Dollar-cost averaging using an option strategy

Most investors are familiar with dollar–cost averaging as a wealth building strategy. It involves investing a fixed amount of money at regular intervals over a long period of time. This type of systematic investment program is commonly used in company sponsored pension plans.

I use a similar approach by selling call & put options to build a stock portfolio. At first glance it sounds really complicated, but the math is simple as long as you can subtract and divide.

The two types of options: calls and puts (Investopedia)

A call gives the holder the right to buy an asset at a certain price within a specific period of time. Calls are similar to having a long position on a stock. Buyers of calls hope that the stock will increase substantially before the option expires.

A put gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of puts hope that the price of the stock will fall before the option expires.

My strategy involves selling options and collecting a premium which will hopefully reduce the cost of buying a stock. For example: I recently wanted to add 200 shares of Royal Caribbean Cruises (RCL) to my stock portfolio.

Here is the math: I bought 100 shares at $72.22 on Oct 11th

Sold 1 call option Nov $72.50 for $3.40

Sold 1 put option Nov $72.50 for $3.65

Now both these options expire on Nov 18^th, so the buyer of the call option can force me to sell my 100 shares for $72.50 and the buyer of the put option can force me to buy 100 more shares at $72.50 depending upon the share price on Nov 18^th.

Scenario (1): What happens if the shares of Royal Caribbean are trading below $72.50 on Nov 18^th?

The call option expires worthless and I will buy 100 shares that will cost me $72.50 – $3.40 (the call premium) – $3.65 (the put premium) for a total share cost of $64.45. If you add the cost of the 100 shares that I bought for $72.22 to the 100 shares for $64.65 and divide be 2, my dollar cost average per share is $68.84

Scenario (2): What happens if the shares of Royal Caribbean are trading above $72.50 on Nov 18^th?

The put option expires worthless and I have to sell my 100 shares for $72.50 but the cost of my 100 shares that I bought for 72.22 have been reduce to $65.17 ( $72.22 – $3.40 call premium – $3.65 put premium), my net profit on the trade would $7.33 divide by $65.17 or 11.2 % in just  38 days. (Excluding trading commissions)

In order to use this strategy, you need to have a margin account with a discount broker and be approved for cash secured put option trading. The added bonus of this strategy is you can use it to buy most index funds and some EFTs, you don’t have to buy individual stocks. However, the option premiums on index funds & ETFs will be much lower because they are less volatile than individual stocks.

I like this strategy because it removes some of the emotion out of investing. In the past, I would take half a position in a stock but I found it hard to commit to buying the other half when the share price fell. Plus I would kick myself for not taking a full position when the share priced increased in value. I found averaging down or up was very difficult. In reality the decision of buying or selling is sold to the purchasers of the options for a fee. An additional benefit, option premiums are taxed as capital gains, as long as you are not making a living as a day trader.

Stay tune; I will post the results of this trade next month plus an additional trade based on which scenario unfolds.

Disclaimer: This post is for educational proposes and not an investment recommendation.

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Is another credit bubble forming in subprime car loans?

I went shopping for a new car last week and was offered a subprime loan rate that sounded too good to be true. Without even checking my credit history, I was offered the choice of nothing down & half of one percent financing for 5 years. If I wanted to pay cash for the $30,000 vehicle, the dealership would reduce the price by 2,500 dollars.

The credit manager took some time to explain how subprime loans work. Auto makers take their cash back amount and give it to the finance company to buy down the interest rate. So in my case, I could take the $2,500 cash back or it would go to the finance company to reduce my loan interest. My choice really didn’t affect the car dealer in any way.

It got me thinking about some of the articles that I read sounding the alarm bells on the rising delinquency rates in subprime auto loans. Much of the concern centers around loans extended to borrowers with credit scores below 600. Some articles warn that the auto-loan market is a powder keg like the subprime mortgage market was when the globe plunged into a financial crisis eight years ago.  Will the bursting of this bubble cause another U.S. recession?

John Oliver, host of the HBO show “Last Week Tonight,” takes on the opaque world of auto lending.

