Archive for August, 2006

I wrote about failed power utilities, failed pipelines in a few other posts and I always end the post with the question, “Who is John Galt?” The question is from Ayn Rand’s Atlas Shrugged and I’ll comment again at the amazing parallels between the book and what is happening in America and around the world today. It appears that some of the main stream media is beginning to take a look at the problem and perhaps asking the same question (in a different way).
The Seattle Times reports

Newhouse News Service

WASHINGTON — A pipeline shuts down in Alaska. Equipment failures disrupt air travel in Los Angeles. Electricity runs short at a spy agency in Maryland.

None of these recent events resulted from a natural disaster or terrorist attack, but they may as well have, some homeland security experts say. They worry that too little attention is paid to how fast the country’s basic operating systems are deteriorating.

“When I see events like these, I become concerned that we’ve lost focus on the core operational functionality of the nation’s infrastructure and are becoming a fragile nation, which is just as bad — if not worse — as being an insecure nation,” said Christian Beckner, a Washington analyst who runs the respected Web site Homeland Security Watch (www.christianbeckner.com).

The American Society of Civil Engineers last year graded the nation “D” for its overall infrastructure conditions, estimating that it would take $1.6 trillion over five years to fix the problem.

I recall viewing a 20/20 broadcast on bridges not being maintained properly and that over the next 20 years, bridges would start falling apart and killing many people. That program aired about 15 years ago and here we are today talking about the decaying infrastructure. Back then, the problem was going to cost over 100 billion to fix, and I can only imagine that it would cost at least five times that to begin to fix the problem today. I urge you to buy a copy of Atlas Shrugged and read it numerous times. Perhaps you’ll join me in asking, “Who is John Galt?”

This past holiday season, we purchased a High Definiton LCD TV. After seeing prices drop from $10,000 a few years ago to $1000 we decided the time had come for us to try HDTV. We paid about $1100 for a 37″ LCD HDTV. We’ve been quite happy with the quality and resolution of the TV. We enjoyed it so much that we opted to sign up for additional HDTV channels by signing up with a satellite provider. I initially thought that $1100 was pretty much all that I would spend on the TV but I should have suspected that this, like every other piece of electronic equipment I’ve purchased, would have some cascading expenses that I had not considered.

First, if you don’t have a built in decoder on your TV then you’ll need to purchase one. Cost $300+

Second, you will need to purchase a series of cables to get “optimum” performance on your TV. Cost $40-$300

Third, you will need to pay an additional fee for HDTV converter box to your cable/satellite provider. Cost $10+/month

Fourth, if you own an XBox or Playstation, you will need to purchase additional cables to hook them up to the TV. Cost $50

Fifth, you’ll likely not want to watch anything other than HDTV broadcasting so you’ll sign up for more channels with satellite or cable company. Cost $30+/month

Sixth, you’ll need to purchase some rabbit ears to pick up those additional “hidden” channles that stations broadcast. Cost $20

I’m sure there are other expense to come in the future. We can’t record HDTV broadcasts on our VCR so it’ll only be a matter of time for an HDTV VCR to come out. We do have the option of using DVR on our receivers but this also requires and additional monthly fee.

If you see an HDTV advertised for $499 out there (I’ve seen a few recently) be forewarned that this is only the beginning of some cascading expense you’ll incurr over the course of owning an HDTV.

Newsweek has an interesting story this week regarding the vast amount of wealth China is acquiring day by day.  Sometime next month, China will accrue over 1 trillion US dollars in their reserves from mostly their trade with the US.  Every month, the cash horde increases by 17 billion for China.

This article refreshes the idea that we have a perfect financial storm forming that can cause untold damage and quite possibly  bring the world markets to their knees.

