I remember reading an article once basically stating the buy and hold strategy is a thing of the past.  That may very well be true…especially today.  Look what happened to GM and the shareholders after years and decades of ownership.

I remember that I had written about “Investing In Speculation” a couple of years ago, so I dug out my notes and this is what I found:

Here’s a question to consider.

Do you really invest in a company when you buy the stock on the stock exchange? No. You invest in the speculation of the stock’s price (excluding dividend investments). Yes you have invested your money, but the company you purchased had original investors for start up, etc.

When the early owners needed more money for growth and expansion, they issued stock such as an “IPO”, or initial public offering. Unless you or me purchased stock here, we simply bought out someone else that had already invested in the company.  But, probably the additional investors were the investment banks such as JP Morgan, not you or me. The investment banks simply sold the shares they bought to us as an IPO to the public.

For example, Investment Bank ABC purchased stock in Company XYZ. Then the stock brokers sold the shares to Joe Blow as either an IPO or later when the demand for the company pushed the value of the stock higher. If we didn’t get in here, we simply are buying out other shareholders.

The original owners made money when they sold shares to the investment houses or went public. The original owners may have kept control of the company and/or got a bigger salary for running a larger company.

What new buyers of the stock got is a small dividend depending on profits. But that’s okay, the dividend is what was wanted in addition to price appreciation (which is speculation because the principle amount of money invested is not guaranteed.  The value can go down big time!).

The difference between investing and speculating has to do with protecting the principal amount of money.  The short version is, investing maintains the amount of money spent; whereas, speculation doesn’t have guarantees and the value can decline or potentially lose great amounts of money if not all.

If the company doesn’t perform well, and the demand goes down, so does the share value and the invested amount of money. The company still continues, excluding bankruptcy and closing the doors.

So technically people do own part of the company, but unless it is a huge amount, most shareholders cannot control operations, salaries, board positions, etc.  In simple terms, people buy out other shareholders and invested in speculation.

So why would you or I want to buy and hold a company knowing you have no control over it or the price of the stock?

Income. We can generate income from selling options, which is similar to renting the stock.

Dividend income. If we use the cash that is produced from selling options and dividends, we have the opportunity to buy more shares or reinvest, or build cash.

This can give “growth” to our accounts even if the stock price goes down simply because the costs have been reduced by building cash and/or acquiring more shares; thus allowing the potential to sell more options and receive more dividends and grow the account.

Finally, if the shares are never sold, such as a buy and hold, without income from the sources just mentioned, is there really a gain?  Sure, on paper, but not in the checking account.

Sorry, no people pictures here.

One of the hardest things to comprehend in the options market is the terminology.

Going “naked” means to have an uncovered position, i.e. not owning the underlying shares. When I sold the “covered call” in my other post “How to make money renting…stocks”, I owned the shares of that particular fund. Therefore, when I sold the option, I was covered against that option.

When I sell an “uncovered” option, I don’t own the underlying shares; therefore, it’s a “naked” position.

So here’s how it works…

Let’s say I want to own XYZ fund. It’s trading at $10 per share, but I want to own it at $9 per share. 1) I can either wait and see if it goes down; 2) buy 100 shares and sell a call against it (covered call) which reduces my cost to $9; or 3) sell a put option.

Selling a put option against shares that I don’t already own is selling a naked put. I have the $900 set aside in a cash account to buy the shares if I get exercised. ($9×100 shares). I get paid $1 for the contract which is the equivalent of $1 per share, or $100. If the fund stays above $9 at expiration, I don’t get to own the shares for $9 but I get to keep the $100. Thus I’ve made $100/$900 = 11% for owning nothing. Pretty neat.

The downside is that if the fund goes below $9, I have to buy the shares at $9, not the current market price. Sounds risky, right? Well, if I had bought them at $10 in the first place and the price went down, I would have lost anyway. So in reality, selling a selling a put option, or a naked put, is really no more risky than buying fund in the first place.

I can use this strategy to lower the cost basis if I already own the fund and want more shares or generate income. If the fund goes up, I didn’t get to buy them at $9, but I did the premium and earn a nice return on my cash.

One very important thing to remember, I only do this on stocks or funds that I absolutely want to own.

Bottom line…I like getting paid and reducing my risk and sometimes I have to get naked to do it.

Copyright secured by Digiprove © 2010 Mark

Many people like to rent a house for investment purposes, but what about a stock or an ETF – exchange traded fund, etc.?

Selling options against share owned are called covered calls. In layman’s terms – shareholders allow someone to “rent to own” the stock, ETF, etc.

What I like to do is find a good fund that pays high monthly dividends. Then I see if options exist. If they do, then I sell the option for a couple of reasons: 1 – income and 2 – reduce my risk.

