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7/22/15
Make Money Where No One Is Watching
In the news last week, I read an article about a group of thousands of Muslims making their annual pilgrimage to the holy site at Mecca, Saudi Arabia. In an effort to escape the heat of the day, some worshipers began pushing and shoving, and this led to a stampede. Over 700 people died.
If there's one thing I always try to avoid, it's lots of people in public. That's because, from my observation, the public is made up of genuinely ignorant and dangerous-minded people. When you put lots of ignorant people together, you get Barack Obama. Bad news.
When you get lots of ignorant people together in a crisis, it's even worse. All hell breaks loose. People die. They lose their lives. And in investing, when lots of ignorant, emotional people get together, lots of people lose their livelihoods.
That's why I do things differently with my investments. The average investor is a gambler. He doesn't
understand the the value of things like diversification, position sizing, fundamental analysis, or trailing stops. His strategy is "Buy and hope." In other words, he buys something that looks good, and hopes it will go up in value.
When he does gamble in the market, he "goes big." And generally, he loses big.
This strategy is extremely rewarding, although it's the slow and safe method of getting rich. This is a fundamental problem for most people, because they want to get rich quick. They don't understand the value of compounding in small increments over time, of building up a stockpile which grows exponentially.
Most people just want to win the lottery.
They're wasting their time and efforts. From my point of view, there are few things worse for one’s financial security than lost opportunities, lost time, and lost money.
If you haven’t done so yet, pick up a few of my articles and take them to heart. Because if you’re still complacent, you’re missing out on the easiest and safest way to grow your money with stocks that has ever existed--basically, watching your money pile up with very little effort.
I don’t want to mess too much with your psychological state by pandering to your fear of missing out (known in economic and social vernacular as FOMO—the emotion that makes you check your Facebook all day while you should be working, or that makes you stupidly jump into bad investments when the timing is all wrong).
But I do want to reiterate that this state of mind must be controlled at all costs if you’re to succeed at mastering money matters. If you’ve taken the right steps, and prepared mentally, emotionally, and financially as an investor, you should have nothing holding you back at this point. Let’s get going!
Recap on a Recent Option Trade
I’m quite happy this week. As you know, I wrote last week about how I closed a successful trade on Cisco, Inc, by selling some poor stock market gambler out there a “put option.” A “put” or “call” option is simply an agreement you take on to buy or sell a certain amount of stock on a given date, at a predetermined price. Depending on which side of the trade you’re one, you will either get paid, or pay, to take on this obligation. Which would you prefer? To pay money to take on more financial risk—or get paid for the opportunity to make even more money than you already have, safely?
The answer is obvious. Back in June, I agreed with my broker that if CSCO was trading below $28, I’d buy 100 shares of stock from him at $28, even if the market price was below that. For the agreement, he paid me $48 free and clear, which after commission netted me an instant cash dividend into my account of 1.6% of my purchase obligation (100 shares at $28 each). I waited 28 days to see where the price was.
As I mentioned in my last post, the price was $28.13. I didn’t have to end up buying any stock from this guy. I got to keep the upfront cash, and moved onto finding my next trade, which I opened yesterday. And here it is—I’m super excited about the numbers on this one.
Intel is an industry-leading technology manufacturer in the realm of basically everything having to do with technology. The company manufactures sophisticated chips for use in everything from servers, tablets and PC’s, to networking components and security products. Its components power just about every kind of “connected” device from your fridge, to your thermostat, to your cellphone.
And this company just gets better every year. Yahoo Finance lists its profit margins at around 21%, and it has an almost 30% market share in its field. It had its best year ever last year. And to boot, this company is always leading the pack in new technology by 6-12 months compared with its competitors.
On a more technical level, Intel’s stock has reached an intermediate low, meaning that the stock is trading at around its lowest price over the past 6 months or so. Before that, the stock did very well and rose by 40%, supported by great fundamentals.
I’m not worried about the stock going anywhere lower than where it is right now. Instead, I think the stock could remain where it is over the next few months, or go slightly higher. Either way, I make money. Because I want to share in the company’s profits, I decided to buy 100 shares of Intel, and sell a “call option.” This means that I’m agreeing to sell these shares to someone else on a certain date in the future if the price has increased, and I get paid for that agreement (an amount called a “premium”).
An option has a “strike price,” which is the price at which I’m willing to sell shares. I agreed to sell my shares if they are above the strike price of $29.50 on August 21, 2015 (the option expiration date). I bought them at $29.27. The agreement gave me an instant dividend of $57 (or 57 cents per share), (which, again, is called a “premium”).
How this trade can work out for me (total gains include broker commission costs):
- If the price increases to above $29.50 and is above that price on August 21, the option is “exercised.” My broker will automatically sell my shares to the option buyer, and I will make about $61, which consists of the premium of $57, a dividend of about $23, and capital gains of about $21 (bought shares at $29.29, sell them for a gain at $29.50.
- If the price increases anywhere up to $29.50, I make between $60 and $71, including premium, dividend, and capital gains.
- If the price goes nowhere, I’ll make $60, which includes the option premium and regular stock dividend.
- If the price goes down, the option premium and dividend I received protect me on the downside by decreasing my cost basis on the stock to $28.75. The stock can decrease by about 2% before my position even begins to start showing at a loss.
So, all things considered, I’ll probably end up making around $60, or 2% in just 32 days. If I repeat the trade all year, that ends up being an annualized gain of nearly 24%. If things go my way and I make $71, that’s a return of 2.4%, or 28.8% annualized. Awesome!
Or, I could have just bought this stock, and stuck with the 3.2% dividend. How’s that sound?
I think you know why I made the choice I did. If you make the same choice, you could double the market returns of the past 84 years, which are estimated at between 9- 12%.
Do you get how to trade options?
Does this strategy make sense to you? Do you need to learn more about it? Or have questions about how to get started? If so, browse some of my articles which I've listed below to help you understand all of this a little better.
And if you have any questions, shoot me a message at thevillageidvestor@gmail.com.
You can also follow me and my other musings on LinkedIn, Facebook, and Twitter--click on the links at the top left of this page.
Jeremiah
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