Technical Analysis Blunders - AAPL, JOYG

I received many emails and comments that my last 2 Trades - AAPL and JOYG violated good technical analysis rules.

First of all thanks for all the feedback. I really appreciate it. This is the only way I would learn.

So, why did I do it. the honest answer is that I do not know technical analysis. Recently, Moom posted recommendations on technical analysis books on my request.



I have started reading this Edward and Magee book. Its very good book but long. So, hopefully my technical analysis skills should improve with time but it may take some time.

Now, to the point of these 2 trades. I do want to own Joy Global (JOYG) and Apple Computer (AAPL). Using put options was simply a way to get these stocks a bit cheaper.

Investing In Apple Computer (AAPL)

I decided to take a fairly large position in Apple Computer (AAPL). Sold five (5) cash covered puts with expiration of Nov 2006.

The reasons to invest in Apple Computer.

• Great product line and growing - ipod, iTunes, iMacs and list goes on
  
• Strong brand
• Good demand in market place for its products - sales growth in excess of 30%
  
• High caliber management team - read Steve Jobs
  
• Stock price on an upswing
  
• Good financials - profit margins, debt ratio etc
  

Apple's PE ratio of 36 is on high side but not so bad for a company with this kind of growth. Dell computer (DELL) has PE of around 20 with much lower growth rate and not as strong a product line.

I am violating one of my risk management rules of selling naked put options. But what the heck some time you have to take chances in life and this one seems like a safer bet. Time will tell :)

10 Tips To Minimize Risk In Selling Put Options

As promised here are my 10 rules-to-live-by for minimizing risk in selling put options:

1. Write put options only for the stocks you want to buy
   
2. Don't sell puts on margin
   
3. Don't sell naked puts. Make sure you have enough cash to buy stocks if put is assigned to you - cash secured puts
   
4. Set option strike price below the current stock trading price. You make less money but carry less risk too
5. Don't write all put options at the same time. Do it over time in small quantity to acquire number of stocks you wanted to purchase anyway
6. Diversify across industries
7. Diversify across strike dates
8. Diversify across strike price
9. Consider other safer option trading strategies in lieu of selling naked puts
   
10. Write put options only for the stocks you want to buy - Did I mention it before!!!

What strategies have worked for you?

Risks In Writing Naked Puts Options

I previously discussed writing naked put options as a way of buying stocks (that you want to own) for less money. Many of the readers emailed me on the issue of risk in writing naked puts. I am no authority but here is my point of view. (Please note that I tend to interchange selling and writing options. They have same meaning.)

Empty Spaces presents a good example of naked calls and puts. However, I disagree with him on one point. He mentioned that "There is unlimited risk in selling naked calls (or puts)."

There is definitely an unlimited risk in selling naked call. Theoretically, stock price could go to infinity (Or very high at least) and with naked calls your losses could be limitless.

For selling Naked puts on the other hand your losses are limited to the share price (to be precise, strike price minus premium received). After all, stock price can only fall to zero. In other words same risk as in owning stocks to start with. So, in my opinion, risks are less than selling naked calls but definitely a high risk strategy.

In another post, I will go in more details of some of the risk management strategies on writing/selling naked puts.

Money Is In The Bank

Finally, its all there. Deposited remaining $91,000 to the brokerage account. That makes it $100,000 as planned.

Excited !!!

Some Strategies For Down Market

We all love market moving up. And why not. After all most of our investments in various companies are in stocks and we make money money only when they move up. Agree that there may not be one-to-one correlation between market going up and your stocks moving up. But, that is the case more often than not.

I have been thinking about what to do when market moves down. Which it invariably does. Here is some food for thought. Please feel free to add to this list.

Maintain a Stop Loss Order - This is a no brainer. If you were to maintain a stop loss order then in the event of market going down your losses are limited. At my brokerage account I have 2 choices. One to set the stop loss order by percent and second by fix dollar amount. Either should work fine based on your preference.

This strategy does have one major down side. A day to day fluctuation in stock price could make you sell the stock. None the less this strategy could save you from major market downward moves

Short Sell - A very popular strategy with investment pros. Here you essentially sell the shares you don't own (basically borrow from broker) and buy them later. Hopefully, you buy at a price lower than the price you sold it for in the first place.

On one hand this could yield some handsome profit. It could be very risky. I can imagine losses that can mount if the stock price goes up. I would take this as an option to use sparingly.

