A call option is a contract sold by a shareholder to a call buyer in exchange for a premium. A call option gives the call buyer the right to purchase 100 shares at a future date at an agreed upon price. Let us look at what that exactly means by looking at the standard components of any exchange traded call option.
The strike price is the price at which the call buyer can purchase the stock from the shareholder from now until the expiration date.
The expiration date represents the last day on which the call buyer can exercise his right to buy the stock at the agreed upon strike price.
An option’s premium is the amount paid by the call buyer in exchange for the call contract. The premium is quoted on a per share basis so a $5 contract represents a $500 investment since each contract represents 100 shares.
Microsoft currently trades at $45/share and you believe it will go to $50 by January of 2016. You purchase a call option with a strike price of $45 for a premium of $3 for a total investment of $300. Lets look at the possible outcomes.
The formula used to calculate the price the stock needs to reach before you are profitable is:
Strike Price + Premium = Breakeven Stock Price (at expiration)
In this example the price Microsoft needs to reach before we are profitable is $48 since:
Strike Price + Premium = Breakeven Stock Price
$45 (Strike Price) + $3 (Premium) = $48 (Breakeven Stock Price)
- Microsoft trades at $50/share
If Microsoft trades at $50 a share on January 2016 and our breakeven stock price is $48 then this represents a gain of $200 or a 66% return on investment. You can calculate your total profit by subtracting the breakeven stock price from the current stock price and multiplying by 100 shares.
- Microsoft trades at $45/share
If Microsoft trades at exactly $45 a share on January 2016 then we have a total loss of $300 since that is what we paid for this call option. If it trades slightly above $45/share but below the breakeven stock price then its not a total loss but it is still a loss.
- Microsoft trades under $45/share
If Microsoft trades under $45/share on January 2016 then we still have a total loss of $300 since you can’t lose more than what you paid for the premium on a call option.
Overall what attracts traders to call options is the incredible leverage they offer in exchange for a small time premium. It isn’t all easy gains though, call writers usually price at the money options using the stock’s volatility making it really hard for at the money call buyers to really benefit from an up move in the stock.
Call Option Definition – The Options Guide
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What is a call option – Investopedia
Security Analysis: Sixth Edition
Security Analysis is one of the best investing books written to date. Written by Warren Buffet’s own professor, Benjamin Graham, this book can be said to have stood the test of time. This book is huge and half of the book talks about valuing bonds instead of securities; The other half however is filled with tons of useful information on stock valuation. This book will teach you what to look for in a good company so that you don’t overpay. Many investors today are too busy chasing the momentum names instead of stopping for a second to think if the company is really worth as much as they are paying. Additional chapters in this book cover things such as discounted cash flow as well as valuation ratios you should look for.
The Intelligent Investor
Another Warren Buffet favorite, The Intelligent Investor will walk you through the basics of value investing as well as show you what a good stable business looks like. Benjamin Graham was the person that introduced Buffet to value investing as well as the core concepts that have made Buffet such a successful investor. Learn to invest for the long term with this amazing book as you learn how dividends affect total long term return. Also covered are how to read balance sheets, income statements, and cash-flow statements; Three useful documents allowing investors to assess a company’s financial health.
The Bible of Options Strategies
While an options book seems out of place for an article on long-term investing, this specific book teaches option techniques that can be applied to long-term investing. For example, most investors would park cash until a stock they have their eye on pulls back to a more reasonable price. Naked put selling as taught in this book, allows you to benefit if the stock moves up or even a little bit down. If you want to know how options can be part of an investor’s toolbox check out our other article on naked put selling. As many people now know, the reason why Buffet has managed to achieve such great results over the years by investing in large caps has been partly due to leverage. Options will give the small time investor the leverage he or she needs to compete if used with caution.
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Intel (INTC) has been breaking into new 52 week highs lately, so I figured it would be appropriate to write up some of the fundamentals that are supporting the price action.
In the last fiscal year total free cash-flow came in at a little bit over $10 billion or $2.80 per share showing the cash generating ability of the chip maker. Current earnings yield (free cash-flow per share / current price) currently sits at around 7% annually, money the shareholder friendly management has been returning to shareholders through stock buybacks and dividends (the current payout ratio is hovering around 50%).
