What else do you buy .. besides Apartment Buildings

[Thomas Beyer]

Frequently I get asked: what do you invest your own (RRSP or non-RRSP) money in ? The answer is obviously that I invest in real estate, namely a few smaller single-family homes or rental pooled condos, but mainly into our inflation protected apartment buildings (with monthly income and prudent cheap CMHC leverage) that we manage for ourselves and 350+ investors. But here is what I do with the more liquid cash, as real estate is not as liquid as cash or stocks and I too have to buy bread, shoes, skis and vacations with cash .. and I sometimes shock the grocery clerk when he ask: will this be cash, debit or credit, and I ask: do you take equity ? (The answer usually is: ??? silence ?? .. or the occasional: no)

Stocks are poor investments for short-term .. and some folks (like Warren Buffet) argue anything less than 5 years is short-term. I do have some stocks and ETFs but relatively few as a % of my networth.

One strategy that works fairly well in a volatile, yet flat, rising and even slightly declining stock markets, in short and medium term, is COVERED CALLS .. this way you make money fairly consistently and fairly conservatively selling "time".

Example: SUNCOR (SU) that trades around $22 right now .. way down from last year .. as it is oil dependent it may drop a bit further .. ditto this strategy works with most quality Canadian or US stocks that have options, including some ETFs even (FXI, USO, EWH ..), banks (BNS, RY, TD, ...) , life insurance companies, telco`s, tech stocks like Oracle or Google or Microsoft or IBM, consumer goods .. all down from last year with potential to fall a bit further but let`s assume that a year from now they will all be a bit higher (I`d say 10-20% a year from now is a fair estimate)

Most options expire worthlessly due to time value, so you can buy options and speculate in a fall or rise of a stock, or you can sell options, either uncovered (naked) or covered.

So you BUY 1000 shares of Suncor for $22,000 @ $22/share.

one option is good for 100 shares. A CALL option is the right to buy stocks, at a certain strike price before a certain date. The further out, the more expensive (the time premium) as the stock has more time to reach that price target !

Now you sell CALL OPTIONS, say a $20 CALL option. Its value is roughly as of Dec. 27 2008:

for Jan. 2009: $2.80
Feb. $3.80
March $4.50
June 5.60
Jan 2010 $7.20

The guy who buys the Jan 2010 SU 20 CALL speculates that SU will be over $27.20 a year from now. Say it goes to $40. He invested $7200 for 10 options, and if SU is $40 in Jan 2010 he has the right to buy the stock for $20. He made $20,000, minus his $7,200 he paid, so he will make $12,800 on $7,200 invested. Pure speculation .. like Las Vegas .. but profitable if "predicted" well ! If SU goes up to $25, he will also exercise his option to buy at $20, and makes $5000, but since he paid $7200 he actually lost $2200. Hence, he breaks even at $27.20 for SU. Will SU be over $27.20 in a year ? Maybe .. maybe not .. I have no idea actually ..

Here is what I know: in Jan 2010 it is one year later than Jan 2009 ! That is a given ! So that is what you sell ! You become the bank like the ones in Las Vegas .. they know, on average, most people lose money gambling. Similar in options, as all options lose time premium, and on average most options also expiry worthlessly.

Let`s assume you do not need your money for a year, so you sell 10 of the Jan 2010 SU CALLs for $7.20.

Thus, you paid $22,000 for 1000 shares, and collect $7200 for 10 call options, thus your net investment is roughly $15,000.
Assuming SU stays above $20 by the 3rd Friday in January 2010, you will have to deliver the 1000 stocks for $20,000. You made 33.33%, i.e. turned $15,000 into $20,000 !

The risk is:
on the downside: SU falls below $15 and you lose $ for $, i.e. if it closes @ $13 you`ve lost $2000. Possible: yes. Likely: Probably not.
on the up side: SU rises to $50. You have to deliver the stock at $20

Thus, you make money if SU stays above $15. Plus you lose any upside if it rises over $20. Thus, you give up a possible large upside (to the buyer of the option, the speculator) to a more guaranteed return.