Buy Puts - You could buy puts for individual stocks or for index like QQQQ. Here maximum risk you have is the amount of money you invested in buying puts. This could, however, create some very good profits if market or stock goes down.

Sell Covered Calls - Suppose you own certain stocks and don't want to sell them just because market is on a down trend. Classic long term investors. Selling Covered Calls provides you extra income while your stocks are going down. How much money you make depends upon how aggressive you are in writing these covered calls.

There are few more strategies involving options such as spreads that provide protection from down markets. The idea is that you can make money from down markets and not just from up market moves.

Why Am I Not Investing In Bonds

Lets review the returns from bonds. Following is a chart of treasury offerings from Yahoo Finance





As you can see from chart, the returns (yield) are below 5%. The returns are somewhere in 5-6% for good (A or better rated) corporate bonds. This is too little a return for money and the risk that I would be taking (locking up cash, interest rates moving up/down etc).

Yes, there are many pros of keeping bonds in the portfolio. However, for me at this rate of return it does not make sense. So what are the alternatives:

• keep it in money market - returns are lower by 1% or so but have freedom to use money as I wish
• High quality stocks with growing dividends like GE. I could make 2.8% in dividends and with dividend growth rate it only gets better. The added plus of security moving up in value. I can earn extra income writing covered calls. Something not possible with bonds (at least I have not learned it yet)

I would reconsider moving into Bonds if the yields were 8% or better for 10 year corporate offerings. At least a part of portfolio to reduce volatility.

Would love to hear your thoughts?

First Trade - JOYG

While waiting for rest of money to transfer I came across an investment in my selected list of industries that looked promising. The company is Joy Global (JOYG). Joy Global is an equipment manufacturer for mining industry and seems to be out of favor.

With limited cash, I was able to write 2 cash secured puts for Nov 2006. Reason for writing puts over out right buying stocks is that I wanted to get the stocks a bit cheaper.

Would appreciate any comment or info on this company.

Internet Blues - Asia

Long hiatus. Could not post in last few days in spite of more efforts than ever. Did not realize that a decent Internet connection, that we take for granted, is a luxury in many parts of the world. Yes, this is the experience from my trip to Asia.

But this also spells an opportunity. Many of these countries are trying very hard to play in international market. I believe that they would have to upgrade their communication infrastructure significantly. Is this time to invest into Telecom equipment makers? Add another industry to the list.

Also, I have not been able to work on getting the money in account. Plan is to get back at it as soon as I reach home later this week.

Investing In Companies - Stocks or Options?

Yesterday, I wrote about the exercise of picking companies. The remaining question is what is the best way of investing in these companies. My assumptions are

• These are the companies I would like to own a piece of, and
  

• My projections of how these companies will perform in short and long term. The tough part.
  

So are my choices limited to owning shares in the companies? Certainly not. I have choices among owning bonds, stocks and options.

I eliminated bonds in this discussion for the time being. Topic for another day. Lets explore other choices.

Buying stocks outright - This makes sense when I am fairly certain that this company has upside potential both in short and long term. This is also the company that pays good dividend to provide me with holding power when stock is not moving up or staying at its place. Good for emotional support anyway.

I find that these are the companies that can form the core of my portfolio. They would help me reduce volatility and could be long term holdings. It could also help with lower taxes but not an issue in my case as I am investing in a retirement account.

Last, it does require fair amount of cash outlay upfront. This could be OK if the stock does not go down in short term else it is tough on emotions of holding power.

Buy short term call options - if I am very sure that stock is on a upswing on a short term and I do not have enough cash then buying call options could be very good strategy. the returns could be huge due to option leveraging.

This, however, could very risky. Sort of loosing 100% if your assessment upward move is wrong. This makes me very uncomfortable unless I am very very sure.

Buy long term call options (LEAPS) - I could also buy longer term call options. Typically known as leaps. This could be a low cost strategy. At least lower cost than owning stocks outright. Once again risk of loosing all your money is there. But then I am assuming that I have done my homework in picking stocks. I could go for this strategy for some of stocks.

Sell put options - In this strategy I could choose a price at which I am willing to buy stocks. If price drops (below strike price) I would end up owning the stock at the price I set. If price moves higher I would not be able to buy stock but would make some money waiting to buy.

I like this strategy when I am not too sure about stocks upside move potential. The negative side - you loose the upside if stock really moves up. Well, as some smart person said - there are no free lunches in life.