Let’s take a look at some key issues:

  1. The US has huge trade and budget deficits; the US currently borrows 4 billion a month to stay afloat and pay the bills
  2. Most of the money that is borrowed comes from China
  3. The US continues to offshore jobs to places in India, China, and other locations.   We’ve frequently heard of the “hollowing out” of middle class America.
  4. Over the next twenty years, we will have a huge number of people retiring from the American workforce.  Americans aren’t exactly in the best of health so the burden healthcare, medication and care will drain resources from the US economy and tax government programs to their limits.
  5. Geopolitical instability in various parts of the world add to the potential mayhem including the potential energy apocalypse, terrorist strike(s), and world war.

These are just a few of the “major” events that can wreck havoc on a global economic scale.  Other “minor” events include a US/Worldwide housing bubble, uncontrolled inflation, currency destabilization, and a slew of other things that can add to the misery of an imbalanced global economic system.

What are solutions?  I fear we have travelled too far down the road of  “Wal-martization” to fix many problems.  There are many solutions but all, unfortunately, involve a great deal of unwelcome changes to the standard of living people have become accustomed to over the years.

To create a solution for the Chinese imbalance we could:

  • Stop buying Chinese products (no more cheap DVD players, Clothes, Shoes,  iPods, etc)
  • Demand China increase the value of their currency (this would create inflation, you’d still buy DVD players from China but they’d simply cost more)
  • Stop borrowing money from China (an immediate increase in interest rates and the cost of money across the board)

I could go on but you see the problem.  Solutions are available but they cause other issues that people aren’t willing to deal with.  It’s almost like having a cavity in a tooth.  If you don’t fix the problem by going to the dentist, the pain and risk of infection increases which will potentially lead to other health issues but going to the dentist will mean sitting down and going through some pain and spending some of our own money to get the problem fixed.  We live in a country where no one wants to visit the dentist.
The end result is a perfect storm of trade imbalances, aging societies, out of control deficits, and political turmoil that can send all of us into the next world wide great depression.  Be careful out there.

I despise the mutual fund industry but before I tell you why I’d like for you to think about Bill Gates.  Mr. Gates is one of the wealthiest people in the world.  A great deal of his wealth, however, is tied up in Microsoft stock.  Keep Bill (and his wealth) in mind while I tell you why I dislike the mutual fund industry.

First, the mutual fund industry feeds off of YOUR money.  The industry uses YOUR money to advertise on TV, radio, the web, and print media to tell you how great they are at investing YOUR money.

But if you ever sit down to ask yourself a couple of fundamental questions, such as:
“If mutual funds are so awesome, why do they spend so much money, hundreds of millions of dollars, in advertising?  Why don’t they simply invest the $100 million from their ad campaign into their funds?”

Then you might come up with some dirty little answers:  The fund companies make their money from fees they charge YOU for supposedly investing YOUR money and NOT from their wonderful investment strategies.
Ironic isn’t it?

So I can imagine the mutual fund companies have a dynamic like this:

Accountant says, “We can take $100 million ad money and invest it in our mutual funds and earn 9% return.  Over 5 years that’ll give us $56.5 million in profit.”

Marketing guy proclaims, “We can take $100 million and spend it in advertising.  We think we can get 1 million suckers err….I mean investors to fork over $10,000 each; we’ll get an inflow of $10,000,000,000 (10 billion) and we can charge them 2% fee.  We’ll make $200 million every year!”

CEO cheers, “That’s great news!  Marketing guy you get a big bonus.  I’ve got to go to the board to tell them the good news so I can get my $30 million bonus.”

Board says, “Wow, we’re managing 10 billion, that’s great publicity for our stock and its up.  Good work CEO, here’s your 30 million dollar bonus… and by the way we have plenty of cash to lend you for unsecured loans for as much as you want.  Help yourself.”
In reality, I’m sure the conversations are much more sinister and disgusting but you get the point.