Educate yourself on COVERED CALLS (or its more esoteric sibbling, the SPREAD, or the NAKED PUT) and you will find another revenue stream ... from stocks !

(with the caveat .. from personal experience .. that in 3Q and 4Q 2008 you too would have lost money in that sphere, but not as big as any stock investor especially if you had sold deep-in-the-money CALLs .. however in a volatile yet overall flat to slightly rising to even slightly declining market I expect 2009 to be it is a great strategy !!)

Successful Investing + Happy New Year 2009 !

 

[Smitty]

Thomas:Caution! As you acknowledged in your post, the risk graph of doing a covered call is the synthetic equivalent of selling naked puts (to the reader; naked means you`re unhedged).

I love my country, but Canada is bass awkards when its comes to how the regulations and margin requirements are set for derivatives. But that`s a discussion for another time. Anyways, many brokers and advisors have long touted the "covered call" as the penultimate of monthly income strategies. It`s not all that cracked up to be, in fact, it can be downright dangerous.

Here`s the bottom line:

1) Covered call = long stock + short call. Keep all the risk of the stock for some monthly income. Limited/capped upside profit.

Instead, here are some alternate, safer, potentially more lucrative opportunities, if you`re willing to give up the addiction to the potential monthly income:

2) Married put = long stock + long put. You have effectively "insured" your stock for usually 85% - 95% against losses, PLUS you have unlimited profit potential. NO monthly income, in fact you have to spend some money on the "stock insurance".

3) Collar = long stock + long put + short call. Nearly Identical to the Married put, but instead, to help "pay" for the put, you sell a call. Very limited risk, limited profit.

Master traders - I am definitely not one of them!

- have used strategies #2 and #3 to great great effectiveness. One fellow I know is master of a strategy of a variation on #3, called the "Dynamically Hedged Collar". Extremely powerful. Took 3000 shares of a company and ended up with a position of over 30,000 shares without having to add more of his own money to the position - the puts, aka "insurance", paid for the additional shares.

Anyways, if you want the definitive book/bible right now on that strategy, you may want to check out the book "Stock, Options, and Collars". Yes, its expensive, but tell me, would you pay $300+ for a book that could make you a lot of money while eliminating much of the risk?
http://www.randomwalktrading.com/tos/tos_books.html

Sorry for the lengthy reply, but there are far less riskier ways to play stock other than covered call writing. In fact, you may say 2008 may be the definitive year to prove that covered call writing can be a devastating strategy.

I have a bmp image I created, but looking up the help file I`ve discovered that I can`t embed the image in this forum. Too bad, things are always easier to see when explained visually.

Mike "Smitty" Smith

 

[Jack]

QUOTE Anyways, many brokers and advisors have long touted the "covered call" as the penultimate of monthly income strategies. It`s not all that cracked up to be, in fact, it can be downright dangerous.Absolutely.

I have a friend who worked on the buy-side of a fair-sized investment firm. The guys he works with loved all the rookie investors that would place bets using these sophisticated trading strategies learned at some weekend seminar, because they`d pretty much take their money instantly. Consider this: when using options, you`re essentially placing a bet against very smart people who`ve been doing it for a very long time. They want people to start doing candlesticks, covered calls, naked forwards, everything.

So it`s essentially you against the real professional investor. I don`t like the rookie`s odds.

 

[Thomas Beyer]

QUOTE (Smitty @ Dec 27 2008, 02:59 PM) Thomas:

Caution!

As you acknowledged in your post, the risk graph of doing a covered call is the synthetic equivalent of selling naked puts (to the reader; naked means you`re unhedged).