So the nest steps is to select a strategy for each of the stocks in my portfolio. Should be fun.

Narrowing The List Of Companies To Invest

Given that I have selected industries and the account is open (only waiting for money to be there), the next steps were to pick the stocks. So I spend last 2 days narrowing the list of companies that fit my investment criteria.

The good part was that it was not too difficult to find companies that meet criteria. That was also the bad part, too many companies. It became an iterative exercise to tighten up each criteria just a little to further narrow the list. Deciding which parameter to value more over the other was a daunting task. I created a systematic plan for this exercise - heavily influenced by Analytic Hierarchy Process (AHP). This technique was very helpful to take out the emotional aspect of decision making. I will post it here once it becomes little more coherent and stands the test of time.

Final list at last. I now have top 2 to 3 companies in each of my selected industries.

This was a huge learning experience. Not to mention fun. A realization that this exercise has to be done regularly. Hopefully, it would be less time consuming next time around.

The immediate next question - what is the best way to invest in each (or some) of these companies? No concrete thoughts so far. But soon I will have something concrete to report.

New Retirement Account Opened

Yes. The game begins. I have a brand new shiny retirement account at Fidelity. This is to track the progress according to the goals. This retirement account allows me to trade stocks, bonds, mutual funds, etf and of course options. No commodities.

The bad part is that right now I could only put $9,000 in it. Realized that rest of the money is tied in up in investments. The plan is to put $100,000 by end of this month. I guess will have to revise the first year goal.

Excited!!!

Zero Cost Trading!!!

There is a new kid on the block - zecco.com with free stock trading. To be fair they are charging money for options and other premium service. Cool site and concept. Look forward to more information on how good they are to use. But for the time being I am sticking with my old broker. Given that I would trade lot more options they would not be cost competitive.

Featured in Carnival

This is exciting. My first post in Personal Finance carnival #69 :) Thanks Flexo for arranging it.

Another Covered Call Strategy

What a conincidence. Since I wrote about covered call strategy with Google as an example, the stock has moved up close to $430 in my fictitious example. Hopefully, this illustrates the risk of covered call strategy - you loose out on upside. But it is still a very safe strategy.

A variation - again taking Google (goog) as an example. This is right now trading around $429. In this strategy one buys 100 shares of goog and sells one (1) call. Remeber one call = 100 shares. Suppose you sell one 450 call for Oct 21st (2 weeks out) you could get approximately $6.6 for it.

So if Google goes about $450 by Oct 21st, you will have to sell it for $450. if not, you have the shares and can sell another call after Oct 21st. In either case you keep $660 ($6.6/call * 1 call * 100 shares). That's approximately 1.53% profit on call or 40% annualized (if you can repeat the story).

Need less to say that this is also one of my favorite strategy.

Rent Your Stocks For Extra Profit

OK. This is a catchy title but the real idea is not too far from it. Consider the scenario - you have certain stocks in portfolio that you are waiting to increase in value. Why not make some money from these stocks while waiting?

The strategy is known as "Covered Call" writing. The idea is simple. You sell a call for the stocks you own. If the price of the stock stays below the strike price of your call by the expiration date you keep the money. Else you end up selling your stocks at the price of the call.

Lets take an example of Google (symbol: GOOG). Suppose you have 100 shares of Google. Last Friday's closing price is $420.5. Now check various options available for GOOG. Suppose you are OK to sell your 100 shares for $430 by Oct 21st. You could sell one (1) call for approximately $10.25 (average of bid and ask for illustration purposes) per share.

Two things can happen

1. Google goes above $430 by Oct 21st - you have to sell your shares at $430.
2. Google stays below $430 by Oct 21st - you keep your shares.

You keep $10.25/share or $1,025 (1 call = 100 shares) in either case. That's roughly 2.4% for 2 weeks. Not bad.

Make sure you OWN the stocks before you sell covered calls. Else you will be taking on some serious risk. Consider reading more details at Chicago Board web site.

This is one of my favorite strategy. Enjoy!!!

Low P/E Ratio - Secret of Investing?

A P/E (Price divided by yearly earnings) ratio represents how cheap or expensive the stock is. Or how much premium market is willing to put on this stock. Value investors live and die by low P/E investing philosophy. This site gives a good over view of value investing.

So, the question - Is buying lowest P/E ratio stocks, the secret of investing?

There are many success stories written around the blogsphere on low P/E investing. Here and here is a good example.

