Options as a Strategic Investment » Investment Strategy

Buying Term And Investing The Difference

admin — Fri, 25 Dec 2009 01:54:44 +0000

You have probably heard of the saying “Buy term, invest the difference” when getting insurance and putting your money in investments. But do we really comprehend what it actually means? What could be the reason why majority of financial planners strongly recommend that you should “buy term and invest the difference” ? On the other hand why is your insurance agent forcing you to buy his or her recommended product?The majority of whole life insurance products available today is tantamount to “rip offs.” In fact, these kinds of products has already been phased out in the United States. When we talk about “term insurance”, this refers to insurance with life coverage only. On the other hand whole life insurance is a term policy coupled with investments. Your insurance agent will always present whole life insurance as something that will “force” you to save for your retirement. This is actually good, but the problem with this setup is that most insurance companies do not usually give a good rate of return for the “investment” component. Sad to say, whole life insurance products are still actively sold in the Philippines. People still buy these products because of lack of financial know-how.To drive home the point, let me give you an actual situation. Sometime last week, my mother asked me if she should continue paying an insurance product she got for my sister. The total price for it was about P 400,000.00 (Philippine Peso). Half of it is already been paid leaving a balance of P200,000.00.According to her, the benefits of the insurance product are as follows; After 20 years, my sister who is still 18 years old will receive P 40,000.00 per annum until she reaches 65 years of age; At the age of 65 she can either choose to receive P400,000.00 lump sum or continue receiving P 40,000.00 until she dies, plus she is also insured for two million pesos for as long as she lives.To evaluate whether or not she should continue paying the P200,000.00 we will evaluate the benefits of the insurance product versus the “Buy term, invest the difference” option.If you add the total money that my sister will be receiving, she will get a total of P1,520,000.00 at age 65, that is if she opts to get the lump sum at age 65, plus she is insured for two million pesos.On the other hand, if we follow the buy term invest the difference scheme, if her insurance company will allow her, she will convert what she has already paid into “term insurance” which usually runs for only 20 years and then invest the P 200,000.00. If she will invest the P 200,000.00 at a vehicle of investment that gives about 10 % return per annum and also re-invest the returns of the investment taking full advantage of compounded interest at age 65 she will get a whooping P 17,639,497.05.Now see the difference !!! Under the insurance scheme you only get P1,500,000.00 and P 2,000,0000.00 worth of insurance. But in the “buy terms invest the difference strategy you get P 17,000,000.00+ !!! The benefits of the insurance product cannot be compared to the benefits under the buy term invest the difference strategy.You might ask what about insurance protection? Take note that pure term insurance is very cheap. She can just buy term insurance and renew it every 20 years.You might be wondering what investment vehicle would give you 10 % return per annum? There are several of them out there. You can invest in mutual funds where returns can run from 10 % to 70 % or more. However these returns are not guaranteed but historically the rate of return does not fall below 10 % per annum. (that is if they are invested in equities) You can also invest in the stock market. In the Philippines, a bullish stock market gives a high rate of return that even the most conservative investors in the stock market earns more than 10 % per annum.Buying term and investing the difference certainly does make sense !!!Would you like to know more about investment strategies ? Visit the blog of Zigfred Diaz where he writes about several interesting topics such as investments, money management, business, making money online and Stock market investing

Options Trading Edge

admin — Wed, 23 Dec 2009 12:24:29 +0000

Many private traders deem that options are thought to be traded by experts with good mathematical skill. There are two reasons why many private traders think so, that are. trading options are too risky and difficult. Many private traders think that it is easier to just trade stocks or futures. So, a simple question, if trading futures or buying stocks looks so much easier and less complex to do, then why options are available to be traded? The actual reason is that options, which are unlike other trading vehicle, can offer a trading edge to the private traders and allow them to cover almost any investment strategy and risk profile with flexibility. In many ways, options are the most superior trading vehicles that many traders use nowadays. To trade options, you certainly do not need to be an expert in financing.

In the book “The New Market Wizards” written by Jack Schwager, concludes that nobody can win without an edge, even you have the world greatest discipline and money management skill. If you trade futures on the All Ordinaries Share Price Index (SPI), you have to know exactly what is your trading edge; particularly, if you are a professional floor trader. With the trading edge, you should able to see the buy and sell orders that coming into the trading pit and also who is buyer and seller. Besides, the speed of execution of your orders and the transaction costs also should able to see. The popularity of the stocks, options and futures is increasing; therefore, many people trade these products. Only a small proportion of these traders apply a real trading edge. The main reasons for the unsuccessful of many private traders in the financial markets are due to the lack of a trading edge, poor risk management and insufficient capital. The key point here is to find an edge, utilize it consistently and use the right risk and money management techniques. When the odds are in your favor, it is better that you learn how to trade options. It is also importantly when the odds are not in your favor, make sure you stand aside. You are doing yourself with the best possible chance of success if you doing so. Trading systems are as many as traders. We won’t trade a system if it doesn’t provide us with some sort of edge. If you have a system, which is able to give you an edge, why not further enhance your edge by trading options in a right circumstance. Before placing a trade, try to get as many factors that going in your favor as possible. By practicing this, you provide yourself with a much greater chance to success in the long run.

Without doubt, with any form of trading, there are no absolute guarantees. You can’t help compared to the many of the people who do not know anything about options and trade without an edge. But, you have a better chance to succeed in the long run and reach your financial ambitions. Flexibilities that can be offered by options are as follows:

i) Profit gained from an accurately anticipating rising or falling market. ii) With a relatively small disbursement, your potential returns can be greatly magnified.

iii) If the market goes to the way that you anticipate, you have unlimited profit potential, whilst you limit your risk by choosing an amount that you afford to risk.

iv) Profit still can be gained by correctly picking options where the market will not go.

v) Profit gained from flat or non-trending phases markets.

vi) Profit gained by letting the time passes by.

vii) Profit gained at an increasing rate when the market moves further in your favor.