Intel’s management has shown competency in buying back their own shares by buying less in the last couple of years as the stock price has soared and more during times when the price has been depressed. The average sits at around $4B in buybacks yearly during the last 4 years. With another $4B going into dividends yearly, management has managed to effectively return most of its earnings directly and indirectly back to shareholders while still retaining enough to invest in growth.
As stated above, Intel’s management has pretty much a 50/50 split between dividend payments and share buybacks making it easy for the company to keep growing its dividends without requiring aggressive growth. Dividend growth as well as the continued stock buybacks during times when the stock price is depressed should continue to fuel the stock higher and increasing the investor’s Yield on Cost year after year.
In my personal opinion Intel is a quality company with a strong moat as the leading chip maker. If you share this opinion then the previous reasons should be enough to get you to consider an investment into intel. As always we recommend playing intel’s rise by selling in the money puts with enough time premium in them to cover any short term pullbacks in the stock.
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Cash secured put selling is the practice of selling put options on your favorite stocks in order to lower your cost basis. When you sell a put on a stock you are taking on the obligation to purchase the stock at an agreed upon price (the strike price) in exchange for a premium which can work to lower your cost basis.
There are numerous put selling strategies available to options investors. Some of these strategies sell puts out of the money, at the money, or in the money. Here at TSO we mainly focus on selling in the money put options with a delta of around 0.70 on large caps with shareholder friendly management (share buybacks / growing dividends). We focus on selling in the money puts due to the fact that they provide a fair amount of time premium as well as capital appreciation.
One thing that is attractive about naked put selling is the fact that you can roll unprofitable positions indefinitely at the same strike price while still possibly collecting a small amount of time premium year after year. One reason we choose stocks that pay a dividend vs those that don’t is because the dividend is part of the options pricing model (Black-Scholes). This works out great for the long term investor since every year you can likely collect the dividend payment through the time premium available for the next year’s put therefore consistently lowering your cost basis (year after year). Eg: If Coca-Cola (KO) is trading at $45 today you could sell the $50 strike next year put with $5 intrinsic value and a few dollars of time premium baked into the option. If next year Coca-Cola is still below $50 a share you can simply buy back your naked put when the time premium has almost completely decayed and sell the same $50 strike price for the following year once again collecting a few dollars worth of time premium. Done year after year your cost basis will surely go down over time until you are finally ready to have the stock put to you and collect an above average Yield-On-Cost via dividends.
The reason we choose large cap dividend paying stocks is because these companies tend to have a much lower risk of bankruptcy than their competitors as well as lower historical volatility vs the market. This allows us to use some of the leverage afforded by naked puts to get better risk adjusted returns vs the general market.
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Amongst one of my favorite and most profitable strategies is selling in the money naked puts on large cap stocks. Many people are misinformed by their brokers as well as their friends about the risks associated with naked put selling. Naked put selling high quality dividend paying stocks that you would love to own pretty much reduces most of the risks related to naked put selling.
First, when you sell a naked put you are basically taking on an obligation to buy the stock at a set price from now until the expiration date (or until the position is closed). In exchange for taking on this obligation you collect a premium. In essence you are acting as an insurance company, insuring people against a drop in price on the given stock.
People find naked put selling risky because of the leverage afforded by naked put selling (approximately 5 to 1). This makes it possible to wipe out your entire account if you are not careful. By writing cash secured naked puts on high quality dividend paying stocks we are 1) making sure we have enough money to buy the stock. 2) lowering our cost basis when we are assigned.
Let us take a look at what makes this strategy so successful.
Reducing our cost basis (while maintaining capital appreciation)
When you sell an in the money naked put you are getting the benefit of moderate capital appreciation as well as lowering our cost basis on the stock by receiving a premium. For this reason we maintain that you should only sell naked puts on stocks you would love to own. For example, Coca Cola (KO) is currently trading around $45, right now you can sell a January 2016 $50 put for around $7.20. If Coca Cola reaches $50 by next year you get to keep the full premium ($5 intrinsic value + $2.20 in time premium received). In the case that Coca Cola instead declines to $40 by next year you can simply roll forward the $50 put to January 2017 while also collecting some additional time premium in the process. You can do this indefinitely until the stock rises again while lowering your cost basis each and every year. If the stock does decline to a price where the valuation seems cheaper though, I would recommend selling additional naked puts at a lower (but still in the money) strike price to further decrease your cost basis.