What do I think?

Low P/E is important but not that important. A company may be cheap for a reason - poor performance, poor products, poor growth and so on. However, if you find a company which is not broken then low P/E ratio is a good candidate for investing.

To decide whether a company has low or high P/E ratio - compare it to the companies in the same industry/sector and to the market (NASDAQ, S&P 500 etc). Companies in bottom 20% P/E ratio can be considered cheap.

However, keep in mind you get what you pay for. A low P/E ratio company may not always be a good investment. I prefer low to moderate P/E ratio stock. I would consider investing in high P/E ratio if everything else for a company looks good.

Your thoughts?

Why Not Invest in Futures Market?

A friend asked me over brunch today - why am I not considering investing/trading in Futures market. Trading things like currencies and commodities like oil.

Good question. Why not?

Simple reason. I am clueless about trading futures. No idea at all. However, I do agree (with him) futures trading could be as risky or rewarding as stock options. But, risk factors goes up exponentially if you don't understand them.

Also need to start somewhere. So stocks, bonds and options is it for now. If I learn more about futures and it makes sense then why not. But not now.

Options 101

Time to freshen up my option trading skills. I remember being very very confused by what is a "call" and what is a "put." Then the whole "buy" and "sell" part. This little diagram was very helpful. Thought I should share it with you.

Here on vertical axis you have 2 types of options Calls and Puts. On horizontal axis you have buy and sell. This leads to 4 choices A,B,C and D. Lets explore them in more detail in context of stocks. Area of my interest. Pay special attention to words in red color.

• A = Buy Call - Gives you the right to buy the shares (of the company for which you bought this option) at the fixed price (that you choose when you buy this option) until a fixed date (that you choose as well). There are variations like "American" and "European" options. They actually have nothing to do with America or Europe. For all practical purposes you can exercise your options up to the date you selected.

• C = Buy Put - Gives you the right to sell the shares at the fixed price until a fixed date. very similar to case A above. One key difference - make sure you get that right.

• B = Sell Call - You now have obligation to sell shares at the fixed price until a fixed date. Watch for the word obligation. This one you are forced to sell your shares (You better have them). That means if price goes up you loose out.

• D = Sell Put - You are obliged to buy the shares at the fixed price until a fixed date. You better have cash to fork out. Remember if price drops you are still buying them at the price you agreed to.

These strategies are simple but have all sorts of risk associated with them. I lost money on many of my trades in the beginning. Hopefully, this gives you some idea. Please read up before trading these. Web has lots of information. Chicago Board is a good starting point.

My Top 5 Industries To Invest

I decided to pick 5 industries to diversify. Here they are

1. Internet and High Tech - I believe this is what the future is. Also probably the companies I am most familiar with. The companies here seem to be a bit out of favor at this time but that's OK.
2. Metals and mining - Although there is a lot of talk about economy slowing down, this group still makes sense. Most companies are global and rest of the world is not slowing down.
3. Travel related - Every flight that I took in last one year has been crazy. Not a single empty seat. This group better make money.
4. Software companies - If companies have made a lot of money then they must upgrade their software. I mean Enterprise level stuff.
5. Retail - Neither I have reduced my shopping nor anyone I know of. We are the credit card driven country after all :)
6. OK the title says 5 but when I wrote 5th one realized the credit card point. So the 6th one is Financials. The companies that issue credit cards.

Now the next goal is to pick some good stocks in these industries.

Scattered Retirement Accounts

What a mess!

Since I finalized the broker thought I should open the account according to goals. This is when I realized I have multiple retirement accounts with multiple brokers. Ignored accounts. Paying fees for nothing. Cash sitting in money market accounts.

Moreover, there are old 401(k) accounts that I have not even looked at. These are the companies I worked many years ago. One of them is even acquired by another company.

I must be an idiot.

Well, there is a silver lining in all this after all. I have more money than I thought. I know this is a twisted logic.

Finally, I will be cleaning it up and for good. Flip side, it would take another few weeks before I could open the new account (and put money) for this blog. New time line by end of October.

Lesson learned.

Selected a Broker

And the winner is - Fidelity

The difference between various brokers I was considering was minimal. They all seem to have most of what I was looking for

The key differentiators were

• Familiarity. I have some other accounts with them as well
• Good research. I think they had an edge here
• Physical location. Important!!!

Also, I never had a trouble with them in last many years so why change.

