Calculated Risk on Netflix, IBM, and Yahoo!

Playing the Expiry: October 7, 2011

The American markets barely escaped bear market status yesterday afternoon when equities rallied more than 3 per cent in the final hour of trading. That was followed by another round of buying today which led markets higher by more than 1 per cent. So, with the markets showing some upward stability and support in these areas, is it time to start writing puts? The answer is yes.

After several weeks of massive volatility, yet very sideways trading, the market has been able to show strength at lower levels, and although the charts are still trending downwards, increased put activity and premiums are become attractive once again. It's time for another installment of Playing the Expiry for October 7, 2011.

Before the markets surged on Tuesday, I attempted to write puts on Microsoft which was trading close to $24. Over the last two years, the stock has shown significant support at these levels and has risen to nearly $28 every time. The stock has gone sideways which is perfect for trading. Unfortunately, I could not get a fill and the stock rose to $26 over the past 24 hours. However, continue monitoring the price-action for future opportunities.

With that trade missed, I chose to go a little riskier and selected Netflix [NFLX:NSD] instead. The stock plummeted from $300 to $110 in a matter of weeks, but is showing support at these prices. Consider writing a 115 put for the remainder of the week. At close, the bid on the puts were $1.25 with the shares at $119.76. Based on the stock price, this pays out 1.04 per cent over the next two days. This also provides protection of 5.02 per cent. That is, the stock must fall 5 per cent or below $113.75 by Friday's close before an investor would lose money. This payout and strong downside protection makes this trade very attractive. For disclaimer purposes, my fill was at $1.87.

If you're looking to go less risky, consider writing International Business Machines [IBM:NYSE]. The stock closed at $176.85, the short-term mid-range point. One may consider writing a put on IBM at 175. At close, the bid was $1.20. Against the market price, one would earn 0.67 per cent, with protection of 1.72 per cent. This may look less attractive, but IBM's stability and blue-chip status makes it easier to handle and it often avoids volatility, unlike Netflix. If the stock trades below $173.80, a loss could be absorbed, or you could consider rolling out the option to the next week or taking assignment and selling the shares once it rose back above your optimal price.

Going against the grain, one trade to consider could be Yahoo! [YHOO:NSD] call options. The stock surged in the afternoon today with rumours (again) that Microsoft would be dishing out the dough to acquire the company. The 16 calls for this week were bidding at close $0.45; the stock closed at $15.92. Many believe this rumour will turn out like it did in 2008, when Yahoo decided not to get bought out, only to see their stock fall 50 per cent since, but I digress. Writing these calls pays out 2.82 per cent for the next two days. Although the loss is unlimited if the shares rise, the odds of the rumour becoming reality by Friday are quite low. The stock would also have to rise 3.33 per cent before a loss would occur. Note, the stock is now at $15.33 in the after-hours market, so before attempting this, consider the values tomorrow.

Because I wrote this blog after the market closed, the values of all puts and stocks will vary tomorrow morning, but these are the three ideas that came to my mind today.

Disclaimer: Writing uncovered (or naked) options requires substantial margin and is only available to sophisticated traders. Uncovered calls have unlimited risk and can have infinite losses. Before making any trade, always discuss this with your advisor or professional broker. Reminder that all Playing the Expiry posts are transactions placed in my account and should not be taken as professional advice. As already mentioned, I have an uncovered put on Netflix.

Let Greece Fail Already

To promote and encourage the default of a nation is very uncommon and a bold statement about your opinion on such matters. The consequences of such drastic actions would cause a violent macroeconomic catastrophe. But history has shown that a sovereign default is often a revitalizing last resort and for Greece, a country whose fiscal problems are worse than many other nations, it may be in its best interest and for the world to implement an orderly and properly controlled default on its debt. Let's take a look at some reasons to support such extreme proposals.

For the last two years, Greece has taken austerity measures to help reduce its debt and revive a current four-year recession. When Greek's debt crisis became relevant, the nation cut and froze salaries of public and private workers and cut holiday bonuses on government employees. It is also reported that many have not been paid for nearly two years. Most recently, the country increased taxes on incomes, created new taxes on purchases (like GST in Canada), and sold national property and assets to raise revenues. These austerity measures forced a heavy burden on its citizens that made significant sacrifices to save their nation. The final result: an August 2011 report revealed the nation's revenue fell 1.9 billion euro and spending rose 2.7 billion - laughable.

Good money is being thrown at bad money. The European Central Bank (ECB) and the International Monetary Fund (IMF) has aided Greece so long as Greece took necessary financial steps to prove they were working towards fiscal balance, but as mentioned above, these austerity packages have proven unsuccessful. The risk of a default is high and credit default swaps on Greek debt are at record prices. Two-year notes are yielding more than 70 per cent and investors are pricing in a 98 per cent chance of a default. But with worldwide sentiment so bearish, the IMF and ECB continue to fuel a dying fire. Continued talks for loan packages are still in the works. They might believe that current debt restructuring plans will save Greece, but it will only stave the inevitable.

