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Global stock market's highs and records suggest that the search for income are pushing investors into the equities market. Low yields have changed the economic landscape over the last five years and will continue to transform it for the next five. It is a dangerous time as those that cannot stomach the inherent dangers of capital losses and volatility may be making poor investment decisions. Given the history of equities, owning quality companies has been profitable. However, those in search of income may want to avoid owning stocks if they have the luxury of trading options, specifically, selling put options.
Frequent readers will know that I favour option selling over stock ownership because of strategic versatility, greater downside protection, lack of capital requirements, and potentially better returns. One may argue that options carry more risk, however, when used in replacement of equity ownership, the advantages do outweigh the disadvantages.
The main disadvantage is the limited capital gains. Selling put options simulates stock ownership because the seller is speculating that the stock will remain above a certain pre-determined price, known as the strike price. However, the option seller does not participate in any strong rallies and gains only on the decreasing put option price. Statistics do show that within a diverse put option account, one can still beat the market's historical returns.
Below is a chart of the top 25 widely held companies by institution that have November 2014 options. Note, only Pepsi was removed from the original list of the top 25 as November options have not been issued by the exchanges.
The data suggests that dividends paid to the investor over the next 84 days will be less than the premiums received by selling the out-of-the-money put options. As well, there is a larger hedge for the put seller, which can be used to offset the automatic price reduction on cum-dividend day. Using Apple as an example, a trader, whose options expire worthless, will theoretically earn over 12 per cent, assuming option deltas remain stable. Because future prices are often uncertain, it may be worth sacrificing any larger gains by accepting the 12 per cent yields on the option.
This strategy is best used for those that are willing to own the stock even at a later date and at a lower price in exchange for immediate upfront cash. This is because almost at-the-money options have a greater chance of being assigned, and as such, the investor must understand they will own the shares if the other party exercises their rights. One must also take into account elevated commission and tax consequences. Dividends and capital gains may be taxed differently in your country. It would be prudent to look into the strategy further.
Other worthy facts: the downside protection for all 25 companies exceeds 3 per cent. That is, the premiums received plus the out-of-the-money (OTM) amounts are all greater than 3 per cent. In the event of assignment, the new stock owner has actually purchased the stock at a discount in November. For investors borrowing money, this will reduce the interest payments to the brokerage. Other people may also purchase short-term debt instruments to expire in November because the loan values of GICs and treasury bills may be 90 per cent or greater. This means a person with $100,000 can sell options and buy short-term debt instruments at the same time!
CEO of Mozilla Brendan Eich recently stepped down amid news that he donated money to oppose same-sex marriage in California in 2008. The backlash he received from his employees and customers was insurmountable, yet he did absolutely nothing wrong. He made the decision to resign because he felt he "cannot be an effective leader." The boycott could eventually lead to the demise or failure of Mozilla as a whole. With the conscience of a saint, it was a big sacrifice he took to ensure the health of the company remained strong.
For the record, I am in support of same-sex marriage and equal rights. I hope that one day all people of any sexual orientation can be allowed to unite as a pair and express their love. But the actions taken to remove Eich from his position is completely wrong, unfair, and intolerant and his political view, however backwards some may call it, does not correlate to his ability to run a business. Now, if he was the head of Trojan condoms and opposed contraception and decided to lead the company into a different direction, perhaps producing Trojan viruses to attack cell phones of sinners, then yes, he is not qualified. But this is far from a Christian agenda. It's an Internet browsing company, which is virtually, no pun intended, the complete opposite.
Eich's non-hateful views on same-sex marriage fall under the socially acceptable political spectrum and he should be allowed to voice his moral opinions through the ballot. His vote and financial support is a part of the democratic process and a testament to the freedom of speech allowed in America. His ideals are clearly rooted in a conservative or religious background and do not break any laws, so to be chastised and chased away from a job he held for merely two weeks is unfair. Millions of voters made the same choice as Eich and maybe executives at other well-known companies too, but nobody is asking for their resignation. Because Eich's financial support was released to the public, he has been unfairly attacked. To be able to work harmoniously side-by-side with those whose opinion we oppose is a natural and mature occurrence.