Secondly, The mutual fund industry creates a great deal of FUD (Fear, Uncertainty, & Doubt) surrounding your retirement and financial well-being. Too often, the industry thinks that you are either too stupid or too lazy to be able to invest your own money.   They promise “sophisticated tools” to grow your money, throw in a few buzzwords like “optimize” your growth, “risk managed” portfolios, and “wealth” management and presto you get average returns like everyone else in their funds sans a hefty fee they deduct from your portfolio.

Remember Bill Gates?  Have you ever considered what would happen if Bill decided to sell all of his stock tomorrow?    If Mr. Gates decided to sell 40 billion of his stock the immediate result would be a significant drop in the value of Microsoft shares.

There is a saying that a rising tide raises all boats.  While true, a waning tide drags everything down with it as well and this perhaps captures what I think mutual funds do for investors.  As long as people are pumping money into the funds, the tide rises.  As soon as the pump changes direction, the tide falls and brings everything down.   We’ve seen it during the dot com bubble.  Every wonder where those brilliant fund managers were during the bust?   I urge you to consider the implications of what will happen to mutual funds when the tide goes out permanently.

From a personal perspective, I’ve interviewed a few “financial advisors” over the years and I always ask some basic questions like, “What do you think about investing in ETFs?” or “What do you consider to be diversfication?”

To my astonishment, these “advisors” often don’t know what ETFs are and they consider diversification to be invested in a few different kinds of mutual funds: bond funds, sector funds, international funds, and various stock funds.

No mention of real estate holdings, cash holdings, bullion/precious metals holdings, real bonds (not bond funds), US Treasuries, currency diversification, offshore holdings and a bunch of other things I won’t get into here.
You don’t have to think too long why they don’t mention any of these things – THEY CANT COLLECT FEES FROM YOU FOR OWNING GOLD OR REAL ESTATE!

And yet another reason why I don’t like the industry is because of the “herd” mentality it creates with the general populace.  How exactly do you expect to create wealth doing exactly what everyone else is doing?  If everyone is doing the same thing then doesn’t that mean you’re doing the average?

As much as I despise mutual funds, they do have their place in our current economic system.  Often, when employed, your tax-deferred investments are tied to a 401k or 403b plan which is usually linked to a small selection of mutual funds.  Essentially, you are held captive to the mutual fund industry by your employer.  On occasion, there is an option for holding your tax deferred funds in cash but this usually pays a paltry 3% return or worse.  Given this scenario, you have little choice but to invest in mutual funds and I can only advise to choose the lesser of two evils:  paltry returns or ridiculous fees.

I recently purchased Quicken 2007 and I’m wondering why Intuit didn’t include any kind of FICO simulator.   There are plenty of areas to enter credit card info, interest rates, credit limits, and more so you’d think Quicken could take these numbers and simulate a score for you!

I’m working on creating my own FICO simulator and it doesn’t seem as daunting a task as I initially thought.  From the info I’ve gathered, FICO score is broken down by:

35% Borrower’s History
30% Debt
15% Credit length
10% Credit Type
10% Pattern of credit use

Assuming 850 points is a perfect score then

Borrower’s History  = 297.5 max
Debt                      = 255 max
Credit Length         = 127.5 max
Credit Type            =  85 max
Pattern ?               =  85 max
Total                      850 points

With some of the categories, I feel fairly confident so I’m assuming I receive:

297 points for having good history – Never late on any payments over the last 10 years
127 points for credit length – The oldest account showing is from 1996; assuming good?  Not sure how opening/closing credit card accounts factors in.
85 points for credit type – Not sure about this but I have a mix of Home, Auto, Student, Credit Cards (all paid off except Home & credit cards)

I am a bit at a loss for how Debt and Pattern are calculated
85 points for Pattern – any ideas?
255 points for Debt – This one is perhaps the trickiest.

Adding my theoretical points (297+127+85) I get 509 and assuming I get half of the “Pattern” score that brings me up to 551 (considered sub prime!)

Clearly, Debt is a big factor (almost half) of your credit score.  I’ve read that anything about 50% utilization on a credit card is considered bad so how do we determine how bad that is?

