[lewman]

I think some of us here are mis-interpreting anxvariety’s statements about options. It is not easy to make money in options but the covered call strategy he noted is an excellent way to “enhance potential returns without incurring additional risk on capital”. I’m bored at work so let me waste my employer’s time and give an example. Let’s borrow Powayseller’s long term position in COP as a basis for our discussion.

Let say your current strategy is buy-and-hold for the long term so you bought COP and stick the statement in a drawer and go on a 2 year vacation. This buy-and-hold strategy implies that you expect COP to EVENTUALLY rise even though as a rational person you do know that it will fluctuate. And this strategy limits your upside potential to the point-to-point return of the stock, i.e. if you bought at $100, then it goes to $150, then back down to $120 then up to $200, your return is limited to $100 per share or 100%. As a greedy person (aren’t we all ?) you ask, is there a way to make more than 100% in this scenario without taking on more risk ? I dare ask this question because YES THERE IS !

Now let’s refine this simple buy-and-hold strategy with covered call. In order to do this, it’s best that you have an objective measure to help determine when a stock is temporarily expensive (for those subscribing Zeal, the stock price relative to its 200dma is as good as any and we’ll refer to it as the rCOP). So you mull it over on the excel spreadsheet and let say it tells you that everytime rCOP approaches 1.20 times its 200dma then the law of probability says COP will soon reach an interim top and gravity will pull it back down, albeit temporarily.

Now after you bought COP at $100 a share (hopefully $100 is near its 200dma so at least you’re not buying it when it’s technically temporarily expensive), you sit and wait until rCOP hits 1.20 which indicates the stock is near its interim top. Let say the price is $140 at this point, you write a covered call option on it with a strike that’s let say 10% above current price (so strike=$154). At this point, the buyer of the option will pay you the option premium. You will then face one of the following scenarios:

1) The life-is-perfect scenario: COP continues to rise to reach an interim peak of $150 before calling it quits and go back down to $120 and next thing you know the option expires. Result: you have a very very big smile on your face because you feel good that COP keeps rising and you made money (on paper at least), PLUS you got the option premium as the icing on the cake.

2) The not so perfect but still pretty darn good scenario: COP starts rising quickly as soon as you wrote the option and broke the strike price on the upside. Result: the option holder exercises the option and pays you the strike price of $154 for the COP shares. You have a medium size smile on your face because in addition to making money on COP shares (realized profits) you also made money from the option premium. Then you immediately buy COP shares again to re-establish your long term position, unless of course you then determine to time it and wait until it comes back down near its 200dma before you re-establish the position (remember if a rCOP of 1.20 is considered expensive, then 10% above that should be considered even more expensive isn’t it?)

Now of course if COP shoots up like a rocket your re-purchase price could be higher then the strike at which you sold the shares but hey who said life is perfect ?

3) Now what if COP falls ? After you wrote the option COP starts falling to $90, then $80, then ….. Well, it proves that your entry point for COP might be a bit premature (or you’ve completely missed the direction of the market) but since COP never hits the strike so you retain the option premium but hey you still have your COP shares, which is exactly what your original intention was anyway; thus the option premium effectively reduced the cost basis of your COP shares. And if you lost your nerve and sell the shares, you would lose less money thanks to the cushion created by the premium.

In all these three scenarios, provided that your ORIGINAL strategy is long term buy-and-hold, ADDING a supplementary covered call strategy will enhance your potential returns without incurring additional risk.

But then of course you can buy/sell options the way anxvariety does and whether it is riskier or not compared to just buy/sell stocks really depends on how you look at it.

[lewman]

I wouldn’t base it on such a short observation period. These asset classes just happened to rise together in the past year. Take the late 90s as an example and you’ll see that equity markets foreign or domestic were generally having a good run while gold was going nowhere but south.

Having said that, Gold’s inverse relationship with USD is more probable as it’s considered by many as a “currency” and there’s a fundamental argument that they should be negatively correlated. And keep in mind that even this relationship breaks down from time to time. During most of 2005 when gold continued its up trend, the USD traded higher compared to most major foreign currencies.