To boycott a brand and raise awareness about an issue, that is acceptable. However, to directly request or petition the removal of an individual because of their personal, reasonable beliefs is not. To not accept another human being's views on a specific issue is intolerant. There is an irony at play that seems to have been lost due to tunnel vision. The progress earned by the LGBT community is a positive direction for humankind, but the momentum may be moving beyond their control. Extreme supporters will lose sight of others views in favour of their own beliefs and this is when turmoil within the community becomes divisive and momentum halts. An individual's rational, political opinion rooted in ethics, morals, or personal choice should have no direct bearing on his employment or personal life. It is possible that a man's financial success and dreams have been quashed here because of his fair political thoughts. This is not the culture we want our top business leaders to exist in. This is not the culture I want to be a part of.
Author, editor, and openly gay Andrew Sullivan appeared on Stephen Colbert's late night supporting Eich. "I actually think we've come a long way on gay rights because we've been open, tolerant, persuaded people by reason and haven't jumped down everybody's throat who's disagreed with us and get them fired. I just don't like that kind of tenor and that impulse to punish people for things they may sincerely believe."
Of the 70,000 estimated that signed the petition or joined the Facebook group or whatever means they used, how many of them jumped on the LGBT bandwagon? How many took the time to understand the position of Eich and his opinions in 2008? How is it that a gay man who opposes Eich's views support him? The outcome that led to Eich's resignation creates a scary thought that a man or woman at any employment rank could be replaced because of their political views.
It is fair to assume that activists are not suitable to determine what candidate is best suited to lead a business, therefore, it is unjustified for them to believe that Eich was the wrong choice considering they provided no recommendations. They should be ashamed of the pressure and stigma that will forever be attached to Eich. The man is a millionaire, so he will still sleep well at night, but what company, knowing the background of the backlash, is willing to gamble on someone that will continuously and forever be asked to step down from every job he acquires? And how great and humourous would it be if Eich made a new browser company and took control of the Internet world?
A sharp drop at the tail end of January was followed by a nice rally to start the first half of February. The market has recouped most of those losses sustained in January. Pundits praised a resilient market and claimed investors seeking long-term capital appreciation knew market depreciations were buying opportunities. However, most traders sifting through the data might tell you a different, more ominous tale.
Changes in wealth occur every second, but most investors can tolerate the micro-sized events. What most investors tend to ignore is the strength in those changes, and this conviction is measured in volume – the amount of shares traded in a given day. It is how one can “read between the lines” and assess the conditions of overall sentiment. Low volume indicates less conviction in the direction of the market, and that is what we are currently witnessing. Volume generates confidence that allows the market to maintain a positive cash flow creating rises in stock valuations.
Let’s use an example to understand the theory. Imagine I was the CEO of a public company called Vacuum Inc. and you owned some shares. On a typical day, the amount of shares traded is 10 million. However, over the past month, the volume has declined to only 4 million, yet the shares are up 5 per cent. What does this mean? Why should an individual care about liquidity?
Low volume suggests that there is less conviction in the direction, as we stated earlier. There could be a number of reasons why the strength of the rise is questionable. Perhaps, big money has maximized their allotted positions on Vacuum Inc., or they have funds tied up in other parts of the market, or demand is reduced due to business concerns. Whatever the reason, it can suggest a negative trend.
Let’s take this example to the extreme. Let’s say volume was 100 per day for the last month with the shares rising 5 per cent. This would indicate that a small group of traders, perhaps even just one person, was propping the value of the shares by buying and selling between themselves. Now, for investors ignoring the variable of volume, the rise in equity appears good. Vacuum Inc. has just increased your overall wealth, but the underlying issue of low volume should trigger red flags. The elevated price of the shares are not an accurate assessment of valuation. There are other variables one could examine, such as buy orders through market depth, to verify unrepresented strength, but under normal conditions, one would assume that liquidity is minimal, so if shareholders decided to sell and volume rose back to 10 million, we may eventually see large drops in price. The price you receive per share is the accurate value of the stock.