If I currently have ~$73,000  in credit lines in 5 credit cards.  I have an AMEX with no limit and not sure how this fits in

Limit              Available         % Used

CC1       10,000                9,000             10%
CC2       18,000              18,000               0%
CC3       28,000                3,750             87%
CC4       12,500                3,750             70%
CC5         4,400                3,565             19%

Total        72,900             38,065            48%

Now the issue is does FICO use the overall total debt load or individually rate each one?  What are some theoretical ways to rate debt?

A total of 255 points are available for debt load so can it be that you lose 25 points for every 10% increase in debt load?  This would only work if the assumptions are based on total debt vs total available credit.

No debt = 255 points?
10% debt = 230 points?
20% debt = 205 points?
30% debt = 180 points?
40% debt = 155 points?
50% debt = 130 points?
60% debt = 105 points?
70% debt =  80 points?
80% debt =  55 points?
90% debt =  30 points?
100% debt = 5 points?

If somewhat in the ball park, then 50% debt load gets me another 130 points to bring my score to a total of 551+120 = 671?

If the debt factor is calculated individually then the math gets more complicated but not impossible.

The whole point of doing this exercise is to try to determine how badly FICO score gets “damaged” doing arbitrage deals.   As you can see, I have 40k in available credit that is just sitting there not doing anything for me.   You have to wonder what good credit lines are if you can’t use them without seriously damaging your credit score.

The more I think about how the FICO is calculated the more I think that it is seriously flawed.

There is no consideration given to how much a person has in savings.  A person with 70k in credit card debt with $0 savings is a much greater risk, in my opinion, than someone with 70k in credit card debt and 70k in savings.

There is no consideration given to income levels.  Again, a person with 70k in credit card debt with 30k in income is a significantly higher risk than someone with 70k in debt with 150k income level.

Ultimately it may not matter since a the new WAMU credit card grants you access to your FICO score every month.  I’ll try to periodically post how my FICO score is affected when doing arbitrage deals.

Washington Mutual is aggressively pushing me to sign up for one of their credit cards and they’ve run through the whole gambit of gimmicks to get me to do it. I’ve received these offers over the last 10 days.

Offer 1 – “Colorful” credit cards with free access to credit scores, coupons and credit line review and an added bonus of 0% APR on purchases until April 1, 2008!
http://www.getmastercardnow.com

wamu4.gif

Offer 2 – Same as offer one but 3.99% Fixed APR on balance transfers with No Fee.
http://www.getmastercardnow.com
wamu1.gif

Offer 3 – 0% APR for 9 months on purchases and balance transfers. Also has free access to credit score. I must hurry because this offer ends 10/31/06.
http://www.wamucreditcard.com/apply3

wamu3.gif

Offer 4 – Same as Offer 3, but I don’t have to hurry because this one expires on 12/01/06.
http://www.wamucreditcard.com/apply2

wamu2.gif

I’m intrigued about having access to my FICO score every month although the disclaimers state that access may take up to 90 days initially. Unless I find a better offer between now and late November, I will likely try out “Offer 4” as my 24k arbitrage deal comes to an end in December. I can only hope that I get as high a credit limit to roll the 24k over otherwise I’ll have to give the money back 🙁

I described the long hard way of finding the right ETF to invest –go through the list and look for the right opportunity. I also have an easier way that unfortunately, for the time being, I won’t be able to share with you. I’ve developed my own application to scan all ETFs trading within a certain price range and sectors I’m bullish on. The app downloads the ETFs along with their options, calculates the best returns and displays them for me. What used to take me hours now happens in under a minute. I will periodically post opportunities on this blog and may eventually turn it into a subscription service but for now I’m still tweaking the app and it looks like I will have to continue tweaking it for a while. The good news is that it has worked fairly well so far and it continuously spots great opportunities for me.