It is important to remember that each time you reduce your cost basis by selling naked puts you are essentially increasing the yield on cost when you are finally assigned and start collecting dividends.
One of the riskiest parts of naked put selling is the leverage possible. By using moderate leverage however we can generate market beating returns with very little additional risk. One of the reasons we use large cap value stocks with this strategy is that they are often the least volatile vs the market with betas often below 1. By utilizing a little bit of leverage we can write additional naked puts on our losing positions in order to further reduce our cost basis. One thing we find often with large cap dividend stocks is that the dividend is already baked into the naked put in the form of time premium. By using moderate leverage we can increase our returns by leveraging the INCOME rather than the PRICE of the stock. In essence this is the same as buying a house using a mortgage and renting it out, your down payment might be just 20% which leads to outsized returns on your capital from the rental income.
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With marriage come a lot of wonderful things. You have someone to spend your life with. You have someone to raise a family with. You also have someone that will come in handy when it comes to your taxes! Of course this is not a good reason to get married in itself, but if you are going to take the plunge you may as well take advantage of all the perks marriage has to offer!
If you are married, you can use your spouses earned income to help fund your IRA. In order to contribute to an IRA you have to show taxable compensation. But, if you are married an exception can be made if you are filing your year-end taxes as married filing jointly. The spouse with the taxable compensation can make a contribution to your IRA if you do not have any taxable income. As long as one spouse is working then it does not matter who puts the money into the IRA.
While your spouse shelters you from harm, they can also serve as a tax shelter. If there is one spouse who is losing money they can take advantage of certain deductions such as those dealing with your home. This is true when it comes to medical expenses as well. Being married can also shelter your estate. If you have a good deal of money you can leave as much of it as you wish to your spouse without having to deal with estate taxes. This exemption will protect the living spouse until the time that they pass on as well.
The law puts a limit on the amount of charitable contributions one can use as deductions each year. When you are married that limit goes up so if one partner makes one big contribution to their charity of choice but does not have double the amount in income, the excess contribution is deducted the next tax year. Just be sure to save all your filing documents in case there are any discrepancies when you go for the carry over. In addition to these things you also may have a chance at getting back more money from the EIC when you file. So, if you are newly married make sure you tell your tax preparer this so they can get you everything possible!
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It takes money in order to make money. This is something people with low incomes know all about. When you are living from check to check, investing may be the very least of your priorities even if it is the one thing you really want to be able to do! However, low incomes do not have to stop you dead in your tracks. After all, if you don’t save some money today you will not have anything to live off of tomorrow. With this in mind, check out the ideas below and see if they can fit into your life.
The first thing you can do to save money for investments (even small ones!) is think of all the things you spend your money on that you don’t have to. How many cups of coffee do you get from Starbucks each week? How often do you grab a greasy burger for lunch each week? Do you go out to the movies more than you should? These are all things that you can cut down on or even stop completely. Just think-if you spend $50 a week at Starbucks (don’t laugh, those drinks are expensive!), you will have $200 a month to invest if you make your own go-juice before work.
Does the company you work for have a 401k plan? If so this is the very first place you should be investing. This is especially true if you work for a company that matches your contributions. This is free money from your company so go to it for investment before going for outside opportunities. There are many perks to the 401k so be sure to look into that right away.
If you can think far ahead, target date funds will help you a great deal. This type of fund works by targeting the date you have set in mind for retirement and changes the percent of bonds and stocks to ensure that your money is staying safe as you get closer to “D” day. This is a great way for you to have your money when you need it without having to do your own portfolio management. Just be sure that you research the fund before settling as some can have fees that are much higher than typical. These are all ways that you can invest if you are living on the edge like many Americans are.
In the late n1980’s, ETFs (exchange traded funds) quickly became popular as investors began searching for something other than mutual funds. Both individual and institutional investors spotted the benefits of having a grouping of specific stocks that had less management fees and more price visibility. However, with the fund having a lesser management there was more of a burden on the investor to choose the proper investments. Here you will learn the pros and cons of ETFs so you can navigate the waters of risk and reward more effectively.