The country has had a long standing history of high debt. Since 2000, the country has never had debt as a percentage of GDP under 97 per cent, with most of those years well above 100 per cent. The nation defaulted four times in the 19th century, so it would not be an unusual circumstance, although in fairness, a different time and setting. There are many possible reasons to blame for the continuous spending problems, but the current mood of world investors is manifested in the phrase, "German taxpayers are funding Greeks to retire at 50."

Greek citizens can retire at 50 with a near-full pension. That is wonderful, but therein lies the problem. The average lifespan in Greece is 80.2 (as of 2009 data), which means that the government is providing an income for about 30 years after retirement. Greece has taken massive steps, but should they consider raising the pension payout to 60 or 65 like most nations? Other nations are already proposing retirement at 71 to keep their government pension programs afloat as the baby boomers start retiring.

There are many around the world who are proponents of a Greek orderly default as well, including a former Argentinian leader who was at the helm of their debt restructuring plan in 2001. Unlike a company default, a sovereign default holds no legal consequences because a country controls its own affairs. A "haircut," as is called, allows a nation to pay back a portion of its debt, with many experts expecting it should be around 35 to 50 per cent, but Greece continues to deny this will happen. Some claim that those who purchased Greek bonds will lose all of their money regardless. By avoiding an orderly default, it is only hurting its neighbours who are forced to fund Greece, regardless of their stance on the issue. It would also remove massive uncertainty in financial markets which have once again become volatile.

A default would also allow Athens to leave the Eurozone and the euro currency and coin a new currency, which gives the country the ability to create money to repay debt obligations, as is similar with most nations, like America. However, this would assure that the euro was a failed experiment and likely why many don't want Greece to fail.

It is a common theme to hear that Greek is nearly insolvent. When I started writing this blog, two-year notes were yielding 26 per cent. That was two days ago! It has nearly tripled, and regardless of what the IMF and ECB decide to do with the debt restructuring plan, one thing is certain: Greek is on the brink of default and things are about to get ugly.

America's Spending a Problematic Staple

America is a country addicted to spending; always has been, always will be. Its economy functions most effectively only when its citizens spend. Nearly 70 per cent of its gross domestic product is consumer spending. We are now seeing a massive shift in consumer spending which has put a damper on a recovery. Because of this, we're seeing America's fleeting dominance fall into a hopeless downward spiral. The government believes that it must spend its way out of the recession. It worked before, so it shall work again. But this concept of government spending, whether it be an addiction, a cure, or a habit, has created a $14.3 trillion deficit that is so large its value seems completely arbitrary. The mindset of massive consumerism and materialism built the country that dominated the 20th century; it is also this mindset that will destroy the country in the 21st century. It is a troubling evolution that has led America to its current hopeless conditions.

Masked in the financial irresponsibility was sustained long-term economic prosperity that took the nation to the top. The idea that America would topple seemed unimaginable. Its debt has been rated the safest global investment for decades and that image still stands today. Its economy recovered strongly after the Great Depression, as did everyone else I suppose, but also thrived for decades after, unlike so many. It contained the wealthiest individuals and corporations on the planet, proving once and for all that capitalism was an overall effective method of financial success. America's rise resulted in consumption and materialism by its citizens so envied by third-world nations. Complacency in the economy proved to be powerful as saving rates were some of the lowest in the world and goods were more important than saved assets. But all this changed in the late-2000's, when the biggest and safest companies in the world started showing signs that giving citizens the power to buy at their own will without accountability was not sustainable.

It started with the issuance of sub-prime mortgages, mortgages issued to higher risk individuals that did not meet the criteria for traditional mortgages. Under stricter regulations perhaps, these individuals would not have received loans in the first place, but since the practice of issuing sub-prime mortgages persisted for so many years, it seemed the norm. These individuals would hold loans that carried higher interest rates as they were considered high-risk. The housing market peaked in 2007, followed by drastic declines in home values. Refinancing became immediately difficult and it resulted in massively high amounts of mortgage delinquencies, which lowered the values of mortgage-backed securities held by the biggest financial firms.

Shortly after in 2008, global markets collapsed as confidence in the financial system eroded directly from troubled mortgage-backed securities. Names like Merrill Lynch, Lehman Brothers, and Bear Sterns, the biggest names on Wall Street, some of the oldest companies in the history of America, bankrupted. Soon thereafter, banks implemented stricter lending policies, which halted economic growth. Suddenly those who qualified for loans two years ago, would be denied access to capital funding. America's economy, which heavily relied on consumer spending, was in jeopardy. Business investment ceased, which would have eased negative growth. And governments spent billions bailing out banks trying to save the country instead of normally investing in infrastructure and programs.

