Sunday, October 8, 2017

OCTOBER 2017 DESERT OF THE REAL NEWSLETTER


OPTIONS IN OPERATION

This newsletter for October 2017 will take a look at common Call and Put Strategies that a stock investor may employ in his or her portfolio.

ANOTHER MATRIX

Investors buy or sell options because of their beliefs about the future direction of stock prices.  (There are other strategies that seek to earn money from the non-movement of the underlying stock, but that is a topic for another month. The matrix below correlates future belief about stock prices with some common option strategies.

BASIC OPTION STRATEGIES

If an Investor owns ICBM stock and:

1. Investor thinks Stock may rise somewhat or
maintain its current price: Sell Call.
This Strategy is called selling a “Covered Call.” It is a covered call because the option investor owns the underlying stock. If the stock behaves as the investor believes, the investor will receive a premium for selling the Call and will pocket the money from selling the premium. 

2. Investor is concerned Stock will fall: Buy Put.

This Strategy is called buying a Protective Put. Owning the Put will give them the right to exercise the option and sell the stock at the Put Strike Price. Also, the value of the Put will rise so the Investor may close out the position and make money on the position.

COMMON STRATEGIES

Numbers 1 and 2 are commonly used. The analysis below will expand upon these strategies and the assumptions that underlie them.

Selling a Covered Call. This is an income generating strategy that a stockholder might use if they believe the stock price will remain steady or fall a small amount. The stockholder must also be ready to sell their shares if the stock rises or buy back the Call at a higher price. Jane owned 100 shares of ICBM. She felt that ICBM stock might fall or stay about the same. She did not think that the stock would rise, but if it did, she was willing to sell her ICBM stock if she was exercised. She had bought it at $40 and it was currently selling at $52. She sells a Covered Call at $55 and gets a $100 premium. Jane read that selling Covered Calls was a way to generate a little more money from a stock that she would be willing to sell anyway.

If Jane is right about ICBM falling in price or staying the same, she will keep her stock and the $100 Call premium. If she is wrong and ICBM goes up to $55 or beyond, she will have to buy back the Call at a higher price (lose her premium) or  have the Cal exercised and lose the stock. She will make $15 per share from the sale of the stock and keep the $1 premium. (55 Call Strike Price - $40 basis on stock = $15 gain on ICBM share).

The downside for Jane is that if ICBM shoots up to $70, she will miss out on the price increase beyond $55, the Strike Price of the ICBM call. In summary, the assumptions behind a Covered Call sale are:

1. The belief that the Stock will fall somewhat or stay the same. (If you think it will fall a lot, you should sell it!).
2. A willingness to sell the stock at the Strike Price of the Call or buy back the Call at a higher price than which you sold it.


Buying a Protective Put
. This is a common protective strategy to protect a stockholder from fall in the stock price. If Jane holds ICBM and is concerned that it may fall, she has two choices. She can sell the stock outright right now or buy a Put. Jane still likes ICBM’s prospects for the long term. To protect herself from a short-term price declines, she decides to buy a Protective Put. ICBM is currently trading at $52 and Jane buys a Put with a Strike Price of $50. If ICBM falls to $50 or below, Jane can exercise her Put and sell ICBM for $50. She can also sell the Put at a profit.


MORE SPECULATIVE STRATEGY IN A FALLING MARKET

A popular strategy in a falling market is to sell stocks and indexes short. Short selling is a little complex and carries some measure of risk. Another strategy is to buy a Put on the stock that you believe will fall in price.  You do not need to own the stock. It puts less capital at risk than short selling. And it also give the investor leverage. Let’s look at an example:

Jungle Jim does a lot of stock research. He believes that the stock of the American motorcycle behemoth, Hogsome-Darlington (HOG), will fall in price. It is currently trading at $49 per share. Jim thinks that the stock is only worth $40 per share. He also thinks that its next earnings report, to be issued in early January 2018, will be very disappointing and will send the stock falling. Instead of selling HOG stock short, he buys a February 2018 Put with a Strike Price of $55.00.

This Put costs him $3.00 per share, or $300 for the standardized 100 share options contract. Because the stock is trading at $50 and Jim’s Put has a Strike Price of $55, this Put is considered an “In the Money Put”. The Put is considered “In the Money” because the Strike Price is higher than the price of the HOG stock.

Options can be “In the Money”, “At the Money” or “Out of the Money.” For an explanation of these terms, take a look at the chart below:

STRIKE PRICE/HOG STOCK PRICE/PUT STATUS

$55    /   $50  /    Put In the Money by $5 – The Put at $55 give you the right to sell stock at $55 when the going price in the market is $50.
If Strike Price > Market, Put is in the Money (ITM)
$55 /  $50   / In the Money by $5

$50  / $50  / At the Money (ATM)
Strike Price=Market Price
$50 / $50  /  At the Money

$50  /  $55 /      Out of the Money by $5 ()TM)
If Market Price > Strike

Now let’s keep in mind that Jim does not own HOG stock. He is hoping that HOG will fall in price and the Put will rise in price beyond the $3 he paid for it. And Jim knows that as the Price of HOG falls, his Put will rise in price. Remember, a Put gives you the right to sell the stock at the Strike Price. So if Jim (or some HOG stockholder) has the right to sell HOG shares at $50 when the market price of HOG is at $40, he has a valuable right. And as HOG price falls, the value of the Put will rise.

Brokerage firms require that customers execute options agreements to trade options and that they understand the risks involved. In this last example, the risk of buying a Put when you do not own the underlying stock is that the price of the stock will rise instead of fall and that the put may expire worthless. The risk of buying a put is less than short-selling the underlying stock, however. In this case, Jim’s loss is capped at $300, the amount he spent on the Put. But if Jim sells HOG short and HOG rises, he will have to buy 100 shared of HOG to cover. If HOG makes a substantial move upward, Jim could lose thousands of dollars.

