was at the end of 2008, but the shares are up 150 per cent in that time span. Revenue has risen significantly, but what's the point of selling more when you end up with less? It is energy well-wasted. It does not feel like Amazon's management wants to thrive as a business, but rather survive. Are they now fearful of Microsoft, Google [GOOG:NSD], and Apple [AAPL:NSD]? Amazon hasn't even considered paying a dividend. That's a sign that management knows their cash flow is not stable enough to pay out long-term holders. 70 per cent of its shares are owned by institutions, so one sell button by one firm could knock the shares back to normality.

Honestly, I believe Amazon will be the number one online retailer for decades and quite possibly for the entire 21st century, but being at the top only pushes competition to be better. And being number one doesn't mean your shares should be outrageously overpriced either. Realistically, for a company that is nearly two decades old and as established as this, the shares should be trading at a generous 15 times earnings, much like the rest of the market. That puts the shares at $20 not $230.

Disclaimer: I am short Amazon shares post-earnings.