I love my country, but Canada is bass awkards when its comes to how the regulations and margin requirements are set for derivatives. But that`s a discussion for another time. Anyways, many brokers and advisors have long touted the "covered call" as the penultimate of monthly income strategies. It`s not all that cracked up to be, in fact, it can be downright dangerous.
sorry: I do not see the danger .. anytime you invest $s in theory you could lose all your money ...
QUOTE (Smitty @ Dec 27 2008, 02:59 PM) Here`s the bottom line:

1) Covered call = long stock + short call. Keep all the risk of the stock for some monthly income. Limited/capped upside profit.

not quite .. only if you sell calls monthly do you get monthly income. Also: the risk is the price you pay for the stock MINUS the $s received for the call .. so if the CALL is deep in the money then you have less $s at risk.

So, in my example of Suncor, rather than selling a $20 CALL for 2010 for $7.20, why not sell the $18 CALL for about $8.20, your risk or cost is: $22-$8.20, i.e.. about $14, but you make money if Suncor stays above $14 .. which is highly likely ..

Yes, limited upside, for a more guaranteed return though !

QUOTE (Smitty @ Dec 27 2008, 02:59 PM) Instead, here are some alternate, safer, potentially more lucrative opportunities, if you`re willing to give up the addiction to the potential monthly income:

2) Married put = long stock + long put. You have effectively "insured" your stock for usually 85% - 95% against losses, PLUS you have unlimited profit potential. NO monthly income, in fact you have to spend some money on the "stock insurance".

sure .. another option .. you buy insurance on the downside .. thus it increases your cost of buying shares (like any insurance) and it has to be renewed frequently .. so in my example you buy a Jan 2010 20 PUT for about $5, increasing your share price to $27 essentially .. thus SU has to go over $27 for you to make any money !

QUOTE (Smitty @ Dec 27 2008, 02:59 PM) 3) Collar = long stock + long put + short call. Nearly Identical to the Married put, but instead, to help "pay" for the put, you sell a call. Very limited risk, limited profit.
indeed .. or a spread .. yet more options to invest ..

I am not advocating covered calls or any method .. I am just mentioning it is a way to invest more conservatively and possibly more profitably ..

What I know is:
a) we have inflation
b) time moves forward

The rest is all an educated guess .. will oil be @ $100 in 2 years: probably but not guaranteed .. but in 2 years it will be 2 years later ! Will Alberta real estate be higher 20 years from now: you bet .. will stocks be higher in 20 years: very likely too .. but in a year or 2 ?

 

[Smitty]

Thomas:Well, as long as we`re doing math, here are some variations that are very close to your example. Just for comparison, #`s for today, for various trades:1) Long stock of Suncor 100 shares: Cost = $1845 Max profit = unlimited Max loss = $1845
Breakeven = $18.45

2) Covered call of SU using Jan2010 17.5 Call (sell):
Cost = $1265
Max profit = $485
Max loss = $1265
Breakeven = $12.45

3) Married put of SU using Jan2010 17.5 Put (buy):
Cost = $2385
Max profit = unlimited
Max loss = $635
Breakeven = $23.85

4) Collared SU using Jan`09 Call (sell) + Jan `09 put (bought):
Cost = $1875
Max profit = $125
Max loss = $125.10
Breakeven = $18.75

So take your pick. You can also do #3 with short term puts. Math is similar, just like you said, renew your insurance every month.
And, as you`ve alluded to, these trades are funstion of probability. Let me address one issue; a year ago many people 90+% could have picked AIG or some other company and said "the chances of stock tanking that low are very small".

In fact, anytime someone says "the probability of company XYZ - even Suncor - of going down is no likely" should raise a small - just a small one - red flag. In fact, it is theoretically possible for any company to trade at pennies. Look at Bre-X, Enron, World-com, many dot-coms during 2000, etc etc.

Now someone is going to interject that Suncor has extremely strong fundamentals, and that of course, the corporate officers will never be involved in any shenanigans. Yeah, probably. Probably Suncor will be trading higher a year, 2years. 3 years from now. Then even more reason not to limit your upside, by doing a covered call!

