Beating Low Yields with Options

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!

Free Insurance in the Market

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

Scary Stories of the Discount Brokerage

In Canada, a discount brokerage is a type of investment firm that can not provide advice and must take all instructions given by the client regardless of how poor it may seem. General information may be communicated but what to buy, why to buy, and when to buy can never be answered. Essentially, these accounts are self-directed by investors with the knowledge and capabilities of taking control of the investments and finances. At least, that's what I thought.

Throughout my tenure at the firm, I encountered a vast amount of Canadians so ill-informed about the market that their stories still stick with me today. I would try to refer them to an advisor but often times that could be taken offensively. It was a fine line to walk on. The stories I share today are not meant to ridicule any one in particular or the firm, but to put into perspective your financial ability's and whether or not you are ready to manage your own investments.

The Dentist
I received a phone call from a brand new client. His profile said he was a dentist and had been with us for less than a week. He asked me to sell his mutual funds which were just transferred in. I made the trade as discussed and noticed that the transfer came from our company's full brokerage side. I made the assumption that either he felt confident in running his own portfolio or he wanted a cheaper commission on the sale of his account. Either way, I went ahead and made the trade. After confirming the order, this is a paraphrase of how our conversation went from there on.

"How much money did I receive?"
"Well, we don't know the actual value of the sale as it is not determined until the end of the day."
"What? I don't understand."
"Unlike stocks, mutual funds are priced at the end of the day. So the price you see on the Internet is yesterday's close."
"But my old broker told me that they would be sold immediately."
"Yes, the mutual fund has been given instructions to be sold, but again, the price is not determined until the end of the day. That is how mutual funds work."

The conversation would loop for a few more minutes before the dentist finally absorbed the information. What was interesting to me was that he mentioned he was with the full broker for years, but did not learn a thing. It was this moment that made me decide that if I took the full-advice channel, I would build a relationship that was built on education and information to form strong, trusting bonds.

The lesson to take away here is not just that mutual funds are priced once a day, but that you should be taking ownership of your investments when you feel educated and confident. And although your level of knowledge on financial products may never be equal to those in the industry, it is beneficial to familiarize yourself with the basics and invest within your comfort level.

To give credit, this client was not stupid by any means, he was simply unaware of the major differences of mutual funds and stocks, which is very frequent as we will see in the next story.

The Research in Motion Lady
I call her the RIM lady because of her holdings. It was well into the six-figures, but a large chunk, like 90 per cent, of her holdings were invested in one company, Research in Motion, now BlackBerry. And then there were two mutual funds which accounted for the rest. This was not well-diversified enough by any means, but she was up like triple on the stock. She called in to sell her mutual funds as well, but had just purchased them within a month.

"Hello there. I would like to sell my mutual funds."
"Absolutely ma'am, but just so you are aware, these funds were purchased two weeks ago and will incur a charge for not holding them at least 30 days."
"What? I thought this was a discount brokerage and these funds don't have charges."
"Yes ma'am, we are a discount brokerage, but mutual funds have a holding period."
"Okay fine, just sell them. I've had them for two weeks and the price has barely moved. They are terrible products."
"Well, that's because these are diversified mutual funds and they're designed to hold a lot of companies. And considering you've had them for only two weeks, you can't say they are bad products. Big returns so shortly don't happen."
"Well, Research in Motion did."
"Yeah, that is an exception."

As you can see, I got emotional and defensive because she was complaining about our brand's mutual funds and in doing so, I potentially may have crossed the fine line between advice and education but I felt that this lady was just not informed enough about her investments. If she still owns her stock, she has seen her shares fall to $8 from as much as $150 just four years ago.

The moral of this story is to diversify if you are starting out and not a great stock picker. Patience will get you through the long-term, especially if the companies you own are very well run and managed and have a steady stream of profits. There will be ups and downs, but what matters is the plan you devised. Although I am against mutual funds myself, they do have their benefits. And before making any purchase in any professionally managed product, always ask questions especially about the fees.

The Crying Lady
The last story I would like to share was actually an event that happened with my co-worker who sat next to me. It was a devastating situation that needed empathy and understanding, but a real lesson can be learned here.

It was days after the financial meltdown and the stock market was plummeting. Margins were being called and people were losing money all over the place. But the story of this one lady struck a cord with me. She was retired and had been very wealthy all her life. Not a millionaire, but saved enough to retire comfortably. Prior to the financial crisis, it was a raging bull market and more people starting borrowing money to better returns. It worked for years until October 2008.

The lady called in and got my colleague. It appeared that she had to sell all her stock to cover her loans but because of the collapse, it was not enough. She had piled up a debt within her trading account that exceed $100,000. To top it off, she was retired. She started to cry because she was lost. She did not know who to turn to or what. I believe in the end Credit made a payment plan of some sorts, but it made me really fearful of borrowing for weeks to come. She went from having a comfortable retirement build up of wealth to massive debt. And this was four days into the crisis.

Again, she was a smart woman and it was not that she was financially naive, no. It was a set of bad luck that tore through the accounts of hundreds, if not thousands of Canadians and millions across the globe. An event like this reminds us that we should invest within our means and if you plan to borrow, which is actually a very good way to make money, you must remember to have a secondary plan when things go wrong. Can you pay back the debt? Can you afford to invest? These are questions you must ask yourself before making your first real investment.

How Low Interest Rates Affect Pension Plans

Two weeks ago, I posted an article examining the health of Canadian defined-benefit pension plans in light of the battle between retired workers and the city of Detroit. I wanted to follow up with a basic educational article discussing how they work and why they are failing.

A pension plan is essentially a fund or scheme designed to provide funds at retirement. Contributions made by an employee through out his or her working life at a company eventually gets paid out when that worker retires. A defined-benefit plan determines the benefits to be received in the future, as is indicated in its name, it defines the benefits to the employee. In between that time, the fund will invest its assets in a number of investment vehicles. The problems that arose in Detroit and maybe for many in the future is that DB plans are only obligated to pay the debt if they can afford to. If a fund or employer declares bankruptcy, those obligations could become a part of a bankruptcy litigation.

The single biggest culprit to the failure of so many pension plans are interest rates. It is the backbone of economies because rates give value to assets and currencies, and determine the cost of borrowing. But when interest rates are as low as they have been, it significantly cuts returns. Although the chemical make-up of any pension plan will vary from company to company, most traditionally will invest in bonds, stocks, real estate, and other opportunities.