I’ve shown you how you can invest in Exchange Traded Funds and squeeze some profit using covered calls but is it really all that great?

I can only think of one entity in the US that can make as much money relatively risk free as they want and that’s the Federal Reserve Corporation; for the rest of us, there is no perfect system of investing. If there were truly any system out there that consistently worked and returned huge profit, word would get out and it would in effect become obsolete in a free market.

Please keep in mind that this strategy is currently about 1/5th of my overall investment strategy.

Lessons Learned to Mitigate Risk

When buying an ETF and selling the call option, there are risks that the price of an ETF will drop; although this may be good if you wish to buy and hold very long term, it is negative if your primary objective is to repeat the covered call selling process. A long term hold on an ETF keeps you from investing in other (possibly better) opportunities.

I currently have a real life example of what can happen when things don’t happen as you’d like. In May of 2006, I purchased 1900 shares of EXPE at $19.75. I immediately sold the May 06 options for $0.95 earning me a quick $1800 (4.8%) in a few days. Unfortunately, EXPE missed earnings and the stock dropped to a low of $13.00 share. I was negative in my investment! Over the past few months however, EXPE has recovered and is currently around $15.70. Prior to this trade, I’ve always gotten called away or liquidated my position without any problems but this was a first.

I currently have two choices with EXPE. I can sell the January ’07 option for about $0.30 to earn another $570 and wait to be called out or wait for the stock to appreciate back to $20 and sell the stock then (or re-sell some more options).  Keep in mind that I am bullish on EXPE and would like to hold it long term but that is not what my intent was with buying it in the context of this blog and investment strategy.

The bad part of this investment isn’t that the stock is down nor that the options aren’t as high as before, the bad part is missing out on other investments that could be yielding me 14% right now!

Lessons learned:

1. Individual stocks are simply too chaotic, I will stick with ETFs moving forward.
2. It may have helped if I hadn’t put all my eggs in one basket and I’ll consider diversifying across two or more ETFs when using this strategy.
3. There are other methods using naked puts that I really should consider using in the future to mitigate some risk.

Finding the right ETF to execute a covered call on can be a daunting task. A list of all optionable ETFs can be found here:

First, we must limit our scope to find the right ETF. In order to sell a covered call, you must own at least 100 shares of the ETF. You will need to figure out how many shares you can purchase by dividing your capital by number of shares x cost \ 100. I’m using seed money of ~$40,000. So if an ETF is trading for $82/share the most shares I could buy would be ($40,000 / $82) = 487.80. I can only trade options in a set of 100 so this rounds down to 400 shares 487 \ 100 = 400.

If you only had $10,000 then you’d be limited to purchasing just 100 shares. Anything less than $8000 in your portfolio and you couldn’t buy any  ETF shares for this strategy.

We can clearly see that the lower the price of an ETF the greater number of shares we can purchase. The greater number of shares has the potential for a greater amount of profit. Conversely, a larger amount of capital has greater potential for increasing the scope and range of ETF choices as well as profit.

How do you pick a profitable ETF?
The long hard way is to go down the list and check the options for each ETF. This is how I initially did my investment research. I spent hours going through each ETF and its options, finding the right one with a high yield then preparing for the trade.

Here is a real life example:

XLE is an exchange traded fund (ETF) that specializes in the energy (oil) industry. As of 8/22/06, the XLE ETF is trading at ~$58/share.

xle8_22_06.gif

Taking a look at the options for September 06, we can see that the $58 strike options are trading for $1.40.

xle_8_22_06option.gif

So if we were to execute our strategy today with our capital we would.

1. Buy 600 shares of XLE for $58 (600 x $58) = $34,800 + commission.
2. Sell the September ’06 option for $1.40 (600 x $1.40) = $840 (our immediate profit) – commission.
3. Wait until Sept. 15th rolls around to see if we were called and our stock gets sold for $58/share or in the event of a price drop to say $56, we continue to hold the XLE ETF to resell the option for some future time.