Oliver points out that while helping people buy a car sounds great, lenders are taking advantage of borrowers with some predatory strategies and absurdly high interest rates. Some are offering loans to those who have recently filed for bankruptcy. Poor borrowers charged high interest rates–the average rate is 19%– end up under a pile of debt. One clip showed that a woman would have to spend $17,000 paying back a loan for a car worth $3,000.

Auto loans, including the loans extended to prime and subprime borrowers, topped $1 trillion for the first time last year, according to Experian data, exceeding the outstanding balances on U.S. credit cards. But that is a far cry compared to the $8.4 trillion mortgage market. Plus, it’s easier to repossess a car than foreclose on a home. There is typically a healthy marketplace for used and repossessed cars. Trying to unload a $300,000 home is far more difficult especially in a neighborhood of foreclosed properties.

As an investor, be aware that massive defaults on auto loans could flood the used-car market, depressing prices for all car types should the bargains among used-vehicle options sway buyers away from new cars. Both Ford & GM are trading with low P/E’s (5.8 & 3.9) and have dividend yields in the 4.7% range. The yield is very attractive for investors looking for income as long as you understand that there could more downward pressure on the stock price.

In a quarterly filing with the Securities and Exchange Commission, Ford reported in the first half of this year it allowed $449 million for credit losses, a 34% increase from the first half of 2015. General Motors reported in a similar filing that it set aside $864 million for credit losses in that same period of 2016, up 14% from a year earlier.

If you are in the market for a new or used car, make sure that you can afford the payments. Don’t fall for, no money down ads, 100% approval rates and no sin number required. Remember a car starts to depreciate as soon as you drive it off the lot. Extending a car loan to 84 months (7 years) keeps your monthly payments low but the outstanding loan could be greater than the value of the actual car.

2nd Anniversary of Smart Money: Lucky number 2

In sports, no one cares who came in second. The number 2 rating of a stock is a buy. There are two sides in investing, you can be either bullish or bearish.  Number 2 in Chinese Culture is an auspicious number because Chinese people believe that good things come in pairs.

“The symbolic meaning of number Two is kindness, balance, tact, equalization, and duality. The number Two reflects a quiet power of judgment, and the need for planning. Two beckons us to choose. The spiritual meaning of number Two also deals with exchanges made with others, partnerships (both in harmony and rivalry), and communication.

What is the 2^nd best investment that you can make?  The number two  investment really depends upon your age, where you live, your risk tolerance, your income level, your time horizon and your family situation. The number two investment choice for someone in their 20’s could be paying down debt. For someone in their 30’s, it could be buying a house.  For a high income earner, it could be maximizing their contributions into their retirement account. For someone who lost their job, it could be starting a small business.

So what is number one?  My answer is YOURSELF because our education system gets a failing grade regarding financial literacy. All these choices requires some financial knowledge and some basic math skills in order to be successful. I was shocked at the results of a recent financial literacy test.

Would You Pass the Global Financial Literacy Test?

Question 1: Suppose you need to borrow 100 U.S. dollars. Which is the lower amount to pay back: 105 U.S. dollars or 100 U.S. dollars plus three percent

Question 2: Suppose over the next 10 years the prices of the things you buy double. If your income also doubles, will you be able to buy less than you can buy today, the same as you can buy today, or more than you can buy today

Question 3: Suppose you have some money. Is it safer to put your money into one business or investment, or to put your money into multiple businesses or investments?

Question 4: Suppose you put money in the bank for two years and the bank agrees to add 15 percent per year to your account. Will the bank add more money to your account the second year than it did the first year, or will it add the same amount of money both years?

Question 5: Suppose you had 100 U.S. dollars in a savings account and the bank adds 10 percent per year to the account. How much money would you have in the account after five years if you did not remove any money from the account? (a) $150 (b) more than $150 (c) less than $150

 

Highlights of the survey:

• The U.S. lags behind other major English-speaking economies in its percentage of financially literate citizens. Citizens of Canada and the United Kingdom beat the U.S.
• Only 35 percent of respondents around the world got the right answer to Question 3.
• Many homeowners can’t calculate the basic interest owed on their loan payments. About a third of adults in the U.S. have an outstanding housing loan; three in 10 don’t understand how their debt accumulates.