When interest rates are low, the income earned on bonds are reduced. In the world of lending, low interest rates push debt prices higher. If the government sets rates at 1 per cent, then a bond expiring in one year should yield about 1 per cent. The bond will be priced so that the purchaser of the bond (lender) receives just one per cent yield. So if the bond pays 3 per cent a year, the value of the bond must rise to offset the 3 per cent earned through interest income (known as the coupon). If a pension plan purchased a 10-year bond that matured (expired) today, the value of the bond will have risen and could be sold for a nice profit. But any new investment option purchased to replace it would be in the same asset class and yield less. And if rates do rise, then the value of the newly purchased bond will eventually decline.

Interest rates affect the prices of equities in the exact same manner with minor differences. The issue that money managers are faced with are low dividend yields as a result of low interest rates. Stocks are at all-time highs, yes, but money managers are in the business of creating income, not net worth.

The third common investment choice is real estate. Whether the property is a sky scraper or housing unit, these products are intended to earn income through rent or revenue-sharing. Think about it like this. You just bought a strip mall and rent out floor space to offices and business. A bad economy simply means lower demand for your space or lowered revenue-sharing opportunities. The value of your strip mall is moot because the intention of purchasing the mall was to generate income.

A reduction in the work force also negatively affects pension plans. When baby boomers retire, it pulls from the plan and obligations must be met. But, the supply and demand for workers continues to be low. Advancement in technology results in fewer workers required for the same job. And a struggling economy means companies are not ready to hire and worse, more ready to fire. The impact of employees matters for pension plans.

Pension plans are steady-state programs that use contributions from current members to pay owed retirees. Any difference is made up by withdrawing from the fund itself. Logically, the fund will release any cash first. Then, if a deficit remains, assets are sold. This is why income generation and cash flow is often more important than the net value of any fund. Combined with low interest rates yielding terrible returns and a smaller pool of workers to contribute to funds, we see that it is a recipe for the inevitable failure of many pension plans.

So, here is a long-winded summary of what money managers are faced with. Pension plans need high interest rates to survive. Central banks cut rates to spur economic growth, but it has failed. As a result, asset values rose to record highs creating low-yielding products for an extended period of time. Historically speaking, economic cycles hint that interest rates will rise, but based on tepid economic growth, rates will not rise until the pace of economic growth is comfortable. Rising interest rates are meant to deter growth. Since Central Banks are not yet ready to raise target rates, the only way to increase yields is to reduce the value of assets in some form. Now, with the baby boomers retiring and claiming benefits, pension plans must sell a chunk of assets at highs to offset shortages. This could be the supply side pressure needed to raise yields. However, these major moves hurt the economy and slow growth too, so businesses might cut hours or payroll numbers, mortgages rise, and demand for business space decline. Down the road, lower asset values means deficits are being offset by selling more asset units. And a reduction in contributions from fewer employees could be made up by increasing contribution payments, but reduces short-term money supply for the worker. A continued cycle exists all because the reduction in interest rates failed to spur growth.

Canadian Pension Plans Not So Good

The plight of Detroit is a somber reminder that the tragic falls of empires can still exist even in the modern-day era. Municipal bankruptcies have become all too common in America and a chapter 9 of this magnitude sent shock waves across the globe. Many questions can be asked how a former vibrant, manufacturing city with a population exceeding 1.8 million crashed to a city of ruins with just 700,000 citizens. Devoid of life and street lights, the city is terrorized by black and white jump suits instead of the traditional blue collars. It might sound like the plot to "Robocop," but the events that led to the financial collapse of a large American city resonates with so many working people all over the world because it exposed that public pension plans are not promises.

Government jobs are known to be lower-paid salaries relative to an equal private-sector job. But the trade-off in salary is off-set by better benefits and pensions. At least, that was the belief until Detroit unraveled and claimed its pension plan obligations as a liability to be considered in its bankruptcy decision. It is expected that all creditors will receive at most 20 cents to the dollar after proceedings are finalized: yes, that includes pension plan beneficiaries. With a world in turmoil and interest rates so low, are your pension plans safe?

DBRS evaluated the health of 461 defined-benefit (DB) pension plans world wide and is "mightily concerned." For the first time in a decade, the aggregate fund status was 78.6%, below the 80% minimum threshold they deem safe. More concerning was that 45% of funds world wide are in the "danger zone." For Canadians, news could not be worse. Not a single private DB pension plan had a surplus. Surprisingly, the government-run CPP had a surplus last year and is estimated to have enough funds for 75 years, although this is a defined-contribution fund.

Among the worst funds were three financial firms and two telecommunications companies. Check the list below to see if your DB pension plan is on the list, courtesy of DBRS.



Stay tuned for a second post explaining how a pension plan works and why they are failing.

Facebook Shares and Lock-Up Periods

Expect a not-so-good day for Facebook (FB) shares on November 14. The third and largest lock-up period will release up to 1.2 billion shares, including 60 million shares owned by Mark Zuckerberg. Although the founder claims he will not sell his shares for at least a year, we can not hold a man to such a proclamation when hundreds of millions of dollars can be pocketed.

The company has 2.7 billion shares outstanding, more than Apple (AAPL), Google (GOOG), and even International Business Machines (IBM). With as much as 44.4 per cent of the company's shares ready to be sold by insiders and employees on November 14, expect a very volatile day to the downside. Don't be surprised if the selling pressure triggers trading halts.

The shares last had a major lock-up period expiration on October 29. However, hurricane Sandy pushed the first trading day to October 31, which had the shares fall 5.28 per cent right at the open. The stock has continued to drop since and is 3.51 per cent lower since that opening minute.

The first lock-up period was August 16 and released 271 million shares. The shares fell 3.58 per cent right at the open and finished 6.27 per cent lower.

The final two lock-up periods will release a total of almost 200 million shares on December 14 and May 18, 2013. If history is any trend, these two days could send shares down about 3 per cent if the shares still have any value.

Stock compensation is also leading the company to report GAAP earnings in the red and will continue to do so for at least three more quarters. An article posted on MarketWatch claims the company's costs in stock compensation is $2.3 billion and ensures the company does not have a profitable quarter until mid-2013 if financial trends do not improve remarkably.

For current shareholders, dilution in such a situation is a double-edged sword. Stock compensation costs will only go down if the share price goes down, not a good thing of course. But, a rising stock will also trigger larger stock compensation costs, which effectively reduces the stake of each share in the company.

A great article was created, also on MarketWatch. Read it here.

Disclaimer: I am currently short Facebook shares.

How to Buy Stocks Without Spending Cash

Education goes a long way in business and investors with knowledge will always have the upper hand. That is why more and more traders have abandoned the "buy and hold" strategy and are replacing it with a less commonly discussed strategy known as a synthetic long.

The strategy mimics a long equity position through the use of options. Two bullish trades are executed that require significantly less capital yet carries the same risks and reward.