THERE ARE ALWAYS OPTIONS IN THE DESERT OF THE REAL!


[i] The Author has discussed the Secular Bear Market in several editions of the Newsletter and on the post of September 19th.
http://desertoftherealecononomicanalysis.blogspot.com/2005_09_18_
desertoftherealecononomicanalysis_archive.html
[ii] http//desertoftherealecononomicanalysis.blogspot.com/2005_10_09_
desertoftherealecononomicanalysis_archive.html
[iii]
http://www.cboe.com/. The website of the Chicago Board of Options Exchange has lots of information on all of these option topics, including Delta. The exchange will also send you a CD with Option information and tutorials.






Sunday, October 1, 2017

Of Idiots and Idealogues

IDIOCY IS TO BE EXPECTED FROM IDEOLOGUES.

North Korea, or the easier to write, DPRK, is the last communist country on earth. And it one of the last few absolute monarchies. The DPRK shares this unique distinction with only had handful of fundamentalist Arabic countries. So it combines the worst forms of government. We have Kim Il-Sung (the father), Kim Jong Il (the son) and now Kim Jong-Un (grandson). In the DPRK, Kim Il-Sung has nearly mythic status. Many in the country, some by force but many by choice, see him as the “Father” of North Korea. Then came the “Son” Kim Jong Il, and the heavier, shorter, but probably much more shrewd “Son” Kim Jong Un. In only a somewhat crude metaphorical, and irreligious for the religious, terms, we have two pieces of the Christian Trinity.

THE WHOLLY SPIRIT?

The official state doctrine of the DPRK is Juche. Juche literally means self-reliance, but it is composed of three linked doctrines:
  1. Political Independence.
  2. Economic Self-reliance.
  3. Self-reliance in Defense.

Many scholars have suggested that juche completes the DPRK “trinity.”  It functions as the “holy spirit” that animates the many North Koreans. Call juche what it is, but it has generally worked. The nation is independent of a larger block of mutual defense partners. It engage is some trade, but it hangs on even as the sanction screws are cranked down. But number three is the salient.

In the mind of the North Koreans, they did not lose the Korean War. And in fact, the war has not really ended. There is only an armistice agreement in place. And the war ended three years after it began, the 38th parallel. 

The highly militarized regime has a million-man army. It is a defensive fortress. It has the 38th parallel lined with artillery pieces. More than 11.000 are aimed at Seoul. In a shooting war Seoul would suffer hundreds of thousands of causalities. A conventional war up the peninsula to Pyongyang would be fought hill by hill. Fortified position by position. Corpse by corpse.

COOLER HEADS???

The DPRK has been in-artfully cranking out belligerent babble for quite some time.  It has been the policy of America (and all Western nations) not to lower itself to responding to the lunacy. No longer. Kim keeps his place on orange alert all of the time. Militarist propaganda is everywhere. The military is worshipped. And its members are well paid and well treated, relative to the masses. 

Over the years, tensions have ebbed and flowed between the DPRK and the west. Trump has matched Kim’s belligerent mistranslations with two am tweets. The US and most advanced nations would not trade taunts, but Trump is all thumbs. In a most minuscule and certainly unforeseen way, and ever the “business man,” Trump has leveraged “egging on” economies of scale. North Korea likely employs hundreds of bureaucrats to figure out new ways to call American leaders capitalists running dogs. Trump does it solo and without a stipend. But we all digress…

WHY ALL THIS BARKING BACK?
There is an Arab folk saying that says “When dogs bark, don’t bark back.” That thought could be rephrased as “don’t stoop to their level.” Or maybe, “that remark is beneath contempt.” Or maybe do anything but feed the DPRK mouth machine. 

Stunts and chest pounding keep Kim firmly ensconced in power. A bowl of rice a day, a bed on the floor of cold two room apartment and a bicycle to ride to and from the munitions factory. But the is very effective method to what looks like to many America is “madness.” Kim has two goals and they are linked. Stay in power and survive to dictate another day. He has achieved the first and the second seems highly likely. 

When the PDRK got nukes, it got tenure. The history of the last 20 years makes it clear that nukes are necessary for rouge regimes to remain in power. Since the fall of the USSR, Russia can no longer maintain the independence of its former client states. After the first Gulf War, Saddam abandoned both his hamstrung nuclear program and his chemical weapons. Mohammar Qaddafi in Libya similarly gave up his quest for weapons of mass destruction. Both men were later overthrown and pulled out of holes to be executed. 

IRAN AND THE KIM BOYS GOT THE MESSAGE…

One of the pillars of juche is an independent self-defense.  Nuclear weapons are the way to assure that self-defense will work and assure the states’ existence. An analogy can be drawn to seemingly inapposite places-Israel and Iran. 

Both Israel and Iran are non-Arabic countries in a predominantly Arab region.  Israel has the US as a strong ally, but does not want to draw directly upon it for its defense. And the last thing the US would wish to do is intervene militarily for Israel. 

Iran has no strong ally that it can call upon. It occupies a very strategic position but is militarily surpassed by US forces. It could obstruct the Straights of Hormuz for a short time, but the narrow passage would soon be reopened and Iran would pay a severe price. 
Israel has a core principle that it won’t rely upon other countries for its defense. To that end, it has nuclear weapons, probably around 100 of them. Iran does not currently have nuclear weapons, but its program is on hold because of an agreement with the US that lifted sanctions.  

MUZZLE THE MUTTS…

Ego and idiocy has no place in measured diplomacy. The facts on the ground must guide the policy choices and implementation. It should not be left to idiots or ideologues. 

THERE ARE NO NUCLEAR DEFENSES OVER THE DESERT OF THE REAL!

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