The reduction in stock volume represents a fundamental change in investor and trader behaviour. With economic conditions muted, this limits growth of participants in the stock market. Since the stock market is essentially a zero-sum game, debateable by many scholars and professionals, it requires continuous net positive cash flow into the market to create long-term wealth. Investors already in the market looking to sell in the future may find that drops in liquidity are not beneficial, especially since most trades created throughout the day are executed by institutions.
Another reason investors need to care about liquidity is that it stabilizes markets. A system that has a billion shares trying to buy and sell will create less volatility than a system that has just thousands. Spreads between the highest buyer and the second highest buyer can be huge. Imagine yourself selling a home to just a pair of shoppers. One offers $400K and one offers just $350K. Your options are limited. But imagine your home having bids from a dozen people, well suddenly, the price received to sell if the top bidder backs out might still be closer to your asking price.
Concerns on volume have been a discussion for the last few years. As US markets continue to reach all-time highs, some wonder where investors are. With a lack of investors participating in the stock market's rise, many question the validity. This chart, from July 2013, shows a significant down trend in trading over the last half-decade, courtesy "The Wall Street Journal."
And if we examine the archived data directly from the NYSE here, we see the same information being upheld in the chart above. Some may say that a rising market means fewer shares are traded at higher prices, however, what we do see is that this is not true. In fact, the dollar volume has also decreased.
It's hard to imagine the stock market's volume being reduced to mere thousands per company, or millions per exchange, but the underlying issues that could lead to such a scenario should be educated. The biggest culprit to wealth is not falling prices as some believe, but in fact liquidity. Without the ability to participate or sell in any kind of market, what motive is there to buy a company whose shares might take days to withdraw from?
As a hockey player, when you're in the offensive zone, the last thing you should be worried about is the performance of your goaltender, but that is how the Edmonton Oilers had been playing the first half of the year.
You see, Dubnyk was having one bad season. He was the fault of the Oilers losing ways. Defendants explained that the Oilers poor play was the reason, and that Dubnyk was a mere victim of such defense. But these people can not deny that he was unable to make timely saves if his career depended on it. Case in point the game against the Toronto Maple Leafs on October 12, 2013. The Oilers led five different times throughout the game and gave up a goal in the final minute on a weak wrist shot. The team would lose in over time.
Twice to my recollection, Dubnyk allowed a goal from the blue line that should not have gone in. One, a harmless dump-in from the blue line, and the second, a seemingly routine save that slipped through his nine hole (blocker and pad). In any given night, a hockey fan could use such an opportunity to bite into his hot dog or take a sip of his beer, but not if Dubnyk was in net.
The Oilers poor defense was magnified exponentially because of poor performances by both goalies. And many indicated that it did not matter who was in net, the Oilers would still allow 4 goals a game.
Enter Ben Scrivens. Since his acquisition on January 15, 2014, the Oilers are 5-4-2 and have allowed three goals or more just three times, once in an OT loss. That's unreal hockey for this team. His first appearance was not so good. He allowed four goals to the Wild and it was "proof" it did not matter who was in net. And then, two games later, the goals-allowed stopped.
It's not that Scrivens has done anything to fix the glaring problems that face the coaching staff; there is a lot of work that has to be done. It's that the players believe that Scrivens, and Bryzgalov, are going to make that one additional save that could be the difference between no points in the standings or two. And that changes the dynamics of every player.
Jack Michaels and Bob Stauffer of 630 CHED are proponents of the concept that this team's good goaltending has led to significant offensive chances and overall play. The pair mentioned during the post-game after the New York Rangers (Feb 6, 2014) contest that the Oilers were playing substantially different and it was all due to confidence in their goaltender. The ability to activate the defense and try high-risk plays indicated that they knew their goalie was capable of forgiving their mistakes. It might not make sense to a casual fan, but the reality is that a team needs to have faith in every aspect before all strengths can develop and emerge, even if they are not the most elite.