The first part of the strategy requires the purchase of a call option, known as the long call. If the trader is correct, the long call will rise as the stock rises. The second part requires the sale of a put option, known as the short put. If the trader is correct, the short put will decrease in value as the stock rises. Shorting (or writing) a put option may require upgrades to your margin account so verify with your brokerage.

Since we are replicating a long-term purchase, it is prudent to use LEAPS (Long-term Equity Anticipation Security). LEAPS are long-term options and typically expire in January of a future year. In fact, LEAPS are already available for expiration on January 17, 2015.

Shares of Apple [AAPL:NSD] closed October 2, 2012 at $661.31. The purchase of a board lot (100 shares) would require an initial investment of $66,131, but not all investors have the capital nor the income to pay interest on borrowed money for such a purchase. As a result, Apple is a good candidate for the synthetic long.

Long Equity

An investor looking to buy the shares would require the $66,131 up-front or could borrow on margin with a minimum deposit of $19,840 (30% margin requirement) but would pay interest on $46,291. Total margin required is a minimum of $19,840.

Synthetic Long

Another investor looking to create a synthetic long would require a deposit equal to the margin required to purchase the call option and the margin required to sell a put option. Using a strike price of 660 for both options, we find the call option is asking $102.50 and the put option is bidding $106.60. Now that we have this information, let us examine the steps and margin requirements.

Step One: Long Call

The Jan 2015 660 call option would be purchased for $10,250 to mimic 100 shares of Apple. A hefty price, but a fraction of the stock holder's initial payment. Total margin required is $10,250.

Step Two: Short Put

The Jan 2015 660 put option would be sold for $10,660 to mimic 100 shares of Apple. The estimated margin required is $13,095 (to view the formula, click here under short uncovered puts or click here for the online calculator).

The margin required for a synthetic long is $23,755 and is equal to the minimum initial deposit. Another thing to note is that the synthetic long automatically generates $410. This investor would actually have $24,165 in the account while the long-term stock holder has paid at least $66,131 for Apple.

The reason that the option trader earns money today is because they forfeit their right to receive future dividends. The call option would discount the value of the dividends in its price calculating the value of time and interest, which is why the put option costs more than the call, even though the call is in-the-money. If you didn't get that, don't worry about it!

Two things can happen to a stock in 15 months. It can rise or it can fall.

If Apple rises, the long-term holder profits the difference in share price at sale and dividends received. The option trader would see the call option rise and be able to sell it; the put option would decrease in value and eventually be worthless. The option trader's profit is the gain (if any) in the value of the call option plus the entire value of the original sale of the put option.

For example, if Apple rises to $800 on January 16, 2015, the stock holder profits $13,869 and earns $331.25 in five dividends. This totals $14,200.25. Meanwhile, the option trader earns $3,750 on the call option plus $10,660 on the put option. This totals $14,410. As we see, the option trader will generate more income after dividends by $210 assuming the stock holder has not borrowed any money.

But what if Apple drops to $550? The stock holder loses $11,131 on the stock but earns $331.25 in dividends. This totals ($10,799.75). Meanwhile, the option trader loses $10,250 on the call option purchase and closes the put option at $110. The put option loses only $340. This totals ($10,590). As we see, the option trader loses less money in the same situation.

In the above example with Apple rising, both traders essentially earned the same amount of money, however, the option trader yielded nearly three times as much. The stock holder earned a handsome 21 per cent in 15 months, but the option trader earned more than 60 per cent in the same time period.

For new investors, the simple idea of an option is overly complicated, but for sophisticated investors, the strategy above is not so. We see that it is more efficient and yields better results, which is why we're seeing a small shift in options trading versus long-term strategies.

Retirees Must Add Risk Back

Traditional investment methods teach investors to make a transition from growth to capital preservation strategies as they approach retirement. This allows investors to focus on preserving wealth and preventing losses and generating income. It has been used by millions of Canadians for decades and will continue to be used, but this strategy still advised by professionals is becoming outdated because of today's low interest rate economy.

Low interest rates will remain a part of the global economic plan until growth in confidence is restored and for most governments, including Canada, elevated interest rates won't be available until at least 2015. For retirees with capital preservation strategies, their savings will be diminished at an alarming rate, especially to the millions that have wealth locked up in RRSP accounts.

Needless to say, low interest rates will reduce returns, especially for those invested heavily in bonds. A 10-year government of Canada bond is yielding 1.62 per cent (view Bank of Canada yields here). That is less than the target rate of inflation of 2 to 3 per cent. If returns can not keep pace with inflation, it forces retired investors to sell more than they expected, reducing their overall wealth and the lifespan of their nest egg.

For those that have most of their savings in RRSP's, they will notice that mandatory withdrawal amounts exceed returns. Although this is already a common downside with RRIF accounts, low yields will continue to force investors to sell more of their bonds. It is this reason why retirees must consider adding risk back into their portfolios.

CPP and OAS (if qualified) will cover basic expenses but is it enough? Choosing to re-balance back into riskier assets like stocks is a tough decision especially having gone through three recessions in the last ten years and stock market volatility will never cease to exist. But great deals can be found in Canada that allows investors to save a little wiser.

Canadian investors looking to stay north of the border will find billion-dollar companies with generous and growing dividends. Although the risks of the stock market will always be in play, dividends will remain consistent in our economically better country. Yields above 4 per cent can be found in 16 of Canada's 60 biggest companies as of September 25, 2012. Click here to view an updated-daily list of the TSX 60's yields. These 16 stocks include major banks, competing telecom providers, and energy and resource companies creating a fairly diversified portfolio.

An added benefit to holding equity over bonds is that one can sell just a few shares of a stock to cover, while bond holders would have to sell one unit which in this day in age would be near $1,000, even if the investor required just $200.

The capital preservation techniques devised years ago are not applicable in today's economy. It assumed yields near 4 per cent (that is what we used in college), but that is not realistic for the foreseeable future. Investors must shift more focus back into risk if they plan on living off their life savings. It isn't right that so many millions of Canadians will blindly follow the advice of an advisor simply following the traditional investing methods. Investors must think outside the box and come to the realization that their savings are being hurt by fiscal policy meant to bolster economic activity. Otherwise, individuals in retirement would have to go back to work just to make ends meet.

Unique Tactic on Las Vegas Sands

Las Vegas Sands [LVS:NYSE] is the world's largest casino company by market cap. It operates hotels worldwide, including the Venetian in Las Vegas, USA, the Marina Bay Sands in Singapore, and the Venetian Macao in Macao, China. Next week on Monday June 18, 2012, the company will go ex-dividend and pay shareholders $0.25 per share.

