Economics and Investing

The Debt Ceiling

The Consumer Spending Problem

I think that this video was a great one. The point that I am most interested in is when Ross said that the consumer is more leveraged now than they were at the peak. This could prove to be a serious problem in the near future if this is true.

Housing Takes a Hit

Housing took a real hit today. Excessively tight mortgage underwriting has been a major catalyst to keeping the housing market down despite falling interest rates which historically help keep the housing market to recover. Take a peek at this video where they do a good job of describing what is going on.

 

Debt Ceiling Reached!

The United States federal debt limit has been reached. The debt limit is the amount of money the government can borrow to help finance its operations. It is estimated that they borrow 40 cents for every dollar they spend.

Treasury Secretary Timothy Geithner informed Congress that he made a decision that he will immediately halt investment in two big government pensions plans so the government can continue to borrow. He wrote a letter stating that the government had officially reached its $14.3 trillion borrowing limit, repeating a warning that if lawmakers do not increase the borrowing limit by August 2, the government is at risk of an unprecedented default on its debt.

The plan that Geithner has presented is that when the debt limit is raised, they will replace the two missed payments to the pensions.

This is not the first time that Geithner has suspended pension payments.

Osama Bin Laden Killed

Thoughts on Ben Bernanke and the Dollar

I thought this was a very good video to consider.

 

Beating Interest Rates

Interest rates are a funny thing. I am in the middle of purchasing a home and I am getting a great rate. But on the flip side, I am looking to invest some cash and the CD I found is paying near 2%. That’s pitiful! But what if there was an investment that would pay you more depending on what the rates did. And I don’t find it all that necessary to explain why rates are going to go up, they will. Maybe not right now, but eventually they will certainly rise. With that being said I find that something people should consider for their portfolio is a floating rate fund.

A floating rate fund has a huge advantage over a CD or a treasury bond. Reason being, if you were to get yourself into a five year CD paying 2.8% then you are locked into that investment for five years, unless you’re willing to take a hit on the fees. The advantage to a floating rate fund is that as rates rise, their payouts rise which increases what you’re getting paid. And you’re not locked in, not for five years or even thirty days.

To help illustrate we can look at how banks make their money. A bank earns money by borrowing money from the depositor for a modest rate, next to nothing right now, and then loaning it out to new borrowers. As rates rise, the depositor will still be paid a meek rate, at least for a while, and the bank will be able to lend at a higher rate increasing their profits. With floating rate funds an individual can profit along with the banks as rates begin to rise.

Options 101

To be clear, I am talking about equity options. This post is for a rookie to the option world, if you are experienced in options, you may want to skip this post.

Let's get started:

There are two kinds of option contracts: a put and a call.

A call is an option giving the buyer the right, but not the obligation, to buy 100 shares of the underlying security. The seller (or writer) of the option has the obligation to sell the shares.

A put is an option that gives the buyer the right, but not the obligation, to sell 100 shares of the underlying security. The seller (or writer) of the option has the obligation to buy the shares.

An options price is called the premium. For the buyer of either a put or a call, the premium is all that can be lost. The writer of the option, on the contrary, has unlimited potential loss.

Let’s break down the basics of an option.

There is an underlying security behind each option. This is the security that an option buyer will have the right to buy (if a call is owned) or sell (if a put is owned). Options are almost always worth 100 shares. This can provide a fairly large amount of leverage for options investors.

Expiration day is the third Saturday of the month. Therefore that Friday will be the last day those options can be traded. After the expiring Saturday passes, the option will cease to exist.

Strike prices are the agreed upon price that the call or put will be executed at. If a contract has a strike price of $25 and the current price of that call is $25.50, they call that being “in-the-money”. If that same call is trading at $24.50 then it is called being “out-of-the-money”. At $25 even and we have what is creatively known as “at-the-money”.

Tying them all together – an option might look something like this

Call option - ABC underlying security – September expiration – 25 Strike price

That is the basics, or at least the basics of how they begin to work. There are many strategies utilized surrounding options. I’ll be going over some strategies in a coming post. But for now, you can read my last post on option strategies.

The power of Options

OK, I’m venturing a bit off my typical post. Normally I have written about economic news and various events. But today I want to look at an aspect of investing that I love. Options!

For Options Rookies – I'm writing a primer on options for Wednesday of next week (4-6-11)

Here is how I like to use them.

Let’s pretend I own 1,000 shares of XYZ company, actually, let’s use a real company, let’s pretend I own 1,000 shares of Microsoft - MSFT (I don’t own this one – but we are pretending). I bought the stock at $25.00; it’s now trading at 25.75. So I’m up a little and that’s good. But I want to make a little more. What have I found is a good way for me to do just that? Sell Calls! Covered calls to be more accurate.

Here is an example for MSFT from Etrade (to save space I am only showing the calls side).

_{Source: Etrade - MSFT Options Chain}

As you can see if I were to sell the July 16^th options with a strike price of $26.00 I will be paid a 1.01 per share premium which is $101 per option and $1,001 for all 10 options.

$26.00 is kind of a close strike price for me. I personally would go with the $27 strike price. Paying me a $0.62 per share premium. That’s $620 I collect for forgoing any potential gains above $27. To me, this is worth it. If the stock keeps rising, I'll increase the strike price next quarter when I write them again.

So what’s the downside? Really what you are risking is potential gains. Let’s pretend MSFT comes out with crazy news and the stock goes to $60, well I still have to sell my shares at $27, unless I sell the options. But there is always that risk.

 

I personally love doing this. It is a way to make a little extra money for risking some potential gains. Another way I look at it is like this; I spent $25,000 on my 1,000 shares of MSFT. If I sell these options quarterly I am essentially lowering my entry price to MSFT. So the $25,000 I spent would be lowered to $24,380 ($25,000 - $620 premium = $24,380). Next quarter I’m down to $23,760 if the premium is the same, continuing along to $23,140 then $22,520. As you can see this makes my MSFT investment look more and more juicy with every passing quarter.

Any questions or comments feel free to email me at jimmy@jmcip.com

Jimmy

This week in Investing

There are a few interesting things coming up this week. Wednesday is new home sales; I am personally interested in this number as I search to purchase a new home. Also on Wednesday Fed chairman Ben Bernanke speaks to the bankers group. Followed up by the weekly jobless claims on Thursday, it is expected that the numbers should decline – the four week average is currently 380,000.