Answers to the literacy test

1. 100 U.S. dollars plus three percent
2. the same
3. put your money into multiple businesses or investments
4. more money in the second year
5. (b) more than $150

Some may argue that personal financial literacy isn’t the number one investment because you can always pay a professional. I would agree if you are lucky enough to select a good one. In twenty years of running a small business, I changed accountants three times. I changed stock brokers countless times until I became a do it yourself investor. I have dealings with three different banks to meet all my financial needs. Plus selecting the right professional still takes some financial knowledge, the ability to understand the advice and act on it.

In reality, the first and best investment that you should make is in educating yourself. Did you get take the financial literacy test and did you answer all five correctly?

You need more than money to have a pleasurable retirement

Having worked as a financial advisor, my main focus in retirement planning was building a sizable nest egg for clients’ to enjoy their golden years. I used to think that the senior who greeted me at Walmart, rang in my groceries or served me coffee needed the extra income in retirement. Did something gone wrong with their retirement plan or did they just fail to save enough to enjoy a life of leisure?

However, I am starting to think that these seniors may also be bored. Imagine, you have been traveling at 100 miles an hour at work and now have come to a dead stop in retirement. No one really prepares you for the shock of getting up in the morning with no place to go. What do you do with all that extra time?

Step One: Avoid the retirement shock, start to plan ahead

There is more to life than your work. Most of your work friends will slowly disappear once you retire. Having a social network outside of your work place is a key to a pleasurable retirement. A common mistake is not developing a balanced lifestyle before you retire. (All work and no play!)

One of my business associate retired at 63 and decided to start to play golf. He join a golf club and found that he didn’t really enjoy playing golf. He hated winning the most honest golfer award. (A prize for the worse score)

Here are a few networking opportunities to make some new friends prior to retirement:

• Over 55 sports leagues, baseball, basketball, hockey …..
• Racket, curling and golf clubs
• Bowling & dart leagues
• Church groups
• Alumni groups – high school, college and sport teams
• Being a scout leader for boys or girls
• Coaching or being a mentor

If you don’t have any hobbies yet, I suggest that you plan to get some before you retire. Sitting on a beach under an umbrella drinking margaritas sounds great but you will get bored after a while. You may not have the time right now but many schools offer adult learning classes. A friend of mine took a class on how to fix small engines. It is never too late to learn something new and it might just keep your brain from turning to mush.

Step Two: Retirement is a life changing event, prepare to change

Married couples have to adjust to being together 24 /7 which can add stress to your relationship. It’s a good idea for couples to have different hobbies and interests. Spending some time apart makes for more interesting dinner conversations. For example, I like to golf and my wife enjoys genealogy.

Household chores can be a thorny issue. Sharing or dividing these tasks will depend on your individual skill levels. My wife does most of the cooking but I will do most of grocery shopping and together we maintain the lawn & gardens. I recommend scheduling your household chores to be done during a weekday, save your nights and weekends for socializing.

Avoid becoming a couch potato, it is a sure way to shorten your retirement years. A regular exercise program should be part of your everyday routine. You don’t have to go to the gym and lift weights to stay fit. There are many simple ways to keep active; walking, cycling and swimming, just to name a few. If you have a partner, find something that you both enjoy doing, having someone to workout with can help you get off the couch.

Step Three: Take on new challenges

Learn to play a musical instrument, speak a second language or better yet give back to the community. There are many fine organizations that are in desperate need for volunteers. You have a wealth of experience, professional expertise and invaluable personal wisdom that shouldn’t go to waste. You have a lot to offer, find things that you are passionate about.

In my case, playing football was a strong positive influence in my life. In honor of all my football coaches, I spent six wonderful years coaching kid’s football.

When people ask me what I do all day, I tell them; “I am so busy in retirement that I was surprised I found the time to work”! Remember, variety is the spice of life.

Is Globalization or is Technology destroying more jobs?