You see how attractive and deceptive the covered call is? Not only does it have the highest probability of being profitable, it has the lowest breakeven! Looks awesome and sexy. And, for a stock trading at $18.45, you`d probably get away with it, and be able to sleep at night not having intimate conversations with your ceiling. But far - FAR - too many investors get killed by (a) income stream and (b) lower breakeven on the wrong stock.

But every investment - but in particular, trading, - should begin with the question; "What`s the most I could lose?" And, aside from just plain old simple stock, the covered call is ranked #2 in terms of $ risk (not probable risk). In fact, the risk of the covered call is nearly double #3 and 10x #4.

Look, I have re-read your post, and in this instance, with a company like SU, you`re probably going to have the "safest" circumstances you could ever get to do an unlimited risk (stock could go to zero) trade like a covered call. Strong company beaten to a pulp + temporary circumstances + bright bright future + stock price being that close to zero means you could get away with it. Is a covered call on SU right now a bad trade? Not necessarily. Depends on your risk tolerance, and what you want in terms of ROI.

But trust me, the higher the stock price, the more dangerous your advice becomes. Just ask anyone who did covered calls on Potash, who would have rather had a married put or a collar rather than ride that stock from $200+ down to $80+

FYI, the numbers are all software calculated, dispute them if you like, but I know they`re right.

Good discussion. But if you want an even more conservative strategy with far more lucrative potential, find a volatile stock - yes more volatility works better - and do a dynamically hedged collar. Yes, I am saying low risk and high reward opportunities exist in the stock market, contrary to stereotypes and cliches about options.

Wow. And I haven`t even started discussing volatility.

Smitty
P.S. I am eventually going full-time in the financial services industry in the future, so I will say again, the above was intended for illustration purposes only, and was not intended as advice or direction to place and invesmtnet or to risk money. Investing in stock, options, and other derivatives, can be very risky and a person should educate themselves fully before even considering placing a position/trade or buying an investment. Past performance do NOT guarantee future results. Also, you should practice trade on paper first, and not risk any money.

 

[housingrental]

Jack - The more I read the more I likeQUOTE (Jack @ Dec 27 2008, 05:41 PM) Absolutely.
I have a friend who worked on the buy-side of a fair-sized investment firm. The guys he works with loved all the rookie investors that would place bets using these sophisticated trading strategies learned at some weekend seminar, because they`d pretty much take their money instantly. Consider this: when using options, you`re essentially placing a bet against very smart people who`ve been doing it for a very long time. They want people to start doing candlesticks, covered calls, naked forwards, everything.

So it`s essentially you against the real professional investor. I don`t like the rookie`s odds.

 

[ohsofrugal]

I do write covered calls but with the understanding it is not a conservative strategy as I have no downside protection and limited upside. I`m comfortable with it because I know what my upside is if my scenario plays out and find it worth the downside risk. Also, at any time I can buy a put to mitigate my downside exposure. It should be noted that in the case of dividend paying stocks, while covered calls do have the downside risks of the stock, you can also retain some benefits of going long the underlying stock. I personally think there are good companies in this market that do give you a fighting chance for success doing covered calls. This may not persist but these are the stocks I am targeting. There are a plethora of options strategies, some relatively simple and some very complex and I think like in anything in life, there has to be a progression from one side to the other. People don`t become master option traders overnight (if ever).
I see both point of views concerning covered calls (for and against) and I think anybody willing to undertake any stock/option or real estate strategy should do so after examining all angles.

This is a great discussion btw. What exactly is a `dynamically hedged collar`?

 

[Smitty]

QUOTE This is a great discussion btw. What exactly is a `dynamically hedged collar`?The dynamically hedged collar is by far the best way - in most circumstances - to play with volatile stocks. And you do need some volatility. It works poorly on safe, non-volatile stocks. It did - note past tense(!) - work great on AAPL and POT.

Basically, it is the same as a "regular" collar; i.e., buy stock, buy protective put (functions as insurance), sell call to pay for the put. You`re getting `free` (or nearly free) insurance for your stock.