This dividend occurs after an options expiry and provides a unique opportunity for traders. But first, let's examine the entire situation here to get a full understanding of the scenario and settlement dates. If you understand settlement, skip down three paragraphs.

Normally, if one wished to receive the dividend, an investor must purchase the stock before the ex-dividend date. In this case, the investor must buy it on Friday June 15 at the latest to receive the dividend. He or she can sell the shares on the 18th and maintain their rights to the dividend as well. By purchasing the stock on the 15th, the shares would settle three business days after, which is Wednesday June 20.

Settlement for an option is significantly different. Regular buys and sells settle in just one day. Assignment is two business days. Example, if I purchased a call option on Monday, it would settle on Tuesday. However, if I decided to exercise the option on Wednesday, it would settle on Friday. I could also wish to exercise the option on Tuesday and have it settle on Thursday, just like if I purchased the stock on Monday instead of the option. This is very important to know because the following strategy could get very confusing.

Now, the most important date in this entire scenario is not the ex-dividend date, but the record date or date of record. Las Vegas Sands would deem the record date for its dividend Wednesday June 20. This means that the shares must be in the account and have settled on this day for an investor to receive a dividend. With all that information provided, and hopefully it makes sense, how can one attempt to receive two payments from the LVS options?

If a trader wrote a put, they would receive a premium. Now, if the stock fell below the strike price on Friday, there is a chance the buyer of the put exercises their option and sells the stock to you at the strike price. The assignment would settle on June 20, which means you would be entitled to the $0.25 dividend as well.

The stock is currently trading at $45.21 and the June puts are priced as follows:

Strike Price	* Last Bid
46.00	$1.07
45.00	$0.52
44.00	$0.22

What you choose to write is your choice, but it is very rare for an opportunity with a silver lining like this to arise, that is, an unwanted assignment would provide income as well. Unlike most weeks, we must consider that the in-the-money put may not be assigned in the account of the writer, since the owner of the put, who may have bought it as insurance if the stock falls, may wish to receive the dividend instead. The stock has also shown good support at $45 and the stock could rally shortly after wards like it did in March after the dividend payment.

As with all trades, there is always a risk of losing your entire investment. The market is currently in a bit of turmoil and there is a chance these shares could fall well below your strike price. Take into consideration your financial strategy, needs, and tolerance.

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.

Top 25 Dividend Yielding Stocks in Canada

Finding yield in a low-interest world can be a tough task. It's no longer the 1980's where saving your money at the bank was actually a wise thing. Today, savers will be lucky to earn 1.5% (the current yield on a one-year GIC). Take into consideration that last year's Canadian inflation rate was just under 3 per cent, savers will actually lose nearly 1.5 per cent on purchasing power. As a result, many investors have turned to the equities market over the last ten years. Since the low of 2002, the market has doubled in Canada, and dividends have grown by just as much.

If you've made contributions to your RRSP's this year, but haven't made a purchase yet, consider buying large reputable stocks with a long history of dividends. If your investment strategy consists of living off investment income and not capital gains or wealth, you could consider buying one of the 25 stocks below, whose dividend yields are north of 5 per cent and are valued at more than $1 billion in market capitalization. 

	(Symbol) Company Name	Yield	Price	P/E
	(ERF) Enerplus	9.29	$23.24	38.1
	(PGF) Pengrowth Energy	8.52	$9.86	39.4
	(ATP) Atlantic Power	8.30	$13.86	0.0
	(FRU) Freehold Royalties	8.19	$20.52	23.9
	(NAE) NAL Energy	7.75	$7.74	51.6
	(AGF.B) AGF Management	7.09	$15.24	12.8
	(DH) Davis + Henderson	7.09	$18.29	11.7
	(CLC) CML Healthcare	7.05	$10.66	533.5
	(BNP) Bonavista Energy	7.03	$19.92	19.3
	(BA) Bell Aliant	6.87	$27.64	19.5
	(AX.UN) Artist Real Estate	6.78	$16.50	5.5
	(SLF) Sun Life Financial	6.26	$23.00	0.0
	(CRR.UN) Crombie Real Estate	6.20	$14.35	32.6
	(NPI) Northland Power	6.17	$17.50	0.0
	(CPG) Crescent Point Energy	6.08	$45.43	54.7
	(TA) Transalta	6.02	$19.27	14.7
	(CUF.UN) Cominar Real Estate	5.99	$24.03	8.8
	(D.UN) Dundee Real Estate	5.91	$37.17	53.1
	(CSH.UN) Chartwell Seniors Housing	5.89	$9.17	0.0
	(BNE) Bonterra Energy	5.84	$53.38	20.9
	(PBN) Petrobakken Energy	5.78	$27.85	12.1
	(COS) Canadian Oil Sands	5.57	$21.54	9.1
	(CWT.UN) Calloway Real Estate	5.56	$27.85	253.5
	(PPL) Pembina Pipeline	5.53	$28.21	28.5
	(PMZ.UN) Primaris Retail Real Estate	5.43	$22.45	22.8

All table information is based on the near closing prices on Thursday March 15, 2012. The information discounts previous and future dividend history, focusing only on current yields, prices, and company value and does not constitute a direction to purchase the stock. Please speak to an investment advisor before making any decision.

The benefit to buying equities is also its drawback. The value of a company over time can rise or fall, but if a person has consistent dividends and the outlook for the company is stable or profitable, then one only has to focus on the cash flow. Imagine the additional expenses one could subsidize by simply looking at high dividend-yielding stocks. On an investment of $10,000, you would earn $543 to $929 per year or $45.25 to $77.41 per month from the above stocks. If the investment is made in a regular investment account, that covers your phone or cable bill, maybe your child's bus pass, or a bank for a future small vacation.

How to Properly Use a Credit Card

When my friend told me that he took my advice and found the advantages of using a credit card for every purchase, I realized that I must share this advice on here. I've seen many people who owe thousands of dollars on credit cards. I can not fathom how they have put themselves in such a worrisome position.

A credit card is the best personal finance product available to consumers. It is essentially a product that pays you to borrow from them at an interest-free rate. The problems that arise from overusing a credit card is a result of a lack of education and discipline. So here's the advice and information I tell my friends.

First and foremost, use a credit card only when you would make a regular purchase in cash or debit, such as lunch or groceries. This avoids large debt. There is no advantage in using cash or debit, so put it on the credit card and keep your money in your bank account. In theory, that money in your bank account will earn interest for you. If you do receive a discount when purchasing with cash, make sure that the discount per cent is greater than your bank account interest rate. In today's low interest rate society, any discount will do.