Could last Friday’s weak U.S. job numbers help make this man president of the United States?

Many Americans believe that China and Mexico are responsible for their job losses. There is no doubt that some industries like apparel & electronics require cheap labor costs and companies have moved production overseas. I also believe that the majority of illegal immigrants (Mexicans) are working at low paying jobs that Americans don’t want. (Even Canadian farmers hire temporary workers from Mexico during planting & harvest season).

Economists around the world believe that globalization has more benefits than detriments. Long term, higher wages in poor countries should theoretically increase spending and help spur global economic growth. Wages in China are going up causing a slowdown in their manufacturing boom. In fact, some illegal immigrants are moving back to Mexico because of higher wages.

Advances in technology has created a large number of new jobs but many of those jobs are unfilled. The major problem is employers find it difficult to find workers with the appropriate skill levels. The education system is really behind the curve in preparing young people to enter the job market. No real surprise that the participation rate is falling as the unemployed are giving up looking for work.

The automotive industry has been well-known for its intensive use of robotic arms for assembly, welding and painting of cars. Many other industries have adopted robotic arms into their manufacturing process. Advances in automation has eliminated an estimated 30% of all manufacturing jobs. Developments in 3D printing could allow consumers to make a variety of products beyond just toys, jewelry and novelty items.

Technology has destroyed a number jobs in many sectors. It is obvious that on-line shopping has really hurt brick & mortar retailers. Retailers have cut full-time staff and reduce costs by hiring more part-time seasonal personal. A large number of book, music and video stores have simply disappeared. Netflix and other low-cost streaming services has really hurt jobs in media, cable and the music industry. Facebook and Google have captured the majority of advertising  dollars which has reduced revenue and job opportunities in radio, television and print media.

Have you ever wondered why there are so many fake reality shows on cable? Production costs are so much cheaper than producing quality programing. Networks have less ad revenue to paid wages for real actors, writers and directors.  

Thanks to ATMs, internet banking, direct deposit and mobile banking apps, bank branches don’t have as many tellers or people waiting in line. The rise of Robo-Advisors will further reduce bank staff over time. I wouldn’t be shocked to find a decline in the number of bank branches in the near future.

Smartphones have reduced the need for buying cameras, voice recorders, camera film, photo albums, alarm clocks, GPS’s, video cameras, calculators, flashlights, landline phones, watches, calendars, note pads, newspapers, books and even credit cards. I wonder how many jobs have been lost because of the popularity of smartphones.

The oil and gas industry used to drill five wells in order to get one producing well. Today’s drilling technology enables 100% success rate in finding oil and gas. Plus fracking technology has allowed oil companies to maximize oil and gas extraction.

Will future improvements in artificial intelligence enable robots to replace human workers?

  

What do you think, Globalization or Technology to blame for job losses.

 

Hedge fund managers making an obscene about of money

Ken Griffin at Citadel and James Simons at Renaissance Technologies

Two actors portraying hedge fund managers in the movie “The Big Short” were nominated for a golden globe. Best performance by an actor in a motion picture – Comedy or Musical. Spoiler alert: nothing funny or musical about this movie.

Call me old fashion but I failed to see the humor in millions of Americans losing their homes and millions more losing their jobs because of Wall Street fraud. I found it despicable that some hedge fund managers made billions on this tragedy.

Fast forward to present day and nearly 3 trillion dollars are invested in the hedge fund industry. Computerized trading strategies has helped reap the biggest profits for some the industry’s largest players. Fully six of the top eight money makers for 2015 use quantitative analysis approaches to generate profits.

Quantitative trading consists of strategies which rely on mathematical computations and number crunching to identify trading opportunities. Price, trading volume, price to earnings ratio and discounted cash flow are just some of the more common data inputs used in quantitative analysis. The transactions are usually large in size and may involve the purchase or sale of hundreds of thousands of shares and other securities.

Tops among the hedge fund managers were Ken Griffin at Citadel and James Simons at Renaissance Technologies, both of whom reeled in $1.7 billion according to the year’s Institutional Investor‘s Alpha Rich List of the top hedge fund managers.