Imagine for a moment a simple restaurant with five average employees. One is in charge of each of the following: utensils, beverages, appetizers, entrees, and dessert. The first employee plates the tables and moves on to the next one. The beverage provider does the same thing. But there is a weak chain in the appetizer employee. He is often late to deliver, mixes them up, or forgets them altogether. Now, a good supporting team would most likely grab that appetizer with the drinks, or explain that it will be delayed. However, if this occurs on a consistent basis, it throws off the timing and chemistry of a well-run restaurant. Now, the waiter in charge of entrees needs to make sure the appetizers have been served or the beverage employee has to spend additional time apologizing in advance for a delay. This simplified example of assignment translates across every job, including sports.
If a receiver can not catch the ball, a quarterback will have to focus else where instead of utilizing the entire field. If a short stop is slow moving, the third base man might have to shift left, giving room to his right. If a doubles tennis partner knows his server will double fault, his close-net strengths will be moot. A team needs confidence in their mates so that they are not distracted by weakness and can focus on strengths and create opportunities. People act differently when they can not rely on others.
I had a lot of trust and faith in Dubnyk to start the year, but as the days progressed, I realized that he was the problem. Richard Bachmann came in to face the Kings one game, and he faced two shots in the final minute of the game that forced overtime. They were point blank shots no more than six feet from the crease, but he made that one, no, two, big saves that changed the game. I remember my brother and I yelling, "Dubnyk would have let those in." This game occured October 27, 2013. The Oilers would lose in a shoot out but earned a valuable one point.
And that is how all the greats are remembered. Some times people forgive average statistics if they make the extra save, or the field goal, or the walk-off home run, or that clutch buzzer beater.
After the Olympic break, we will see if my theory holds true. The Oilers have technically gone above .500 in a stretch from late November to early December which also lasted 11 games. However, I firmly feel that the Oilers have significant confidence in their goaltending and should earn them an extra four wins by the end of the year. I would argue that three of the Oilers last five wins were courtesy of great goaltending, including that 59-save shut out. Those four wins might not sound like a lot, but the Toronto Maple Leafs have the worst shots ratio and have 11 more wins than Edmonton. The Ottawa Senators and Washington Capitals also have porous defenders and are above .500.
Had the Oilers won 5 additional games or sent more close games to extra time in the last 60, they would be right up there with the Canucks and Coyotes. In professional sports, there is such a fine line between winning and losing and some times it takes very little to turn things around.
The performance of global equity markets to kick off 2014 has been a painful one for investors. In a sign of things to come for the year, January's direction as an almanac is accurate 80 per cent of the time. This means that 2014 could be a down year.
Volatility, especially downward, comes in bunches. That's what history tells us, so the next few weeks could see severe selling. Big money is leaving the market and for good reason. The rise has been attributed to fed stimulus, but that is winding down, and the earnings reports of big names and market leaders have been unable to turn the tide. So what actions can an investor take without worrying about their portfolio and wealth?
The simplest thing to do is to sell your holdings. But for long-term holders, this might not be practical. They may be in dividend-reinvestment programs and would appreciate the slight drop in valuation. Others may want to always be participated in the market for any eventual rally. Or perhaps investors don't want to realize any tax gains until retirement, especially if they are planning to get back in the market. This is where the option market comes in, and why I have always been an advocate for it.
The endless array of strategies that exist in just two products should persuade many investors to get a basic understanding of how they work. The covered call can introduce monthly or weekly income immediately in cash so any taxes owed at year-end can be simply withdrawn from the account. But covered calls are only half the answer. Today we are going to introduce the married put.
Let's say you have owned Google (GOOG) shares for 5 years now, buying after the market crash of 2008 and you bought 100 of them for $380 a share ($38,000). Those shares today are worth $1,137.50 each ($113,750). Well, cashing in would create a capital gain of $75,750. But you truly believe in the stock, so if you sell today and bought a 100 shares in a few weeks at roughly the same price, you would still owe taxes. Instead, you can essentially lock in that $1,137.50 price without having to worry about the movement of the market for the next several weeks using a married put strategy.