Secondly, most credit cards, even annual-free credit cards, will give you "cash back" on purchases. The range can be as high as 2 per cent to as low as 0.5 per cent. Take advantage of this. The cash back rewards can total up to hundreds of dollars per year. Don't forget that this "income" through the cash back program is also tax free because it is a penny saved versus a penny earned. Saving $10 on a purchase is equal to earning approximately $14 at a job, so don't ever undervalue a few dollars saved.

A third tip is to find out the billing cycle of your credit card. Mine is the 14th of every month. So if I were to buy something today (Oct 13), it would show up at the end of this month's bill. If I postponed it to tomorrow, it would show up in next month's bill, pushing the debt to a future date while earning about 47 days of additional bank account interest. This was also a tip my instructor told me during my college days. It is great for financing non-essential items that can be purchased at a later time.

The fourth tip is to pay the credit card on the required pay date, never before. By paying days earlier, the money in your bank account will lose potential interest. Just make sure you don't forget. Most credit card companies give you a grievance period before they will charge you fees or interest anyways, but make it a good habit to pay on the day. Set up a reminder or have a post-dated payment from your bank account.

The last tip is really a summary of the first tip. Use the credit card only to replace common purchases and for emergencies. Personally, I use my credit card mainly for lunch, gas, and my cell phone bill. With a few other purchases for entertainment, my credit card bill is very consistent, which makes life easy because I don't need to keep track of my purchases.

If you happen to be someone with spending problems, start by ensuring your total credit card purchase per day is less than the amount you make at work per day. Once that becomes habit, alter it to the disposable income per day through basic calculations. Maybe talk to a financial advisor to determine this value for you. If you can follow my above tips, you should be spending your credit card at most twice a day which should never put you in debt. You will even profit, tax-free, from it too!

Citigroup $4 to $40

Since the week has started, I've had two friends ask me about Citigroup [C:NYSE]. On Monday, my one friend thought his shares had skyrocketed ten times over the weekend, while the other, today, asked me if I had purchased any. For the record, I did own Citigroup, but sold the shares above $5 in the spring of 2010, but I digress. The move from $4 last week to $40 this week did not represent a significant rise in the company, but a reverse-split that was announced back in late March or early April. Understanding the reverse-split process is often confusing, so I am going to attempt to explain it in the simplest way possible.

A reverse split, not uncommon, is a process in which the shares of a company are moved up a factor of n with the amount of shares decreased by the same factor. In this case, Citigroup did a 10-for-1 reverse split; 1,000 shares at $4 on Friday would be show in one's account as 100 shares at $40. Note that the equity of the shares still remains at $4,000.

What does a reverse split normally entail? Many believe a reverse split could be treated as a sign that the management team lacks confidence in the share price. Stocks trading below $5 normally have a stigma associated with them, even if the company is worth billions of dollars. Companies like to have stock prices trading between $20 and $50. If the company believes the shares won't move back into that eye-catching price, they will do a reverse split.

Historically, reverse splits have not boasted well for stocks in the short term. Because of the above factor, a short-term sell off often follows, as we have already seen on the shares of Citigroup. Conversely, announcements of a stock split (where the shares are reduced by a factor and the shares are increased by the same) prove to be good ways to attract new investors into the mix and push up the price. This is because investors like to buy in board lots. If a stock is too expensive, investors are reluctant on buying 23 shares of a stock. A split would lower the cost of a board lot.

Another possible, but very unlikely, reason for the sell-off is a misunderstanding of the value of the company. People might think they have made a significant return and will sell all their shares, oblivious they own fewer shares. In reality, most brokers will have a prompt indicating they do not own 1,000 shares, unless the investor just clicked sell in their account without looking at the share count. As well, most brokers, leading up to the pay date of the new shares will have messages and notices about the reverse split. I know I did, even though I don't own the shares, so this theory is not entirely practical in today's computer world.

Option traders holding contracts should also be cautious when entering orders in. The old option chains will probably remain the same, but the new option chains might have an indicator of a stock reorganization. Although most option traders are sophisticated enough to know what the contract is, it is always safer to ensure the options are the correct strike and have the same delivery expectations.

If you are trying to sell your shares today, for unrelated purposes, check to see if the new shares are in your account. You should see a journal entry that shows a disposal of 10n shares and a purchase of n shares at the new price. If this has not happened, you may not be able to sell them because the shares in your account are not the proper Citigroup shares; they will have a different stock identification number. Again, just call your broker if you have concerns. All this should clear up by the end of the week.

Reading a Detailed Quote

It's been a while since I wrote something that was basic and educational for some of my readers, so I'm gonna make a post of the most basic element of investing: reading a quote.

Many people get their quotes from the newspaper or a financial website, but most people don't really know how to read a full quote. They just check to see how well their companies finished. But more experienced investors understand that a day-end quote is not necessarily an accurate tale of the company. So today, I'm going to review a basic detailed quote normally obtained through brokerages and many financial websites, and understanding what each part means.

The picture below is a standard detailed quote you might normally obtain through a brokerage, in this case TD Waterhouse. Each bit of information on the detailed quote has a very important function and I will break that down (The original image has been edited to fit this page).


Line One: Buy, Sell, BANK OF NOVA SCOTIA (THE), 3:04:38 PM EDT
Buy, Sell Two quick links that provide ease to an order entry screen allowing you to buy or sell the stock.
BANK OF NOVA SCOTIA (THE) Simply the name of the public company.
3:04:38 PM EDT Not the current time in Eastern Time, but the time of the last trade. This may be important for low volume assets that may not trade every few seconds as you will see later on.

Line Two: Symbol, T, Bid, Ask, Last, Change, Volume, FSI
This line is just a heading line and needs no explanation. See line three for a detailed explanation of each column.

Line Three: BNS CA T, +, 59.02, 59.03, 59.03, -0.45 (-0.76%), 862,497
BNS CA T Indicates the symbol of the company, which is BNS. The CA stands for Canadian market and the T stands for the specific exchange, in this case, TSX.
+ The "+" symbol is the tick. The tick informs the trader if the last trade was above or below the last trade. A "+" means the 59.03 was above the last price. A "-" would indicate the last trade was below the previous trade. If the trade is at the same price, the tick does not change.
Bid The highest buyer's price. Selling at market would sell at this price.
Ask The lowest seller's price. Buying at market would buy at this price.
Last The last traded price. This price is less important for stocks with low volume as it is possible for the bid and the ask to be priced well above or below. Many stocks only trade a handful of times a day, and the last price could have been hours ago, not truly representing the market price if the demand of the stock has changed.
Change There are usually two numbers: The nominal change in dollars, in this case, down 45 cents as shown by the negative and the red font. And the change in per cent. These are always a change from the previous day's close.
Volume The total amount of shares traded between buyers and sellers including cross-trades. It excludes option assignments or other derivatives.
FSI Financial Status Indicator, generally is blank, but will indicate if the stock is halted, bankrupt, etc.