You use front month, short term options.

And basically, the term "dynamically hedged" part means that you`re looking for the occasional, temporary setback in the stocks price, because as the price falls, you puts get more valuable. When that happens you use the profit from the puts to buy more stock. Then you repeat; buy another put, sell another call at wherever the stock is currently trading.

Bottom line: It is a stock accumulation strategy that allows you to dollar cost average using the market`s money. Too bad Suzie Orman doesn`t tout that strategy, because $ cost averaging with your own money as the stock falls is a no-no in my opinion. Do you want to pay for your stock, or would you rather have the market pay for it?

Check out the reference`s I have supplied earlier in this thread. I recommend the book if you are serious about looking into it.

Honestly, I have absolutely no idea why there aren`t funds out there for people to invest in that specialize in the D.H. Collar. Much safer than plain `naked` stock, and it despite some subtleties and guidelines and `rules` to follow its not a terribly difficult strategy to understand.

Smitty

P.S. My apologies in being repetitive; but please don`t start using this strategy because I have given you the basics. No way this forum is the appropriate venue to learn this strategy in its entirety.

 

[RedlineBrett]

In addition to real estate, I invest in private financings by O&G cos and capital cos that fund O&G service companies. I don`t have a dime in any publicly traded company right now.

All of them are long term plays of at least 3-5 years. I simply cannot put in the time to get and stay informed enough to invest with a day (or month) trader mentality. My motto is if I don`t understand the business I don`t invest in it!

 

[housingrental]

You know its odd the more I read on this forum the more I realize how different my perspective is to investing.

Is there anybody that shares my love for index based ETF`s and also believes that:
That 99% of people are around as smart as they are (with the other 1% not being smarter)
Random events beyond their ability to analyze will determine the price of a companies stock 1 month, 1 year, and 15 years out
That it`s an egotistical fools game "investing" in individual companies (BETTING!!!)

And the exception to this are:
Cash and near cash investments
Business`s you have some control over (such as real estate and others you run)
Business you have significant knowledge and insight into (Investing in local restaurant operated by someone else when you`ve owned your own local restaurant nearby and have oversight of local restaurant NOT spending 1 hour a day reading about the activities and operating environment of XYZ corp.)


Am I nuts?
Does anyone else think that most of the above posts are reckless ? (Though I wish you nothing but good fortune to smitty, redline, thomas, and jack, etc..)

 

[EdRenkema]

QUOTE (housingrental @ Dec 29 2008, 10:02 PM) Am I nuts?
You are nuts, you`re a PM in student housing right?

Seriously, there are 3 ways small investors can invest: paper assetts (least work, most risk) or a business (most work, average risk), or real estate (some work, some risk)
Why invest in something you don`t know? unless you can afford to lose $
Here is food for thought: Financial Success does not necessarily equate Financial Intelligence.(RK)
The two things in life people struggle with most are also the ones people have the most indivdual control over, namely: body weight and financial net worth(me). Think about it, those 2 things are what you hear most people complain they have no control over but both are ultimately totally controllable!

 

[Smitty]

QUOTE (housingrental @ Dec 29 2008, 09:02 PM) You know its odd the more I read on this forum the more I realize how different my perspective is to investing.Is there anybody that shares my love for index based ETF`s and also believes that:That 99% of people are around as smart as they are (with the other 1% not being smarter)
Random events beyond their ability to analyze will determine the price of a companies stock 1 month, 1 year, and 15 years out
That it`s an egotistical fools game "investing" in individual companies (BETTING!!!)...Am I nuts?
Does anyone else think that most of the above posts are reckless ? (Though I wish you nothing but good fortune to smitty, redline, thomas, and jack, etc..)

Housingrental:

I repsectfully disagree.

I understand how or why you`d say the above is reckless, but let me also say, I think your opinion - please, I also say this with respect - is based out of ignorance. Ignorance is not a bad thing, nor is intended as insult, it simply is what it is.