As you know, the market has taken a beating over the last couple of years and we have been hit hard in our IRA’s, 401K”s, etc.

The financial world uses terminology, such as calls, puts, covered calls, write, etc. making investment strategies harder to understand.

So here’s how a covered call works.

When you write a call (write means to sell), you sell a call option. Each option controls 100 shares, so you must have at least 100 shares or increments of 100 shares for multiple options.

For this example, I’ll keep the share price at $13 in the future. It won’t go up or down. XYZ is at $13. This fund pays a month dividend of $.11 per share.

I’ll buy 100 shares. I will sell an option at a strike price at a specific date in the future, say June 2010.

The strike price is the price that I have to sell my shares of XYZ. I can sell an a option at, above or below the price paid for the stock, i.e. $15, $17.50 or $12.50.

Selling an option at $15, I have to sell your shares at $15 and make $2 per share or $200. If you sell at $17.50, you make $4.50 per share or $450. If you sell at $12.50, you lose $.50 per share or $50. Or do you?

When selling an option, I get paid a premium for that option. If the June 12.50 calls are at $1.85, my cost is actually $13 – $1.85 = $11.15. My profit would be $12.50 – $11.15 = $1.35 or $135 plus dividends of $11 per month. In 6 months, I’ve collected $66 to add to my $135 for a total of $201. $201 / $1,115 = 18% in 6 months. Depending on the option price, dividends, etc., I might sell a $10 call to further increase my downside protection.

Here’s what could happen. If my shares get exercised (meaning I have to sell my shares) 1 month from now, I don’t collect the dividend, but I make $135 / $1,115 = 12% in one month. If my shares don’t get exercised (purchased away from me), then I keep the $1.35 per share and the option expires worthless. Then I’ll sell another option and do the process all over again.

If the option to buy my fund is going to be exercised and I am going to have to sell my shares, I can either sell the shares by letting them get exercised or “roll out” the option to an even further date and keep the shares. Rolling out is buying the option back and selling another one at a later date. I’ll keep the difference that I get paid between the two prices on the options and keep collecting dividends and premiums. Pretty cool.

Now in the real world, stock prices go up and down. The values can go up slow and down fast – or as some financial experts say – the values climb the stairs and jump out the window.

People may or may not agree with me because they say I’m giving up to much upside potential for the downside risk. I’m not here to give advice or suggest anyone else to do this, but hopefully this may open your eyes to a world that many don’t know about.

Here’s the point though – I get paid. I get income. I reduce my risk while having the potential to make a nice return on my money.

Some people like to rent property, and we’ve leased some as well. I just simply like to “rent” a stock or exchange traded fund as well.

  Copyright secured by Digiprove © 2010 Mark

I like options when dealing with investments. Apparently Timothy Geithner and Washington do too.

A difference in terminology regarding options exists, such as options and warrants. In layman’s terms; however, both give a party the right to purchase shares of a company.

As part of the bailout money, banks sold warrants, i.e. collected the cash, to the government. The government then in turn received the right to exercise the warrants (up to 10 years) and take ownership in companies such as JP Morgan and Bank of America if they want too.

However, banks started getting the government out of their affairs as I mentioned in “Do They Get It?”

Today, the Treasury sold its warrants from Bank of America and made a ton of money, to the tune of 1.5 billion dollars!

The Treasury didn’t sell these warrants for that amount, the amount is the profit from the sale.

As a Treasury statement mentioned, the money made is an additional return to the taxpayers.

OK, give me a check for my percentage of the profits.

Let’ do some math for the profits.

Let’s assume there is still around 156 million taxpayers (from 2008 filers). For even quicker math, let’s use 150 million which makes dividing in my head easier. $1.5 billion divided by 150 million is $10.

$10 is not a big amount per person, but the idea is big to me and the small amount is supposed to be an “additional” return as well. I’ll take the rest too, how about you?

Aside from me not getting a check, let’s look at the investment or options side.

Options are basically a derivative investment.

Didn’t Obama and others blast banks and CEO’s for taking on risky financial activities?

Options are risky right? Wrong. Lack of knowledge is risky.

The government made billions in options (warrants technically), but this is considered a good strategy.

The difference in who decides what is good or bad depends on who is controlling the money – the private sector or the government.

When the private sector makes money, in my opinion, the people in government and other socialist demonize profit taking on the citizens. When the government makes the money, the actions are in the interest of the citizens.

Regardless whether the Big Boys (or Fat Cats) or Big Brother makes the money, if they are doing, I’m following the money. If the strategies are good enough for them, they are good enough for me.

I’ll continue buying and selling options in order to reduce my risk and make money.