Line Four: Bid Size 3, Ask Size 18, Earn. Per Share 4.07
This is the start of the detailed quote, often ignored by passive investors.
Bid Size 3 This represents the number of board lots at the bid price. One board lot will vary depending on the price of the stock, but in this case, it is 100 shares. Therefore, there 300 to 399 shares wanting to buy at 59.02.
Ask Size 18 This represents the amount of shares wanting to sell at 59.03, in this case, 1,800 to 1,899.
Earn. Per Share Earnings Per Share (EPS), a very important figure used to determine how profitable the company is. The earnings per share is the net income divided by the total amount of outstanding shares in the market. A higher EPS does not always mean it is a better company, it just represents its profitability per share.

Line Five: Day High 59.57, Day Low 59.00, Price/Earnings 14.5037
Day High 59.57 Simply, this is the highest traded price. Again, it does not show the highest bid of the day, only the highest traded price.
Day Low 59.00 Similar to the day high, it is the lowest price of the day, but not the lowest bid/ask.
Price/Earnings Also known as the P/E ratio, it is the stock price (59.03) divided by the EPS (4.07). This is used to determine if a company is over priced or not. 14.5 is considered an average earnings for bank stocks, but every industry will have its own valuations. It can also be thought as the years to break even. It would take an investor 14.5 years to break even if all the profits were paid to the shareholders directly.

Line Six: Open 59.42, Yield 3.5236, Dividend 2.08
Open 59.42 Simply the value of the first trade of the day after exchanges find a best fit price. Has very little importance to many, but in this case, shows the stock has been dropping throughout the day.
Yield 3.5236 The dividend yield, in per cent, indicates the annual return on the dividend. In this case, by purchasing the stock at 59.03, and collecting your dividends, you would earn 3.52% for the entire year. The yield is solved by dividing the dividend into the stock price. (2.08/59.03)
Dividend 2.08 This is the annual dividend value. Most stocks pay quarterly, so this number will be divided by four to find out the next quarter's payout. In this case, it would be 52 cents a share.

Line Seven: 52 Week High 61.28, 52 Week Low 47.71, Ex-Dividend 01-Apr-2011
52 Week High 61.28 This informs the investor the highest price in the last 52 weeks. This number may change if the 61.28 was traded in April of 2010.
52 Week Low 47.71 This informs the investor the lowest price in the last 52 weeks. Both figures are used by investors to determine the current strength of the stock compared to the last 52 weeks.
Ex-Dividend 01-Apr-2011 This informs the investor the next dividend date. The ex-dividend tells an investor when they must own the stock to qualify for the dividend. In this case, it is April 1. Many sites may use the record date, which would require you to understand the settlement of a stock. It takes three days to settle a stock. Most sites often put the ex-dividend date to remind investors to buy BEFORE this day. You may sell on the ex-dividend date and still receive the dividend, however, in many cases, the stock will have dropped an amount equal to the dividend.

So that's how you read a detailed quote. There is a lot of information, but each piece of information is very valuable, both fundamentally and technically. Before you end it here though, some brokerages provide the book order, also known as market depth and level II quotes. The picture below from iTrade is of the same quote at almost the same time.


As you can see, all the information from the TD Waterhouse quote is also available through iTrade, but in a different format. iTrade seems to also include for free the first five levels of the book order. This can be important when trying to penny pinch an order. The book order shows us the total amount of orders at each price for the highest five bids and lowest five asks. The 15,200 shares at 59.00 suggests there are many buyers wanting to buy at 59.00, hinting at support. However, day trader's will eye this level and see how the stock reacts. If the stock hits 59.00 and pushes upwards, it may mean the stock is heading higher, and that there are not enough sellers. But if the stock falls below 59.00, it means there are enough sellers, or not enough demand, to keep it above 59.00, hinting that the stock may start to fall in the short term.

You may have also noticed the PE for both quotes is a little different. This could be because of reporting errors or different methods of reporting on their system. In a nutshell, the P/E should be used as a guideline as its exact number is not really important.

Understanding the Bank RRSP

If you haven't made your RSP contributions yet, there's still a few hours before the deadline, so make it count. When it comes to investing in your RSP, there are many vehicles that allow you to grow your money. Unfortunately for most individuals, their RSPs are at the banks and not at a brokerage, limiting their options to low yielding products. Banks can not tap the equity markets, except in the case of mutual funds, as a result, you'll be stuck "purchasing an RSP," a commonly misused term by banks. But what are you actually "buying" when your money is contributed into the RSP?

The most likely product available at the banks would have to be a Guaranteed Investment Certificate (GIC). They are covered up to $100,000 by the CDIC and are easily accessible at the banks, however, not all GICs are available. Most banks will promote their in-house GICs before their competitor's. Shopping around and researching the best GIC might be a benefit if we're talking about bigger numbers. Canoe has posted the GIC rates for Canadian institutions, available here.

Unfortunately, as you may have seen, the rates for short-term GICs are substantially low. A $10,000 investment in a GIC for one year is going to yield you at most 2.25%, which works out to $225 in a year. And the big banks don't offer anything close to 2.00%. Not something worth cheering about, but that is the trade off when you want to protect your principal.

With interest rates in Canada expected to rise in the next few years, it might be worth laddering your investment. Laddering is a strategy investors often used to evenly spread out their wealth amongst an investment product with different maturity dates. This prevents investors from investing all their money during unfavourable market conditions, as is the case today. If rates were to rise, GIC rates would reflect this and would go up. But if you put all your eggs into a five-year basket, your GIC would not go up with it because the rates are fixed. By having a cash flow that participates in future rate changes, it allows you to potentially capture future interest rate increases.

Another added benefit with laddering is anticipating liquidity. Locking all your funds from today's contribution for five-years might seem like a good idea today, but what if an emergency were to come up in three years? GICs can not be sold prior to the maturity date, unless ordered by the Supreme Court of Canada under financial hardship, and it is very rare for the courts to rule you so poor you must break a contract between you and a financial firm. Of course, deregistering your funds (withdrawing your money from an RSP), is a totally different story and should be a last resort.

It can also provide you with money for large purchases. The Canadian government created the First Home Buyers Program years ago, and tapping the funds from an RSP is common. By being able to predict and anticipate your funds to the penny for such programs is a valuable asset.