The strategy is implemented by selling a covered call and using those premiums to purchase a put. Let's say a trader wants protection until the end of February, they would find February 28, 2014 options and sell the call for at least $28.80 a contract ($2,880) and buy the put at the same strike price costing at most $29.80 a contract ($2,980). The overall cost of the "insurance" is at most $100. The reason for this is because we sold at the bid (highest shown buyer) and bought at the ask (lowest shown seller), which in reality, is the worst case scenario and better fills often exist.
So, here's why it works. Let's say today is now Feb 28 and the shares fall to $1,100. The covered call would be worthless, and the trader would NOT exercise his option, but simply sell it for about $37.50 ($3,750). This would create a profit on the put option of $770. The profit on the call is the entire $2,880. A net profit of $3,650. However, the shares of Google have fallen $37.50, so the equity value has dropped $3,750. The total loss of equity is $100, the cost of the option.
Let's use a table to demonstrate this.
| Date | Google Value | Cash | Equity |
| Feb 3 mid-day | $113,750 | $0 | $113,750 |
| Feb 3 close | $113,750 | -$100 | $113,650 |
| Feb 28 close | $110,000 | $3,650 | $113,650 |
It is the allure of fast money that we seek when financial adversity strikes; it is the incomparable suspense and drama that eats away at our nerves minute-by-minute, second-by-second; it is the roller coaster that brings both twists and turns, ups and downs; it is the bringer of extreme frustration and exuberance; it is the unending permutations and combinations of unfolding events that help us break away from the monotonous nine to five; it is the reason that Mondays are loved and Fridays, well, are loved as well. It is my life. I am an options trader.
The misconceptions people make about me and option traders is a result of at least two things: their misunderstanding and lack of knowledge of the financial markets, and the stigma day traders have. To call me a day trader is a bit slanderous but having done both, I can tell you that the styles are vastly different. Sure, we have minor similarities. We both hope the direction of a stock goes in our favour, and we both might watch the market all day long to capture that fast money, but that’s really where the similarities end.
Day traders need significant movements or capital to make money. That is why so many have charts up all day waiting for the right time to close their positions. It is why it is an extremely stressful task, especially when you have an interest in the money being traded. Every second you must make a decision at the same time as every trade goes through. It represents your missed opportunities or your vindications, stirring doubt and questions about the validity of a sudden rise, processing every bit of information or lack of and creating a conclusion. You must time it and hope the move you made was correct, like sliding the queen, sitting next to the king, across the board as you prepare to execute some divine plan.
Thankfully, I have evolved beyond the stresses of day trading and onto the options trading market. Yes, I am arrogantly calling options traders better than day traders, live with it. While day traders worry every waking moment, I sit back and wait for the days to roll by until the morning of Friday or more commonly, the middle of the afternoon as I prepare to close my positions. This is the life of an options trader.
Monday January 6, 2014
Waking up at 9 AM MST is a bit tough for me, because I am a night owl. I love being up until 2 AM getting in some exercise, reading articles, playing computers games, or just watching Jon Stewart and Sportscentre. So, I decide to wake up at noon. I rarely trade on Monday. It's just too far from expiration and the market is more volatile than the option market is pricing. This Monday was particularly boring too. I usually let the big guns on the floor duke it out, flex their muscles, and move their stocks in whatever way they feel like. So, I keep note of the stocks on my watch list: Apple on a downtrend, not too good but heading higher on the day; Amazon still trading between $390 and $405; Netflix charts show negative sentiment taking over; Google supporting at $1,100, waiting for some direction, GLD extremely volatile and had a flash crash; and Tesla Motors moving sideways. Time to just sit back and relax.
Tuesday January 7, 2014
Nothing to take advantage of again. I'm my own boss. I only make money by trading, but nothing catches my eye. Again, it's time to relax and just cruise through the day. As we can see, there isn't much stress so far. Meanwhile, there's probably some day trader ripping his grey hair out as the market either is not moving or his stocks aren't performing for him. Either or, I'm taking the day off.