Nearly half of hedge funds lost money, according to Institutional Investor, and some familiar names on the Rich Lists of years past were missing, including John Paulson of Paulson and Co., Leon Cooperman of Omega Advisors, and Daniel Loeb at Third Point.

These industry leaders, however, did make the list, and qualified for the top 10:

Hedge funds hot hands

Manager	Firm	Income
1. Ken Griffin	Citadel	$1.7 billion
1. James Simons	Renaissance	$1.7 billion
3. Ray Dalio	Bridgewater	$1.4 billion
3. David Tepper	Appaloosa	$1.4 billion
5. Israel Englander	Millennium Mgmt	$1.15 billion
6. David Shaw	D.E. Shaw	$750 million
7. John Overdeck	Two Sigma	$500 million
7. David Siegel	Two Sigma	$500 million
9. O. Andreas Halvorsen	Viking Global	$370 million
10. Joseph Edelman	Perceptive Advisors	$300 million

Source: Institutional Investor’s Alpha

Now add the fact that the world’s wealthiest investors are benefiting from a broken U.S. tax code. Hedge fund managers’ profits are treated as long-term capital gains, which means they’re taxed at no more than 15 per cent. Any wonder why the 1% are getting richer and the American middle class is disappearing.

Americans are so angry that this man could be the next President.

 

Beware of identity theft & tax-return fraud

Tax season is the one time of year that a lot of sensitive personal data is on the move. Employers and financial institutions are sending you tax documents, you are then transmitting them to your accountant or using tax filing software. Take care to safeguard that data every step of the way. Tax season is already stressful enough, individuals increasingly have to contend with the possibility of fraud or identity theft involving their tax return. Tax return fraud is a huge problem for U.S. citizens.

“Tax-return fraud is a mounting problem. In 2013, according to a Government Accountability Office report released last year, the Internal Revenue Service thwarted $24.2 billion in fraudulent refunds requested — but paid out $5.8 billion.”

Scammers can easily whip individuals into a panic, aggressive efforts to steal data and cash by masquerading as IRS officials. Some scam artists try to convince you that you are a victim of a fraudulent return and need to verity your personal information. Others threaten audits, fines, arrests and all manner of other dire consequences to victims who don’t wire cash immediately or click-through a link to confirm their personal information.

Here’s a conspicuous flaw in the system as currently set up: To file a tax return electronically, all someone needs is a name, date of birth and an SSN. The IRS accepts tax filings as soon as Jan. 1, but employers aren’t required to submit correct employment information to the agency until March, by which time roughly half of all refunds have been paid out. (For that matter, the IRS doesn’t begin matching employer-submitted data to tax returns until the summer.)

You might see official-looking seals and language in an email that have been pulled from legit IRS communiques, or hear background noise in a voice mail meant to resemble a call center. Don’t click on any links in emails or call back any numbers left for you in a voice mail. Pushing calls and emails are the easiest tax fraud to avoid. Your best defense, keep calm and think it through.

“The IRS and the CRA have said repeatedly that its first point of contact with you is going to be by mail. Not an email and not a phone call.”

The agency has suspended processing of 4.8 million suspicious returns so far this year, worth $11.8 billion, the IRS said in an email to CNBC. Among that number are 1.4 million returns with confirmed identity theft, totally $8.7 billion.

Additional pre-cautions:

1. Not receiving an expected form could be a red flag of old-fashioned mail theft.
2. Make a check list of documents or forms with the approximate date that they should have arrived.
3. Use a secure file service to transmit documents electronically to your tax preparer
4. Avoid sending tax information by email
5. Personally drop off documents to your tax preparer.
6. Delays in receiving last year tax refund could signal that you could have been targeted by scam artists.

When in doubt, your best bet is to hang up. Contact the entity directly through a phone number that you know is legitimate or by email. Even if you’re not a victim, be aware that government authorities have put in place safeguards to thwart tax fraud which could delay your refund or snarl your return.

This post was inspired by my daughter who reminded me that sending tax information via email isn’t very safe.