Lastly, determine when interest payments are made. Most GICs have interest paid out annually on the anniversary, however it is possible for some GICs to offer a monthly payout with a reduced interest rate. Do the math and see what nets you more over the long haul. Remember that interest in a GIC can be compounded and ensure your interest is re-invested back into the GIC, otherwise, it will sit as cash in your RSP earning next to nothing.

The banks make "buying an RSP" very simple, and in a nutshell, it is. But even with a low-yielding product such as a GIC, there are many strategies most investors have never considered, and there are more than those discussed here. You've worked hard for your money and you deserve to get as much out of it as possible. It might sound like being cheap, but you're gonna need the nickels and dimes when you're retired.

How a World Crisis Affects Oil Prices

Wednesday last week, my friend sent me a text message asking how to profit from tensions in the Middle East through crude oil. At the time, the unrest had been a few days old, and oil prices had already surged more than 6 per cent in a matter of days. I quickly replied suggesting that he should not bother chasing old news since traders have already priced in the worst case scenario. Four days later, I have been proven correct.

I bring up that story because novice and intermediate traders in North America often try to chase news and buy ETFs or options on crude oil, especially when a major conflict could disrupt oil supply. Many times, these traders will realize they are on the losing end of a gamble for a few good reasons.

You see, there are different types of oil used as a benchmark: Brent Crude Oil and West Texas Intermediate (WTI, also known as Texas light sweet) being the two most followed. Brent, which is less followed in North America, but is the largest classification worldwide, is drilled in the North Sea located between Great Britain and Scandinavia. WTI refers to the oil from the U.S. Midwest and the Gulf Coast. Brent Crude contains more sulfur and is often considered lower quality and less sweet in comparison to WTI. As a result, Brent often trades at a discount to WTI.

However, during major world crises, such as the current Egyptian tensions that may disrupt oil supply in the Suez Canal, Brent's value will reflect risks more so than WTI. The temporary risk premium, that is, increase in price, in Brent occurs because the disruption to oil affects a larger amount of people and businesses in Europe and Africa. A crisis in North America would have little impact on Brent which does not typically get delivered here. It would be like walking into a grocery store on the west side of your town or city and there was only one loaf of bread left. People who shop in the west end would bid up the price of the bread. Shoppers in the east side of the town would see little change in their bread prices because they continue to have an ample supply of it.

Today, Brent trades near $100 a barrel while WTI is trading below $90, a rare anomaly that has only occurred once prior to this year. The premium between Brent and WTI are at historical highs, but should revert back at the end of the crisis.

One other reason WTI is not moving up with Brent is because of excessive supply in the USA. Last week, the stockpiles in Cushing, OK were near record levels suggesting demand for oil in the US is very low or production of WTI is very high. Either the case, these would be bearish cases for the asset on a short-term basis.

When trying to make money on speculative trading, it is very important to fully understand how a commodity or asset would move. When purchasing an ETF on a commodity or asset, find out what the asset is tracking as well. Last week, USO-NY and HOU-TSX saw significant volume on the news, but these track the price of West Texas and not Brent. Both stocks are down about 8 per cent since with little volume following. This suggests that buyers last week are still in their positions holding onto losses.

And to answer your question, no, I have not seen a retail investment product that tracks Brent in North America.

ETFs Favoured Over Mutual Funds

In December 2010, it was announced that Exchange Traded Funds (ETFs) hit $1 trillion worldwide. And a recent estimate suggests it will double to $2 trillion at the end of 2012. The paradigm shift from mutual funds to ETFs has been a common trend since the introduction of the Internet. Low-cost trading, financial reports, and free researching tools has allowed investors to become smarter and given them confidence to invest on their own. As a result, mutual funds are slowly becoming obsolete, a dying breed that I have never been a proponent of.

My detest for mutual funds stems from two main talking points: the Management Expense Ratio (MER, fancy for manager's fee) and lowered rate of returns.

The MER of mutual funds are well over two per cent. Canada's largest mutual fund by assets under management (AUM) is the Fidelity Canadian Asset Allocation Series B (click on name for Morningstar report) which charges 2.16 per cent, which is considered low in the industry.

Secondly, their rates of return are often very low. The above mutual fund has earned 5.83 per cent (after MER) over the last decade. The comparing benchmark, the Toronto Stock Exchange, has earned roughly 4 per cent per year over the past decade, excluding dividends. When accounting for dividends, it's return exceeds 6 per cent.

Mutual funds also must make public their asset allocation and top holdings. Those who want to mimic a mutual fund's holdings can easily do it without paying a management fee. And if anyone has ever done enough research on mutual funds, Canadian ones especially, you will notice their top ten holdings are often Canadian banks, telecom stocks, and some mining stocks.

These two main problems are resolved with exchange traded funds. ETFs are investment vehicles that mimic an index, benchmark, commodity, or other asset class. The most heavily traded Canadian ETF is the iShares S&P/TSX 60 Index; it tracks the TSX 60 almost exactly. For those looking for American exposure, the SPDR (pronounced spider) tracks the S&P500, the most diverse basket of stocks in North America.

ETFs also trade on the exchanges and provide better liquidity, that is, the ability to sell it immediately and take the cash. Mutual funds are priced once a day, at the end of the day, which means you do not know how much you are receiving or how many units will be sold.

Because ETFs trade on the exchange, you will endure a commission from your broker, but with competition in Canada so fierce, commissions are very low now, often $10 to $30 or lower. And some companies are now providing free ETF trading for a certain period of time.

The only caveat to ETFs are ones tracking commodity prices. Due to contango (a difference in the price of commodity futures from month to month) you will lose out on the monthly spread when one contract expires or is rolled out. Commodity ETFs are meant for trading and not investing, so please take caution.

But before you go and redeem all your mutual funds for ETFs, remember that most ETFs do NOT allow investment plans. Mutual funds do have one positive characteristic that ETFs do not have, and that is the ability to invest small amounts without fees. Those who have monthly or weekly systematic investment plans into mutual funds will not be able to do the same with ETFs without paying the commissions, which will erode earnings.

If you're a young investor with less than $20,000 and want a good way to expose yourself to the market without stock picking, ETFs may be the way to go, depending on your needs of course. They provide great liquidity, the same diversification as a mutual fund, and low cost management fees, if any.

Why Endure Winter When One Can Trade?

For the S&P 500, December has been the best performing month every year since 1960. That's 49 years of data, and if yesterday's rally was a sign of things to come, bulls are back to finish the year with a vengeance for the 50th consecutive year.

But to continue this trend, the S&P 500 would have to beat September's per cent gain of 8.76. That would require the breadth market to close above 1283.91 (1206.07 today) by New Year's Eve, a feat that traders might not be compelled to do just yet. Given the gains seen since the end of June, many are still anticipating a correction in the stock market. 1283.91 is also 4.63 per cent higher than the 52-week high set on November 5, 2010.