[lewman]

according to my sources it was the n. koreans disguising themselves as chinese … don’t get fooled … though all orientals look the same !

[lewman]

Thanks Chris. I tried to access your sites but for some reasons couldn’t. Not surprisingly since I’m in China and a lot of sites get blocked for no apparent reasons. Have you done anything to piss them off lately ? 🙂

Re: the housing futures. What baffles me is for most cities, the prices shown were all higher and this applies to all months.

[lewman]

Re: China. I agree that a slowdown in the US will indeed adversely affect China’s economy. But it doesn’t mean that you could translate that into a short china play. The mainland Chinese stockmarket is basically still a closed market. The bear market started in 2001 and bottomed out in mid-2005 and since then has bounced 60%. This is pulling HK (there’re about 150 mainland chinese companies listed on the HK board) up along with it. There’s also money rushing into HK/China in anticipation of the RMB appreciation.

Re: Sector. Perhpas retail is one worth looking at. If consumer spending slows down, I would imagine retail would be one of the hardest hit sectors. RTH is the retail sector HOLDRS ETF.

[lewman]

The “invest overseas” and HELOC parts complicate things and took this discussion in a different direction than I intended. So let’s take them out of the equation.

What if it’s just purely a reverse mortgage, then let say money that comes out of it gets stashed in a low risk CD or t-bills etc. Do you think that’ll allow me to achieve my goal of “locking the profits in without selling the property or moving out” ?

Has anyone done a reverse mortgage or is in the process of doing one here ?

And powayseller thanks for the “welcome back”. Actually I was never totally away; it’s just that I’m 12 hours behind so makes it hard to follow some of the discussions. Enjoy your posts btw and am amazed by how you can recall figures and facts 🙂

[lewman]

I also took a look at builder’s stocks a few weeks back and have to say that at least in the short term they have been driven down (30%+) since early this year so even if you believe they’ll keep going down over the next few years today may not be the best time to short as even dead cats bounce back somewhat. And as Chris J said, the stocks’ valuations aren’t really that excessive at the moment so there’s a chance that they could just range trade over the next few years.

I’m also looking at mortgage companies that depend heavily on mortgages. Companies like bay area based Golden West Financials (GDW) which Wachovia’s buying. GDW derives a high proportion of earnings from mortgage business and over 30% of those mortgages are ARMs. Unlike builder stocks that have been beaten down GDW’s still quite near its 52 week high. Any comments ?

And as I mentioned before there’s always the housing futures that’s supposed to be launched in a weeks time. You can find info here at Chicago Mercantile Exchange http://www.cme.com/trading/prd/env/housingover16250.html

Btw, I read that the Grizzly fund is one of the few “true” short stock market funds available.

Powayseller: Could you tell me where you opened your futures account ?

[lewman]

Thanks rich for the info. I definitely didn’t mean to suggest you were trying to persuade people to sell and rent. It was actually my own situation and I ask myself the question by “thinking out loud”.

I guess the keys are wage growth (or the lack of it in the foreseeable future) and exotic mortgage resets (expected rate increases).

Just out of curiosity, property prices skyrocketed in the late 70s while rates also soared until 1982. What were the causes that drove prices that high ? Was it due to true economic growth (i.e. everybody actually got richer in reality) ?

And I wasn’t aware of capital gains law change. Powayseller thanks.

[lewman]

I have exposure in most major foreign currencies except CAD but am looking to add that to my portfolio either by buying the currency or investing in canadian stocks.

Beware that these currencies seem to have gone up a bit too far too fast since 05Q4 and along with gold (if you think of it as a currency as well), they’re starting to soften a bit.

I’ve never used Everbank but currency buying/selling is such a commodity I don’t think there’s a huge difference which bank you go with.

[lewman]

Powayseller, there’s a Symbol Catalog link where you can search for other symbols.