I thought at some point someone might post a reply similar to what you`ve said. I hesitated greatly before replying Thomas original post. I my only intention was to shed some light on an otherwise fairly dark area of investing, where cliches and stereotypes abound.

So it bears repeating that, as Redline alluded to, people should stick to what they know. I know options frankly because I`ve paid a lot of money and spent time knowing how they work. Most investors should just pick something they like and feel they`re good at. And for most of us, that`s real estate. Don and the REIN team do such a tremendously good job at teaching rock solid real estate fundamentals, that in theory, everyone`s Belize ought to be attainable on real estate alone.

Just wanted to say that because my intention was not lead anyone down a garden path, or somehow provide a pancea/holy grail in discussing alternatives to real estate. It is both factually correct to say that there are many do-it-yourself traders/investors who, like real estate investors, develop a level of expertise and do very well in terms of ROI, on a monthly, quarterly, and annual basis while also saying - factually and correctly, that without proper training, patience, and emotional control, investing on your own can indeed be reckless, and that comparing it gambling is very appropriate - couldn`t agree more.

But does that mean its gambling for everyone? No. Not by a long shot. Best traders I know never gamble or "bet" as you put it. The best traders make thorough decisions, that are deeply analyzed, have a written trading plan, and they position themselves to control probability as best they can. A few good traders do indeed develop large egos, but ego has nothing to do as a basis for making a trade. Usually when it does, the market kicks them in the pants. Hard. Just read "When Genius Failed".

Or, better said, the best traders never rely on their ability to "predict" anything, let alone when the sun will rise. But they are zen masters at controlling 2 things; (1) risk (2) emotions.

Really, all I tried doing was to simply say, that beyond the covered call game, and if there is going to be a discussion about alternatives such as options on a real estate forum, then let me point out some alternatives, and set the record straight about a few things.

Good investing - no matter what vehicle(!),
Smitty

ETF`s can be very good too - when it comes to the stock market, its all about what suits your needs. That`s a compliment to you and the market; its good the dodo birds on wall street have woken up in the past 10 years and have provided a much broader amount of choices to the retail investor to select the investments, and timelines that suit them.

 

[Thomas Beyer]

QUOTE (housingrental @ Dec 29 2008, 09:02 PM) You know its odd the more I read on this forum the more I realize how different my perspective is to investing.

Is there anybody that shares my love for index based ETF`s ...
such as .. ??

even an ETF assumes you make an educated guess about the direction or future value of banking sector, the Canadian oil sector, the Top 60 TSX .. i.e. the company baskets that comprise the ETF .. any investment is based on some assumptions such as "gold is going up" or "the banking sector will always be more stable than oil&gas, and rising in the long term" etc. ...

yes I do ETFs .. and write or have written covered calls on up or down oriented (or even currency based) more esoteric ETFs such as: EWH, USO, EFZ, EEV, EZA, FXY, SRS .. not that they are all great ..

I think one should not rule out stocks or gold or any investment class in general .. it is just some are better than others .. and real estate has its limitation i.e. liquidity especially right now: if you wish to sell any asset and must sell by January .. only a huge haircut is going to do that .. so it is relevant to have this discussion on what to invest "cash" in !!

Are you saying that your cash is just that ? cash ? what % of your networth is cash ? 2% 10% ? 25% ?

 

[housingrental]

Very trueQUOTE (EdRenkema @ Dec 29 2008, 11:54 PM) You are nuts, you`re a PM in student housing right?

Seriously, there are 3 ways small investors can invest: paper assetts (least work, most risk) or a business (most work, average risk), or real estate (some work, some risk)
Why invest in something you don`t know? unless you can afford to lose $
Here is food for thought: Financial Success does not necessarily equate Financial Intelligence.(RK)
The two things in life people struggle with most are also the ones people have the most indivdual control over, namely: body weight and financial net worth(me). Think about it, those 2 things are what you hear most people complain they have no control over but both are ultimately totally controllable!