Assuming we get called out, we would recoup $34,800 plus we get to keep the $840. Our profit % is = $840/$34,800 = 2.4% (does not include commission). So in less than 30 days, we made 2.4% profit. Imagine if we could repeat this every month! 2.4% x 12 = 28.97% profit gains!

Could we have done any better? You bet!

Suppose that instead of selling the Sept ’06 option, we decided to look a year out.

xle_7_07_option.gif

We look at Jun 07 and see that the $58 option is trading at $6.90. So if we had sold the Jun 07 option, we would have made 600 x $6.90 = $4,140. Our profit would be 11.90% for the future year CAPTURED TODAY!

Did you catch the best part here? If we made our transaction in August, we RECEIVE the cash benefit ($4,140) the day we made the trade. That’s $4,140 in your pocket today!
The downside (if you want to call it that) is that you now have to wait until June 2007 to see if you’ll get called away. If you do get called away, you’ve unloaded the ETF and pocketed your profit. If you don’t, you hold on to it and resell some future options.

Of course, the first thing the nay-sayers (and mutual fund lovers) out there will say is “well, what happens if energy (oil) goes down and XLE drops from $58 to $40/share?”

My response is what happens if your energy mutual fund drops from $58 to $40/share? Did you make $4140 during that drop? Did you pocket 11.9% profit? What happened to that buy and hold mutual fund philosophy?

Then the other thing the nay-sayers say is “Well, what happens if XLE goes to $100/share? You lost out big on that one (with a smug look on their face)!”

My response is, “congrats, I missed out on that one, I got called away at $58 and only made 11.9% profit and pocketed $4140 a year ago in my portfolio; I’m happy with that but I’m sure that your mutual fund manager is ecstatic – he makes 2% off of your growing investment!”

If I can consistently make 12% return on $40,000 then in 20 years I will have $435,702. If however, the stock market makes an average return of 10% then that’s a difference of $142,579! Worse yet is if mutual funds only return 8% (after fees) then you’re looking at a loss of $238,629!

Tomorrow, in Part IV, I’ll share the easy way of finding the right ETF for great returns and some things you can do to mitigate the downtrends in ETFs.

My Covered Call ETF strategy operates on a few assumptions:

  • You have an interest in wanting to immediately capture a certain rate of return
  • You have little or no desire to be in the market for long periods of time with these funds
  • You want to increase cash flow to repeat this process and strategy

The ETF covered call strategy:
ETF (exchange traded funds) are a basket of stocks (similar to mutual funds) with an added twist of having the ability to buy/sell options on them. Although not all ETFs have option trading ability on them, there are a wide array of choices.

You’ve often heard that investors need to be diversified. This advice comes with good reason, individual stocks can fluctuate in price radically and there is always the danger of losing all your money if “all your eggs are in one basket” and a stock suddenly drops to nothing (e.g. Enron, Worldcom).

Remember our premise: We want to capture profits TODAY and hold stocks the LEAST amount of time possible. Given the choices below which would you choose?

Choice 1. Buy a mutual fund today, wait a year and earn 7% return
Or
Choice 2. Buy an ETF today, sell an option 1 year out and capture 7% return TODAY.

If both choices look the same to you, take a closer look. By choosing to earn 7% today, you’ve earned a greater return, increased your cash flow and offset inflation. Your risk is relatively comparable to that of a mutual fund but you have the added benefit of squeezing money out of the ETF you already own. The best part is that with new flow of cash coming in you can re-invest the cash to repeat the process.

There are numerous debates and arguments over whether diversified mutual funds out-perform other stock/option investment strategies and my only comment on it is that I’ve never encountered a wealthy person who got super rich owning mutual funds – you need to do more. You can earn a decent, somewhat stable return, in mutual funds but that is NOT what I’m looking for with this particular investment strategy.