For the market to reach such lofty goals, the problems over Europe must either be resolved or traders must overcome these worries. Positive news from China, India, Japan, other parts of Europe, and America could help quash these fears and provide confidence that the global recovery remains intact.

If you fully believe that December will continue to be another stellar month, even if it does not beat 1284, consider getting positions ready on high-beta stocks on the next down day. Companies like Apple (AAPL), International Business Machines (IBM), Goldman Sachs (GS), Google (GOOG), MasterCard (MA), and Starbucks (SBUX) are a few S&P 500 components that often move substantially more than the index itself.

However, if you're leaning more towards a potential correction or that the month will finish flat from today's close, consider buying some protection in puts or writing calls to earn some additional income for Christmas shopping.

*Disclosure: I do not own any stocks or related derivatives mentioned in this blog. The blog is not intended to be financial advice or recommendations on buying or selling equities mentioned above. Before making any financial purchase, consider your investment objectives, risk tolerance, and liquidity needs (especially during Christmas) and speak to a financial advisor.

Make Three Paycheques a Month

In less than six months, weekly options have already surpassed the traditional monthly options in terms of volume. For options buyers, the minimal time value attached to the price along with the shortened time horizon during this continued bull market rally has made weekly options much more attractive.

For options writers, the 5-day life of the calls and puts gives longer-term stock holders the ability to make money every week without capping gains. It's quite common for an options writer, especially long-term holders who generate income via the covered call strategy, to see 17 days later that their covered call is deep in the money, capping their gains. This common problem has pushed many traders to head towards the weekly options, which allows the investor to gauge the value of the stock on a weekly basis and gives investors the opportunity to roll out or roll up their call.

Over the past month, big-name technology equities have posted decent weekly option premiums. Last week, Netflix, because of earnings, allowed an at-the-money options writer to make over $700 per contract, when the stock was trading around $155. That works out to 4.5 per cent in a week. That's more than some people make on a two-week pay cheque! In general though, most of the options trading at the money are providing about 1.5 per cent return for the week.

October 29 options for some larger name equities priced in the $100 range, which I find the most suitable for myself because of the lowered costs on options commission per contract, are paying out about $200 today. The table below illustrates how weekly options on some majorly helds could pay out 50 to 75 per cent a year without capital appreciation.

Stock Name	Current Price	Strike Price	Option Bid	Weekly Return (%)
Bank of America (BAC)	11.15	11.00	0.34	1.70
General Electric (GE)	16.12	16.00	0.23	0.74
Intel (INTC)	19.92	20.00	0.13	0.65
Microsoft (MSFT)	25.25	25.00	0.57	1.27
Microsoft (MSFT)	25.25	26.00	0.18	0.71
Baidu (BIDU)	109.90	110.00	2.08	1.89
Goldman Sachs (GS)	157.56	160.00	0.96	0.61
Netflix (NFLX)	166.59	165.00	4.20	1.57
Netflix (NFLX)	166.59	170.00	1.83	1.10
Amazon (AMZN)	169.38	170.00	2.33	1.38
Apple (AAPL)	310.26	310.00	3.25	0.96
Google (GOOG)	617.90	620.00	5.50	0.89

If you would like me to continue posting the weekly numbers for the above equities on this blog, or include other stocks, please let me know and I will do this every Monday.

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- Return (%) assumes only the option premium received and subtracts assignment differences if the option is in-the-money.
- Option premiums will differ every week due to outside factors, including, but not limited to volatility, news releases, dividend payments, mergers, etc.
- Prior to implementing option strategies, discuss all trades with your investment advisor. The information provided is not designed to be professional advice, but shared stories of personal strategies that have worked over the past month. Past performance is not indicative of future gains.

Weekly Options Expand to Stocks

Trading equity options on a monthly basis is a thing of the past, now that the CBOE has introduced weekly options to a small group of securities. As of July 5, 2010, weekly options were expanded from indexes to stocks and ETFs, including Apple, Google, Ford, and the Direxionshares Financials 3X (see link).

These new products, which launched at the start of earnings seasons (most likely intentional), enables traders with shorter time horizons to speculate on large movements in securities while paying a discount on time value. Long straddles may finally become a mathematically profitable trade, since the discount on time value creates a smaller break-even range. It will also allow options writers to become more active and take on less time risk, and possibly earn more income through calendar spreads and other strategies.

Every Thursday, the weekly options are introduced and expire the Friday in the following week, providing six days of existence, and two days for roll outs if required.

The weekly options have been very popular. In only three weeks of inception, volume on the weekly options are above 50 per cent volume of the regular monthly contract with the same strike. In many instances, they are trading with more volume and have more open interest as well.

So what are some ways to make money? Here are two real-life examples using today's closing prices for a company with and without earnings.

Amazon [AMZN:NDQ] with earnings July 22 closed at 117.43 on July 21:

Expiration	Option type	Strike	Premium (bid x ask)
July 23	Call	120.00	2.68 x 2.75
August 21	Call	120.00	4.90 x 5.00
July 23	Put	115.00	2.63 x 2.75
August 21	Put	115.00	4.95 x 5.05

Apple [AAPL:NDQ] with no earnings closed at 254.24 on July 21:

Expiration	Option type	Strike	Premium (bid x ask)
July 23	Call	260.00	1.03 x 1.05
August 21	Call	260.00	7.30 x 7.50
July 23	Put	250.00	1.26 x 1.33
August 21	Put	250.00	7.65 x 7.80

In the tables above, we see that Amazon weeklies, which releases earnings tomorrow, carry a premium more than half the monthlies. Although they are high, the premiums are significantly reduced. The break-even for a long straddle is now 114.50 and lower or 125.50 and higher, an immediate move of about 6.8 per cent, instead of 8.6 per cent.

And the Apple options, which no longer carry a premium for an earnings move, still carry $1 in value. Why does this matter? Many new option writers do not understand that writing options are profitable 95 per cent of the time. As a result, they are hesitant on writing the monthly options for fear the security will make a large move. Most traders will sacrifice significant time value and write them in the final week, exposing themselves to less risk, a forgiving characteristic. Now, providing weekly options allows these traders to make money every week.

Calendar spreads can also become very profitable. Spreads are a good way to replace longing stocks, especially expensive ones like Google, Apple, and Amazon (which also pay no dividend). Go long a LEAP and write calls at that strike or above.

I did a calendar spread for Apple prior to earnings on the 260 calls and made money on the August call going up in value and on the July calls losing a chunk of premiums after earnings. If it had gone above 260.00, I would have simply rolled out the July 23's to the July 30's and capture an additional week of time value.