 

[housingrental]

I take issue with this section of your quoteI don`t believe these are valid investment alternatives There is a reason why top traders work at firms on behalf of clients - They can make money taking a cut of fees from investors not from earning off their own trades


QUOTE (Smitty @ Dec 30 2008, 01:44 AM) But does that mean its gambling for everyone? No. Not by a long shot. Best traders I know never gamble or "bet" as you put it. The best traders make thorough decisions, that are deeply analyzed, have a written trading plan, and they position themselves to control probability as best they can. A few good traders do indeed develop large egos, but ego has nothing to do as a basis for making a trade. Usually when it does, the market kicks them in the pants. Hard. Just read "When Genius Failed".

Or, better said, the best traders never rely on their ability to "predict" anything, let alone when the sun will rise. But they are zen masters at controlling 2 things; (1) risk (2) emotions.

Really, all I tried doing was to simply say, that beyond the covered call game, and if there is going to be a discussion about alternatives such as options on a real estate forum, then let me point out some alternatives, and set the record straight about a few things.

 

[housingrental]

Note I'm a proponent of INDEX based ETF's (Follow TSX, NASDAQ, SP, ETC.. with currency hedge in place as needed)



Choosing specific sector's or ratio based baskets is also a guessing game



I'll allow for one exception for this - the one strategy that has historically provided above market returns has been high dividend paying stocks that meet specific additional criteria.



Apx 5% of my net worth is in cash currently(earning nothing), but needed for tax liability.




QUOTE (thomasbeyer2000 @ Dec 30 2008, 11:43 AM)
such as .. ??



even an ETF assumes you make an educated guess about the direction or future value of banking sector, the Canadian oil sector, the Top 60 TSX .. i.e. the company baskets that comprise the ETF .. any investment is based on some assumptions such as "gold is going up" or "the banking sector will always be more stable than oil&gas, and rising in the long term" etc. ...



yes I do ETFs .. and write or have written covered calls on up or down oriented (or even currency based) more esoteric ETFs such as: EWH, USO, EFZ, EEV, EZA, FXY, SRS .. not that they are all great ..



I think one should not rule out stocks or gold or any investment class in general .. it is just some are better than others .. and real estate has its limitation i.e. liquidity especially right now: if you wish to sell any asset and must sell by January .. only a huge haircut is going to do that .. so it is relevant to have this discussion on what to invest "cash" in !!



Are you saying that your cash is just that ? cash ? what % of your networth is cash ? 2% 10% ? 25% ?

 

[Thomas Beyer]

let`s try this:of the Dow Jones 30 stocks, in 2008 only TWO were higher than at the end of 2007: Wal*Mart and McDonalds . as both benefit from a recession that will started in late 2007 all the way through 2008 and that will continue in 2009 ..
Let`s use Wal*Mart as an example as it won`t go anywhere and in a recession they have more customers .. but hey, they too might drop 10% .. who knows ..

Today Wal*Mart can be bought for about $56.

1st Example: Let`s buy 1000 shares for $56,000.

Then sell 10 Jan 2010 CALL for $11 (or so), net in your account: $11,000. Net cost to you: $45,000. If Wal*Mart is above 50 in January 2010 (which it very likely will be) you make $5000 on $45,000 invested or 11% !

This is highly liquid, can be traded into cash in seconds, it fairly conservative and like cash. Not as good as cash-flowing real estate in the right markets with the right cheap leverage, but decent, less work and liquid. So why park money in a chequing account @ 1% if you can get 11% almost guaranteed !?

You can be more aggressive and sell $55 or $57.50 calls 2-5 month out, and make possibly a higher return if Wal*Mart stay above $55 or $57.50 even .. but less conservative.

This strategy also work on some of the ETFs mentioned as well as many large Canadian stocks like banks, oil companies, TelCo`s, insurance firms ... I just use Wal*Mart as a case for a fairly large, well run, recession proof firm.

Is it guaranteed that Wal*mart trades at 90% of today`s value in a year .. no .. is it likely: yes.