Fast forward to August 2011. America is technically not in a recession, but its "positive" GDP growth doesn't inspire confidence. Millions of Americans are pinching every penny and low interest rates aren't bailing out the innocent victims of a troubled system. Banks still have bad debt on their books and nobody has money left to fund them. Bank of America and Citigroup probably won't make it to the next federal election. Business spending has ceased and companies are still laying off workers. Signs of a recovery disappeared months ago and optimism is a shadow of today's state.

Consider that over the past three years, the country's multiple plans to restore confidence in the market and economy required spending or borrowing through quantitative easing strategies and low interest rates to "spur" growth and spending. The lack of creativity and imagination from lawmakers have been ineffective and continued bailouts of banks, automobile firms, and government-sponsored enterprises pushed spending to the $14.3 trillion debt limit. Consequently, the country is in worse condition than it was three years ago and the country was on the brink of default.

It was clear that nobody would ever allow this to happen, not even the Republicans, but the stalemate drew worried eyes. Republicans prevented the debt ceiling from being raised for what seems like political motives. Although a deal eventually passed, it resulted in the first ever downgrade of the country's debt by the Standard & Poor's because of political ineptitude, along with other reasons. After all, the US debt ceiling has been raised nine times since the turn of the century, some of which occurred during Bush's presidency. In fact, the US has only twice gone more than three years without raising its debt since 1939 (See link). So why the fuss? It seemed Republicans decided it was time to cut the massive spending and show some fiscal responsibility and they would not budge on this concept. Brilliant!

But wait a minute... The debt deal that raised the ceiling to nearly $16.7 trillion passed through bipartisan cooperation is expected to be revisited in 2013, after elections (coincidence?). Even with the Republicans spending cuts, the country is still borrowing more money than it earns and saves. The deal did not raise taxes which ultimately puts the burden of debt reduction on savings programs. The country is expected to save $2.4 trillion over the next decade, yet the country is expected to spend a net of $2.4 trillion over the next 18 months. Not only that, the "savings" is expected to be withdrawn from public programs aimed to help those who need it the most, such as social security, Medicare, and education. Can someone explain how this leads to the resolution of spending addiction in American government while restoring economic sustainability?

The economy is highly dependent on one facet, consumer spending, therefore it lives and dies by the sword. Now that we are witnessing consumers drop their spending and pay off credit cards, loans, and save, a majority of the economy has been affected. It is a shame that the plethora of personalities and opinions of US government has become too large to be effective. The government's inability to resolve its economic woes leads me to believe that its lawmakers lack or will not pursue creativity. Other countries have escaped a long-term recession, and although conditions are not near pre-financial crisis levels, growth in many sectors are relatively strong. Yet, signs of a real recovery has started to dissipate everyday.

With rumours swirling that the Fed is about to act, maybe they can do something else other than spend another trillion dollars keeping interest rates low so that the few that still have money left to spend or wish to spend eventually do. Or maybe, America is too addicted to spending it will never find another way to resolve its problems.

Juicy Option Premiums on Tesla and HP

Playing the Expiry: August 20, 2011

It's August options expiry tomorrow, which means traders are looking for massively low risk options to sell for a nickel or a dime. But consider two option trades that might prove to be more profitable with just a little more risk.

Tesla Motors [TSLA:NDQ] can be considered a volatile stock. Just like any other stocks, it has its good and bad days, but its option premiums are pricing some sort of event that shouldn't be existing in the next 29 hours. The company's earnings were two weeks ago and showed growing revenue. With that in mind, take a look at a short straddle trade at 24.

The shares are trading at slightly above $24.00 at the moment, and the call and put options are bidding $0.40 and $0.50. The spreads are ridiculously large, so you might be able to earn an extra dime on each leg too, but low volume on the options might mean a lack of a fill on the sell and the buy back tomorrow, so trade wisely. Anyways, you would earn $0.90 minus Tesla's deviation away from $24 tomorrow. That is, if Tesla trades at $23.50 tomorrow, you would earn $0.40 per contract or 1.67 per cent in a day. This trade requires you to close out at least one side, but the closer to $24, the better.

A second trade consideration would be to play Hewlett-Packard [HPQ:NYSE] earnings. The company reports earnings after market close today and is expected to report $1.05 per share. Writing options on earnings historically is a very profitable thing to do, as buyers bid up option premiums in anticipation of a heavy move up or down.

