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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The covered call can introduce monthly or weekly income immediately in cash so any taxes owed at year-end can be simply withdrawn from the account.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 |
Google has admitted that its three biggest mistakes were Google Wave, dejanews.com, and Gmail (quite surprised by the last), but if reports about Google's offer to buy Groupon is true, Google may see its list of regret grow just a little longer.
Google is expected to announce as early as Wednesday that it will be buying Groupon, the company with the "Enjoy (city) 50-90% off" advertisements seen commonly on Facebook and probably to the right of this blog. The price tag: $6 billion. It's a lot for a company celebrating only its second year this month, but Google is expecting the company to pay off early and often.
Groupon has been touted as the fastest growing company ever, already generating revenues of $50 million a month ($600M annually). And revenues are expected to reach $1.4 billion in 2011. Sounds like the best investment Google has ever made, except that it probably will be more trouble than it's worth.
Groupon's business model, which will probably remain intact, goes against many of Google's business practices. Groupon requires a team of thousands of salespeople negotiating with local businesses willing to offer its services and products at half the cost, with larger discounts often applied too. Google, however, uses computer technology to create its ads by using keywords, phrases, and website content. It's a concept that Google may not embrace or fully understand, which may cause a rift between the two.
Another problem is the unproven track record of Groupon and this industry itself. As mentioned, the company is only two years old, and management have not yet had to deal with long-term issues that often arise in business. This mainly includes competition, which is already starting to become extremely fierce in the advertising business. Redflagdeals.com has started to mimic Groupon's advertising model and have created their own deal of the days. And as more and more entrepreneurs decide to enter this industry, Groupon will face more challenges of competition. Unlike recent history, Groupon can not buy out every company in markets it aims to target.
The company only features one, that's right, one, deal per day (per city). And the company makes money only when the coupons are purchased and only if enough people opt-in to the deal. This business model limits any possibility for expansion in established cities and markets and is at the mercy of individuals looking for deals and nothing to do with its business partners. As a result, local businesses that frequently use Groupon may decide to find other clones if the waiting lists become too long or commissions are lower else where. The company claims 97 per cent of its partners want to be featured again and there are backlogs of over 100 requests in some markets.
The coupons may help create additional customers short-term, but businesses having to rely on low margin customers never survive. To top it off, Groupon earns half the revenue from the purchase of the coupon. So if a video store wants to sell $20 of videos for $10, they earn only $5. That's just 25 per cent of the regular sale. Now that's price-gouging! In business, there are two methods of success: increase margins or increase customer base. The latter is not sustained by Groupon and one website talks about poor customer retention.
Customers using Groupon will almost never turn into loyal customers, as said in the Quora link above. 80 per cent of a company's profits often come from 20 per cent of their customers, known as the 80-20 rule. The idea is that those using Groupon will always be looking out for the next deal. If waiting lists do become too long, companies may have to wait months or years to post up their next deal. In addition, those using coupons make it a habit. I know I do this, and so do many of you. I will never visit many shops and restaurants if I don't have a coupon because the prices are usually too high for my budget.
The article also notes that the customer has no connection to the local business, but only to Groupon. Businesses with no customer base will lack consistency and create volatility in margins. Local businesses also suffer because they are forced to attend to low-margin customers who might take away from high-margin customers waiting in line or leaving due to heavy volume. In fact, one article mentioned a spa company overwhelmed with a massive increase in clients. As a result, the company had appointments for several months, with many unhappy customers wanting their money back.
Many Groupon partners who want to be featured again have also lowered their discount values. That is, instead of offering $50 of fare for $25, they drop it to $40 of fare for $20.
Groupon's business model has been attacked by many of its partners, and although the company does have many repeat features, the truth is that the lack of profitability will eventually become a reality. Many articles have already been written about how Groupon coupons took out small businesses, which, to be fair, was possibly a neglect on due diligence by the owner. The point is that businesses will want to avoid low-margin customers with low retention when the economy picks up.
Google's bid to buy Groupon is a bit of an overvaluation and with only two years of a track record, Google is making one of the largest gambles in its history. It's basically buying a penny stock and hoping it will work out, but with so many negatives impacting business partners, it's tough to say if businesses will want to deal with a company that takes half its earnings when it already discounts its prices.
Today, US Congress praised Google for their actions on leaving China. I was under the impression that the majority of people had the same beliefs, until I read many of the posts on CNN's story. To my surprise, there were many people opposed to what Google was doing, with many angry at Google's supposed attempt at world domination.
I wrote the following post on my Facebook link discussing my belief that Google did the right thing.
"Congress, although they do have more important issues to work on, did the right thing. People need to see the bigger picture here. Congress is supporting a US company going against the grain by sacrificing huge market share and profits in China for their company's values, morals, and integrity.
Google is standing up for what they believe in. Many conglomerates stands up for their employees and ideals by choosing to donate to great charities, bettering the environment, and providing aid to Third World Nations. These countries are often praised for their work, yet when Google just leaves a country, without breaking any laws, they are shunned? That is absurd.
Anybody who shuns Google for leaving China has no idea what they are talking about. Google did not disobey any laws while they were there. And the fact that the Chinese government supposedly hacked their systems to oust or obtain Human Rights Activists information is itself illegal, at least in North America.
People often disassociate corporations and human beings. Do we need to remind people that corporations comprise of hundreds or thousands of employees? I believe it is fair to say that a large majority of Google staff, along with the rest of world, would like to see Freedom of Speech imposed positively in every nation. The ideals of democracy are taken for granted here."
Those who do not support what Google has done should provide me with a strong argument for your side. I believe that any company should do what they believe is best for them. Money may be a big factor in business, but it is not the only thing now.
If you opened up a company in a country and found out they were hacking your systems or stealing from your warehouse, would you honestly consider staying in that nation? I hope not. Your beliefs should trump money.
Christine Jones, executive vice president of GoDaddy.com, also told the commission today that China had asked for copies of photo identification and signatures of all registrants to their website. Privacy is an important matter to Americans. How can one argue for China in this situation?
Google is clearly standing up for the Freedom of Speech and Information. To be fair, there are 25 countries that block Google, and 40 censor the Internet. Now that a precedence has been made, Google should continue to spread this into other natinos as well. But regardless of the laws in China, they are doing what they believe is right. Would people be angry if Google donated millions of dollars to Cuban aid relief if there happened to be a natural disaster? The US does not trade with Cuba, but that should not stop people from believing in humanity and caring for others.
I for one am glad to see Google become the poster-child for Human Rights in China. This may be controversial, but China has become obsessed with growing their country with greed, with a lack of care for human and environmental rights. Those that built China into a super power in international trade will leave and subsequently submerge China back into the last century.