2nd Example: USO, a US oil ETF, which trades around $37 today. Buy it, and sell a Jan 2010 30 CALL at around $12, and your net cost is $25. You have to deliver the ETF @ $30 in a year .. so if USO stays above $30 you make 20%, i.e. $5 on $25 invested if ETF closes above 30 (i.e. oil is 20% lower than today, i.e. above $40 .. it is $47 today). Or less conservative, buy the ETF and sell a Jan 2010 35 CALL for $10, your net cost is $27, and you make $8 on $27 invested or 29% if oil stays higher than where it is today (i.e. ETF closes above $35).

Is this guaranteed .. no .. is it likely that oil is higher a year from now than today: yes.


I rest my case ..

 

[gwasser]

I missed this thread before and it is truly great. Both Thomas and Smitty`s discussion points are excellent. My concern with Thomas` remarks is that he sells call options more than a year out. This not only limits his upside, but it limits his upside for a LONG time. I prefer too use 3 months call options to reduce the upside limit risk. But, the transaction value of short term options is less.

I understand Smitty`s remarks on risk although following his numbers gives me sometimes a headache. Smitty`s concern about a stock going to zero while your upside is limited is true but again it depends on the time horizon your working with. Short term stocks have a much lower probability to go to zero or to significant decline than over a longer term (1 year). Since all investments involve risk and risk tolerance, for me the short term option risks lies within my range of risk tolerance.

So overall, I side with Thomas on the benefits of writing covered call options provided you use a low commission broker, use "somewhat predictable" stocks, and are willing to sell that stock at the strike price. As pointed out elsewhere, also consider the effect of losing dividend payments and incurring capital gains taxes. I have not looked in the tax regime in which the proceeds of option sales fall, however, that is another issue of importance.

The most critical aspect of options is understanding its risk. That should also answer the postings on index investing. Index funds or ETFs still carry risk. All investments carry risk whether it is investing in cash (inflation and currency risk, opportunity costs), or in bonds, stocks or real estate, or commodities. By investing, however, you learn and you can gain more expertise in the fields your are active in - e.g. real estate. Thomas`s point about liquity is very important as well, because you do need easy accessible funds to navigate the economic rough spots in your life.

Investors like Vangaurd`s John Boggle believe in an efficient market theory where all news is instantly reflected in the asset prices and that the overall stock markets increase in value with earnings growth which is basically a reflection of GDP. Investors like Warren Buffett believe that there is a difference between the discounted future earnings stream of a company (intrinsic value) and the price paid for a company`s stock on the stock market. He makes his money by buying good companies below their intrinsic values. But even Warren Buffett states that this method of stock investing is not suitable for the average small investor and that they should invest, like John Boggle advocates, in index funds or TFSs to represent the widest possible markets.

The longer I invest, the more I start to move towards easy investing - why fight for that extra 0.5% income especially if the risk of getting that extra 0.5% is so high? There are always opportunities in life to take advantage of and that may be your great chance of dramatically increase your wealth. An example are employee savings plands and stock options or just participating as an equity owner in a business you believe in. Thus, one could say, be happy with the return on your index funds which reflects average market returns and use the special opportunities in your life to add to even more to your wealth.

 

[Thomas Beyer]

For the record, SU ended up over $30 in early 2010.

 

[DanieLL]

Hi Thomas,

The example provided at the beginning represents the opportunities of 2009 and could be hard to replicate. What you get for those options depends primarily on implied volatility (option price).


The implied volatility was very fat (high 40s low 50s) back in 2009 thus the cash collected on those calls you sold was large enough to provide a cushion vs. losses on your shares. The time decay is also more accentuated when implied vol is high.





Currently, the implied vol is in the 18-19 and the calls we would sell right now would not bring the same amount of cash.





Also, I`m not sure if it was mentioned here, however, dividend announcements (other than the expected ones) could create anomalies in this strategy. That's one more page of typing.