If you're looking to do a short strangle or combination, try to cover yourself from a 7.5 per cent move. I have found that to be the safe area since many blue chips do not often move that much after earnings. With that strategy, you would be looking at the 33 call and 28 put. Both options are bidding about $0.39. The stock sits right in the middle at $30.50. As long as the shares move less than 8.1 per cent, you would not have to buy anything back. However, one warning is that HP's last two quarterly earnings have seen the shares move well over 10 per cent overnight, so it is up to you to decide if another big move is in the works this earnings play.

Disclaimer: Writing uncovered (or naked) options requires substantial margin and is only available to sophisticated traders. Uncovered calls have unlimited risk and can have infinite losses. Before making any trade, always discuss this with your advisor or professional broker. Reminder that all Playing the Expiry posts are transactions that may be or have been placed in my account and should not be taken as professional advice. I own shares of Tesla Motors.

Stick With the Market

If there were any lessons from last year's market correction in August, it was that those who sold in the summer lost out on massive gains in the winter. And those who have panicked and sold this summer will surely miss out on another fall and winter rally.

Historically, the summer is often the most volatile and least profitable months. It just happens to be for whatever reason. But those who stick with the market over the years have seen the resilience of stocks through optimistic eyes.

Short-term corrections like this often clean house. Investors and traders who are reactionary or lack discipline in their long-term strategies are weeded out of the market. It enables the major players, hedge funds and banks, to start adding to their portfolios. Those who generate income on a monthly or quarterly basis will now be able to put their cash into good use. The market has no reason to be negative this year and there are many good reasons why to get ready to start buying again.

Even if American debt gets a downgrade, it is expected to be AA (highest is AAA), which is still healthy. The rating on government bonds has no real correlation to American corporations and profitability. Yes, the government will have to pay more on their debt, but let's not forget that American corporations are not as connected to the government as they once were. And so far this year, 78 per cent of stocks on the S&P 500 have beaten estimates, suggesting that American corporations are still extremely healthy and have hired executives who know how to make money, unlike the lawmakers Americans voted in. Just look at today's big earnings. Proctor & Gamble [PG:NYSE] recorded profits that rose 18 per cent or 84 cents per share, beating estimates handily. Same goes with clothing retailer Abercrombie & Fitch [ANF:NYSE], construction giant Fluor [FLR:NYSE], and online travel company Priceline.com [PCLN:NSD], whose shares all rose significantly today.

Low interest rates won't attract many buyers. Bonds and treasuries aren't exactly paying you much money for borrowing your money and you'd be lucky to earn a penny on a thousand dollars in the bank. Investors should not be happy with returns that par inflation, so expect money to be injected into the healthiest and most efficient system, the stock market.

Many established companies have dividend yields that exceed most 5-year US notes and even Canadian bonds. Add hedging strategies like covered calls to top up your profits and you could be earning well over 15 per cent annually. Remember that as you age, your investment accounts should be geared toward income strategies and not overall growth.

Low interest rates have also allowed companies to borrow cheap money to purchase their shares back (often termed buyback programs), which lowers their float, and eventually increases share value. A company's profit is measured in two ways, net income, but more importantly, earnings per share (or EPS). The larger the float (or shares outstanding), the more profits must be divided evenly by shares. But if a company has fewer shares in the market, that $1 billion is divided into fewer shares, which increases EPS. And if you've ever read anything before about investing, the P/E ratio is the price of the stock divided by the EPS, so a higher EPS means a lower ratio, and a lower ratio means a better time to buy, all things being equal.

Another reason why it's time to buy, or even to argue, the time not to sell, is that even with all the fear that has appeared in the market over the last week, the economic reports that have been released have not differed much from what we've been seeing over the past three years. Factors that helped the market rally and create the bull market are still relevant today. Yes, growth is very stagnant and jobs are not being created fast enough, but this isn't something new. And until the market hears that unemployment has risen to 13 per cent, GDP is actually negative, and manufacturing data has consistently been below 50, I will not sell. Fear always subsides once rational thinking re-enters the market.

The governments know that their nations are in turmoil and they will do anything and everything to get their country back on track. Whether that country is America, Italy, Greece, Canada, Brazil, Russia, or Japan, governments have nearly total control on the supply of money, thus currency, interest rates, taxes, and many macroeconomic factors. And we're seeing an international battle for devaluing one's currency. This means inflation and an increase in asset values. They also want to stay in power for as long as they can so doing what's best for the nation isn't just their job, but it's how they keep their job.

Of course, it's hard to get out of the moment. There is so much negativity, but if you stick with the market, you will handsomely be rewarded.

In 2010, the market peaked in April then corrected in August. As referred to in the opening paragraph, after an autumn rally, the stock market gained roughly 15 per cent by the end of the year. In 2011, the market peaked in April then corrected in August. What autumn has in store for us this year has yet to be seen, but considering that the stock market is a gauge of the health of companies that comprise it, I'm confident that those who sold in the past week will regret their final decisions.