There are many pros to EFTs. The first one is diversification. Just one can allow a great deal of exposure to a variety of equities, styles, and market segments. Compared to stock, EFTs are able to track a larger range of stock and even try to mimic returns of a specific country. For example, you could put your focus on India, Russia, China and Russia in an EFT. Although mutual funds can also be diverse the EFT rates are lower and the trades are closer to equity investments than mutual funds are. The expense ratios of EFTs are lower when they are managed passively as well. The expense ratio of a mutual fund is higher because of costs like load fees, management fees and the wages for the board of directors. And even though EFTs are so diversified, they trade just as stocks do. All of your dividends can be reinvested automatically and since they are so like stocks you can easily search for the daily changes in order to track your investment.
When there are pros there are also cons and this is true when it comes to EFTs. One con is that although you will see dividend yields, they may not be as hefty as they are in stocks. Also, in some countries you may be limited to stocks with large caps because of a narrow market. This could be an obstacle to the potential growth of your EFTs. In some cases, the cost of the EFT may be higher when dealing with big corporations. In this case you would be better off going with actual stocks or perhaps a managed fund instead. It takes some work to figure out your needs and desires so go slow and find what works best for you.
Creating and sticking to a budget can sound like a scary and complicated task. Anything dealing with managing finances can seem like a monumental thing! However, a budget is just a tool for you to organize the money you have coming in and going out. In a way, you are the CEO of you own little business and by keeping a budget you are ensuring that your business (I.E. your family), has a good cash flow and is monitored well every month. Keeping this in mind, read over the following answers to what are likely your most pressing budget questions.
The first question to be answered is how much you should put aside for your investments. To answer this you have to consider your liquid needs, your disposable income and your age. How old you are will help you with asset allocation and in knowing how much you should set aside for major purchases. For instance, a younger person would have to set aside more for buying something like a home, than an older person would. Your disposable income stands alone from other costs that must be paid out so you can survive. This type of income can be spent on wants and desires. How much disposable income you choose to save now will decide what you will have for the future. You must also ask yourself how quickly you can turn your assets into cash (liquidity). The liquidity level will help you figure out the interest rates you will get and how quickly you can gain access to your own money. The personal amount of liquidity you keep is totally up to you and before you invest you must decide how much you do want to maintain.
The second question to be answered is how much money you should set aside for your debts, including car loans and credit cards. Some debt, like car loans, comes with a payment schedule. However, rolling debt like credit cards can be paid according to your ability to pay them. Here is the main rule – do not set money aside for investment accounts if you have credit card balances. The majority of credit cards will charge anywhere between 5 and 30 percent annual interest and this will outpace the amount you can earn from funds, bonds and stocks. It is smarter to pay your credit card bills off first and begin with budgeting some of your money for the investment accounts that is taxable after. If you do this you will let yourself save money on rising interest expenses. In the end you should keep in mind that keeping a budget is not a pesky part of life, it is something that actually brings you freedom and the ability to relax about your finances.
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Having good credit has become increasingly important. Without good credit it can be virtually impossible to get a car, a house, a loan or even smaller and simpler things. The problem is that getting and keeping good credit can be a real challenge. There are many reasons for this including getting a credit card too when you are too young, using credit cards like debit cards (small charges can build up fast!) and other things. So what can you do to fix your credit mistakes? Read on to find out more.
The first step you must take is getting your credit report. There are any sites online where you can get your report but according to the law, you must get a free copy of it each year. Go over your credit report with a fine tooth comb to make sure there are no errors. If you see something that you know that you did not do, file a dispute right away and this can help fix your credit. Experts recommend that you file your dispute by letter and not email so that there is a paper trail to follow.
Look over any delinquent accounts listed on your credit report. Most things will only stay on your report for just seven years. Most people know this but what they do not know is the following: even if you set up payments for delinquent accounts, they will not fall off of your credit report until the amount due is paid in full. Because of this it is sometimes in your best interest not to even attempt to pay off these accounts. What you can do to improve your credit is find the delinquent accounts that you can afford to pay off all at once and do it. They will immediately fall off of your credit report and your score will go up.
Even if you recognize that you do owe on a delinquent account you can still try to remove it from your credit report. Go over each one and send a letter to the reporting energy disputing the claim. They must contact the creditor within thirty days and the creditor must look up your account to prove that you do owe them. For older accounts this is more difficult for the creditors. Many times they will not take the time to do the research and they will not answer the query letter. If they do not do it in thirty days the delinquent account is removed from your credit report automatically. This may not work for all delinquent accounts but it is definitely worth the time to help improve your score.