The plan is a simple 3 step process:

1. Find an ETF with some decent returns prospects (no less than 8%) by checking the options chains on an ETF for both 30 days out and 12 months out.
*Make sure you can purchase at least 100 shares of the ETF in whole hundreds (e.g. 100, 200, 400, 500 NOT 144 or 250)
2. Upon finding the right ETF candidate, execute a buy-write on the ETF.
*Buy x00 shares of ETF and sell the appropriate Call OPTION to capture return
3. Hold the ETF until expiration or call execution.

Tomorrow, in Part III, I’ll cover how to identify the best ETF choices for the greatest amount of profitability.

Note: 1/5th of my Investment Strategy is doing Covered Calls on Exchange Traded Funds (ETFs)
This week, I’ll be focusing on the mechanics of how I plan to grow my portfolio by 20% year over year but before I do I want to share that these tactics only comprise a small part of my overall investment strategy (about 1/5th). This blog is dedicated to utilizing covered call transactions on Exchange Traded Funds to return higher returns. Like with any investment, there is a degree of risk (including loss of principle) so please be cautious and due your due diligence before investing.

Before I begin, I want to start with a very basic overview of the typical investment strategy for stocks.

The old buy and hold strategy:

Pretty much everyone knows how buying/selling stock process works. If you bought XYZ stock for $10 last week and it’s selling for $20 today, you can immediately capture a $10 profit by selling today. Your total profit is the difference multiplied by the number of shares you purchased.

The major downfall to this strategy is that it takes TIME for a stock to grow from $10 to $20. Ten dollar increases per week are a rare occurrence. This strategy works well if you’re starting out relatively young and you don’t know any other investment strategies. Often, you’ll be doing this inside a 401k with mutual funds (which I happen to despise) where a “professional” will do the buying and holding for you automatically.

The old options strategy:

In addition to being able to buy/sell stocks, you can buy/sell options on many of stocks. Essentially, options purchases give you the right to buy a particular stock by paying a small fraction (premium) to the holder of the stock. Think of it as “layaway plan” for something you might buy at a department store.

Imagine you want to purchase a $1000 bike. You don’t have $1000 but you do have $10 so you give the department store clerk $10 to hold the bike for you; the clerk gives you a “layaway certificate” to show that it’s “your” bike. Now, imagine that the world’s bike factories get destroyed. Bikes are now worth $2000 and you’ve got one in layaway – what to do?

At this point you have two courses of action:

You can buy the bike outright (execute your option) and sell it to someone for $2000 and pocket a $1000 profit. In order to do this you need to come up with the remaining $990 to give to the department store clerk. Ouch! You don’t have that much money but you really want to profit from that bike appreciation!

Why not sell the “layaway certificate” to someone who does have the money to buy and profit from that bike?

This is where the second course of action comes into play. There is a market for people to buy/sell “layaway certificates” so you check it out. It turns out that last week, the going rate for bike layaway certificates were going for a $2 but because of the bike factory incident, they’re now selling for $20! So you paid $10 for a certificate but it’s now worth $20. You can sell the certificate and make 100% profit! Now, you only wish you could have bought 100 certificates to make $2000 in profit. Well guess what! You did because much to your surprise each layaway certificate actually represents 100 bikes!

This is a simplistic overview of how the options market work. You buy/sell options and each option represents 100 shares of stock. Of course, this strategy is risky because you need something dramatic (usually) for a stock and option to appreciate in price this quickly. If nothing happens, no one will want to buy your options so they end up worthless.

If you wish to learn more about options I suggest you visit the following websites:

http://www.investopedia.com/university/options/
http://www.optionscentral.com/basics/default.jsp

or purchase the following book:
http://www.amazon.com/gp/product/0967412897/002-2055413-8732821?v=glance&n=283155

Please note that option investment is risky. Almost 80% of all options expire worthless. The safer side of investing is to become a SELLER of options of stock you already own. Tomorrow, I’ll cover ETF Covered Call Strategy in more detail.