Wednesday January 8, 2014
For my own level of comfort, I find that executing my credit spreads after 2 PM EST on Wednesday seems to work best for me. So, looking at the prices of the options of my followed stocks, I find that only Amazon is worth touching. So I call in, spend a whopping 7 minutes, and ask for a 4-legged spread on Amazon with five contracts to expire on Jan 10. The trade speculates Amazon will be between $395 and $405 with protection at $385 and $415 at the close of Friday. At the time of the call, Amazon was trading at $400.xx, a price it continued to tread near for weeks. The total capital required is $5000 (as that is the maximum loss); the total money received: $1,037.02. That's 25 per cent (calculation is actually $1037.02/($5000-1037.02)). That's better than the average mutual fund's return in a given year. Now you see why I moved into the options market.
Thursday January 9, 2014
So, I get up around 11 AM and check the markets. Again, very little excitement remains. But holy, Amazon opened up above $405 but quickly drew back to $400. It's a new all-time high for the stock but it could not manage to hold gains. Fortunately for me anyways, it was what I needed. I decided to call again, this time it was 8 minutes, and asked the trader to create the exact Amazon position I have, doubling it to 10 contracts on all four legs. With an entire day's worth of "time value" gone, the total proceeds dwindles to just $542.02. This creates a return just over 12 per cent for one day, still a remarkable return. And the work day is done. I have now spent 15 minutes having to call in, with perhaps a total of another 10 minutes checking the prices of the options prior to each phone call. Everything is looking good so far, but it's not Friday. Nothing matters today.
Friday January 10, 2014
I wake up at 10 AM , always earlier in excitement, and find Amazon shares at $397. Still holding strong. I take a shower, eat some breakfast, and get ready for work. Okay, the shares have moved closer to $396, but I am still safe. Some stress is forming. I think to myself, "I knew I should have done lower call strikes." Doubt kicks in the moment it went below $395.
It is now 12:20 PM MST. I was not happy at all. For the next 40 minutes, it is excruciating pain. Oh my goodness, it's $393.80! For every penny it drops, I essentially lose $10, so you can understand why I'm now angry. At $394, I would have to pay $1 x 1000 shares to close. "I should have just paid the 25 cents!" I scream in my head. Day traders can empathize. It's now 12:58 and I call to ask iTrade if they can ask credit to extend the closing deadlime an additional 30 minutes. I want to see if Amazon will move back out of the money. It's now $394.40ish. They agree. I enter a buy to close for $0.25 while the option is bidding about $0.75 to an ask of $0.84.
Out of no where, the stock pushes higher at around 1:04. Some firm must have made a very similar bet too and must be buying the shares. I don't care if it's coincidence or manipulation, but it's helping me. Amazon had a nice upward move in a matter of 15 seconds pushing it from $394.40 to $395.26. Like a switch, my feelings went from disgrace to ecstasy. I would compare it to watching your favourite hockey team allow a goal in the last seconds of the game and then winning it in over time on the first shot. The stock makes another move at 1:14. Before I can even change the order, it has been filled. The shares would end up closing at $397.66. The total profit earned after fees was $1,309.55. All in three days!
To capture the emotional roller coaster that exists on the last day through this blog does not do it justice. Every second, every sweat drop, every penny, every share trading hands sends multiple emotions through my body. As I discussed above, it can fill you with joy and excitement or anger and frustration, sometimes all emotions before you blink. Is it fun? I love it! And when I'm right, when I tell myself to be aggressive and get the trade perfectly, that feeling of success, fulfillment, and self-gratitude boosts my confidence like nothing in this world. And when I'm wrong, shame, disappointment, and failure just takes control. It's a short-lived addiction that has its financial benefits, where work is considered a phone call, and a casino looks like child's play. But for everything that is negative about it, it is the positives that I love. And I wouldn't have it any other way.