Trader or Investor?

Which one am I?

Spend whole day thinking about it. Definitely a day trader but I seem to fall in both camps.

Is this a bad thing? Should one be either investor (long term) or trader (short term)?

I think this duality may be my defining strategy. Keep an investor perspective for good companies and a trader perspective for OK or even not so good companies.

Any perspectives?

And DOW Goes Even Higher

DOW 11850.61 - It seems like my not being worried worked out OK today. But, more interesting question would be what would I do differently if Dow started going down. Would I sell the stocks. Not really. However, if it was options I might have.

Dow All Time High - Should I be Concerned?

Yesterday Dow reached all time high of 11,758.95. Definitely a good news. But it also makes me worry if we are reaching another high where if I buy I may end up loosing again.

Exploring further, Reuter reports that 18 of 30 Dow components are lower today than on Jan 14, 2000. When Dow made the last high. If names like General Electric, Intel and Home Depot are lower today, I guess I should not worry much.

Waiting to see when NASDAQ and S&P will reach their highs as well. I may get worried then!

My Stock Picking Philosophy

To be honest. I don't have one. Ooops! Never gave it much attention but can't avoid it now. Can I?

So, how would I pick my stocks for this journey. For now, this is what my plans are

• Company with good products that I know of. For example Apple. I love their products like iPod, iMac and iTunes
  
• Should not be very expensive. Low to moderate P/E ratio
• Good growth rate
• Good financials. Low debt and enough cash so that they don't go belly up
• Favorable Macro climate. Don't want to buy a housing company when real estate market may be iffy
• No tips. All stocks must be studied. I have seen people go crazy when Cramer mentions a stock on CNBC TV show Mad Money
• Last but not least, no crazy legal stuff like options scandal or accounting fraud. I don't understand it - Not a lawyer or accountant for that matter
  

Lets see how does it go. I am sure this list will evolve as I learn more about this thing called stock market.

Investing Goals -- 20% For Year 1

The common wisdom says that my investing returns from stocks, bonds etc would be no better than that of S&P 500. In long term most frequently used return is 8 to 10%.

I am going on a limb here. Firm believer in stretch goals. Lets set a target return to 20% for year 1. This means I have to make $20,000 from investment. Grow the total to $120,000.

Of course, I will report progress and the trades regularly.

Damn...need to hurry up with broker selection and money transfer.

What Am I Looking For In A Broker?

So far I am some what familiar with trading stocks, bonds and stock options. Don't know how to trade currencies, commodities or other exotic stuff. So my criteria for broker selection is

• Ease of use - Given that I am not a pro it should be designed for novices like me
• Good research - Hey! need to find things to invest into
• Low trading fees - It seems like everyone has low fees so this may not be deciding factor
• Good customer service - I would even prefer if they have physical locations. Nothing beats walking into a brokers office and giving them a piece of your mind :)
• Online trading capability - Goes without saying
• Good execution capabilities - In the past I had trouble with one of the broker. They bought instead of sold my stocks. This one was scary!
• No hidden fees stuff - I would like to know upfront what am I getting into
• Stocks, bonds and stock options trading - this is what I want to trade

I realize that making an ultimate selection criteria list would be impossible. So will go for something reasonable now and if need be switch later.

Any recommendations?

More Decisions - Which Broker?

The easiest answer is to stay with my current broker - Fidelity. But, then there are so many other choices - etrade, Ameritrade, Scottrade...

A friend suggested optionsxpress. Could be interesting given that I do like trading options.

Time to do more research.

Retirement or Regular Account?

I am leaning towards retirement account. Few good reasons

• No tax hassles. Keeps life simple
• I don't need this money for a while. Guess it pays to start early.

Ah! One major negative depending upon perspective - can't trade on margin. May be its not such a bad thing after all.

Retirement account it is then!!!

An Ambititious Journey!!!

Got tired of all the investment gurus saying that a regular person like me can not be a good investor. They can not consistently produce good results.

Really!!!

So I decided to put my money where my mouth is. The goals for this blog are very simple.

1. Put $100,000 in a separate account
2. Invest in publicly traded things (stocks, bonds, options and so on)
3. Grow this to a cool million. And do it faster than Investment Gurus

This is not meant to be an investment advise. Don't buy, sell, trade anything because I did it. You will be doing it at your own risk.

I don't know how, what etc. But will figure it out as time goes on. Please join me in this journey. Let the fun begin :)