[lewman]

Export is bread and butter for China so an artifically depressed currency means keeping those factories humming and helping put food on the tables of hundred of millions of low skilled laborors. And it is the fear that a revalued RMB will cost massive job losses that stop the Chinese gov from letting RMB appreciate too much too fast. There are already reports some savvy manufacturers are scouting places like Vietnam where labor cost is even cheaper than China and gradually moving the assembly lines over there.

Now the US is a different story. The US economy is driven mostly by consumption (approx 2/3s). And since the US don’t really make much anymore, it has to import just about everything (how often do you see a Made in the USA label in Walmart?). If the USD continues to decline, it’ll soon take more dollar for you to buy that nice set of wheels made by Toyota, playstation for your kids by Sony, etc etc. For now, companies have been able to resist raising prices by enhancing productivity, but sooner or later, it will have to pass on the increase to you and you’ll have to cut back because there just isn’t enough money to buy everything. Alternatively you speak to your banker about an equity loan and next thing you know you’re swimming in debt. The US savings rate is already negative. How much more negative could it get before the system crumbles ?

Now, how does one get a canadian citizenship ?

[lewman]

Beware that even for USD based invetors returns of T-notes & bonds are not guaranteed unless you hold til maturity. 4plex posted a link to Ron Paul’s speech about the USD and gold, an excellent piece that’ll help you understand the “big” trend. As you can guess I’m sold. If you’re interested, there’s now a way for ordinary investors to short T-bonds without having to dabble in the scary world of futures. Check out the mutual fund RYJAX. It moves inversely to T-bonds.

Re: CDs. I would be cautious about the yen as the Japanese central bank is notorious for suppressing the yen to aid exporters and besides as you said the interest rate differential is just too huge (you’d be betting the yen will rise at least 4~5% before you breakeven). They haven’t done that for over a year but I won’t be surprised if they do that again if the yen continues to strengthen. The other currencies like euro, aud, gbp are better deals from an interest rate differential perspective. If you have a difficult time deciding which currency to buy, check out the fund RYWBX, which tracks the inverse of the US Dollar index. The USD index already includes a basket of foreign currencies.

And even if Ben continues to raise rates I’m not so sure it will help the USD by much. Short term maybe but my money is on the continued weakening of the USD. Remember the other countries have either started to raise rates (aussie, europe) and japan’s expected to do so by end of 2007. And the higher the interest rates, the more money will be required to service the enormous debt and that means running the printing press even harder and increase in money supply will cause its value to drop.

[lewman]

Chris & Jim, I would like to read your blogs but unfortunately and for some reasons I couldn’t access them. I’m in China and the government is known to block access to some foreign sites, maybe blogspot.com blogs are in this category. Oh well …

I bought into the commodities theme after I read jim roger’s book Hot Commodities. I started by buying gold because that was the only commodity that’s easily accessible by me. I’m allocating a portion of my money into oil. I think commodities’ a long term story but at the same time I also agree that it’s not the best time to get into metals now … I wouldn’t be surprised if gold has to drop below $600 before resuming its uptrend.

[lewman]

Chris J, would you also share with us where you think money can be made next ?

[lewman]

Re: inflation. The actual inflation is indeed higher than the headline CPI figure reported by the government. The Bureau of Labor Statistics has been doctoring this number to artifically suppress inflation numbers since Clinton by changing the the CPI’s calculation methodlogy.

Re: Gold price increase. In addition to the Yen carry trade, I suspsect the accelerating increase in gold price this year also has to do with the carry trade of gold itself. For years, traders could borrow gold from central bank for next to nothing, sell them in the market then reinvest the money for a quick buck. As gold prices rebound, there ought to be a lot of short covering.

Re: USD decline and why now. Not now; it’s been happending for years. Take a look at the chart of the USD and you’ll see that it’s been losing value for decades. It’s just that most of us don’t remember things more than a few years ago that you think it’s just happening now. It’s simply a resumption of a long term trend, nothing special about it.

Re: money supply. Turn off the spigot while we’re all enjoying a nice long hot shower ? Who’s got the guts to do that ? Greenspan’s the one that gave us more. How about Ben ?

Chris J: could you post link to your blog ?

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