Extremely flexible trading tool is option. You can use options trading strategies that are precisely suit your view of market, whilst sewing them closely to your personal risk tolerance level.

People who trade options for a living and as their business will try to understand and apply the principles, which have been outlined in this article. They do so because they know that there is an edge for then to be gained compare to the people who don’t. They are similar to the typical casino gambler if they do not trade with edge; their money will be destined to be lost ultimately. They are exactly like the casino itself if they trade with trading edge. For those people who trade the markets to make their living, you probably don’t have the chance to talk with them. Their occupation looks exotic and these people are imagined as weird mathematical geniuses who could give their money to Kasparov to run it in a chess tournament. The flair of occupational options traders couldn’t be going beyond from the veracity. Although many of the professional options traders who involve in the financial markets are intelligent people, they were not in the genius category. Nevertheless, they have one thing in common among them. They knew and applied certain unique principles in their options trading. The principles that they utilized offered then an edge to successfully trading in the market. Therefore, throughout their options trading life, they earn a good living.

You don’t have to be a professional options trader. The edge offered from the principles to the professional options traders also available to the private traders as well. Practically, these principles can be learnt and applied by yourself and the odds can be helped to put it more squarely in your favor. All the advantages that most of the professional options traders have may not be possessed by you. By using the same principles that they used, you can learn to make your trading more selective. In this way, you too can benefit from a trading edge.

Investment Strategies for the Stock Market

admin — Fri, 27 Nov 2009 04:17:32 +0000

When it comes to Investment Strategies for the Stock Market most people believe that there is only one safe strategy.
‘Buy and Hold’
The reason why most people believe that this is the safest investment strategy for the stock market is because that is exactly what their financial advisers have told them. Have you ever heard the phrase
“The key to successful investing is Time In the Market NOT Timing the Market”
I believe that this is a lazy approach to investing and is really just an excuse to hide the fact that some financial advisers have no idea what the market is doing. Wouldn’t successful investors use multiple investment strategies for the stock market? If the market is at a record high and there is a chance of a correction then surely there is something that you can do (other than selling your stocks) to protect some of your profits?
The reason why financial advisers don’t want you to know about any other investment strategies for the stock market (other than buy and hold) is because it isn’t in their interest for you to know about them. They want you to remain reliant on their advice and have you feel as if the stock market is a very scary and dangerous tool – only to be tamed by the so called experts.
What is your opinion? I certainly believe that at times the stock market can be very scary and dangerous but like any thing; the more you educate yourself the more comfortable you will feel with it.
So what are some Investment Strategies for the Stock Market other than buy and hold?
Let’s have a quick look one very simply investment strategies that can be used to great effect on any stock market.
Covered Calls
This is one of the most effective, low risk investment strategies that can be used on the stock market. The basic idea to sell call options on a stock that you own. What? I hear you saying. In simple terms it means that you are renting out your shares for a monthly premium and in return you are giving somebody the option to buy your shares at a predetermined price that is higher than what you paid for them.
Let’s say you own 1000 XYZ shares that are worth $15.00 each. People will pay you a monthly premium to have the option to buy these XYZ shares at a predetermined price within a predetermined time frame.
For instance someone might offer you $500 for the right to buy your shares at $16.00 within the next month. Why would they do this? Because if the shares happen rise up to $18.00 they will be able to buy 1000 XYZ shares at a $2.00 discount per share ($18-$16).
The great thing about this strategy is that both parties can win e.g. If this was to happen you would be happy too because you would get to keep the $500 premium and you would also make $1.00 from every share that you sold because you bought them at $15.00 and sold them at $16.00.
What happens if the share price was to go down?
If the share price was to go down from $15.00 to $13.00 then you would still get to keep the $500 premium which would reduce your paper loss from $2.00 per share to $1.50 per share.
Writing covered calls (or renting out your shares) is one of the most commonly used investment strategies by the rich. It is a great low risk low risk investment strategy for the stock market that everybody deserves to know about.
So there you have it a simple investment strategy for the stock market that can help increase your cash flow and also gives you downside protection. What more could you ask for in a stock market investment strategy? So next time you see your financial adviser ask them about covered calls and see what response you get. My bet is they probably won’t even know what you’re talking about because their university course didn’t teach that subject.

Investment Strategy: Contrarian Investing 101

admin — Thu, 26 Nov 2009 20:25:07 +0000

Have you ever wondered why some people are able to invest in any financial instrument or property at a low price and why you have always missed the boat? This article explains the importance of understanding why contrarian investing works and how having such a mindset can help you make more money as part of a larger investment strategy.
1.Value Investing mindset
Before one can profess to be a contrarian investor, you must have an understanding of the underlying value of the thing you are buying and decide that it is undervalued and historically and the market will rebound within a good period. A good book to start reading on value investing in the stock market is “The Intelligent Investor”, by Benjamin Graham who was Warren Buffets’ Professor in Columbia University and helped shape his investment strategy. So because you know the usual market value of something, you can purchase it on the cheap when prices drop , not unlike shopping for discounts at a supermarket.
2.Look out for downturns
Another key indicator is to understand your market well and then pay a careful attention to downturns in the economy or freak incidents like September 11. Some investments do down in value due to macro economic factors that may have nothing to do with your particular investment. A contrarian investor would spend time looking for ominous signs in the papers which may lead to a downturn so as to purchase stocks, shares at a discount to the average price.
Downturns that can prove profitable include:
• Natural Disasters that have nothing to do with the underlying stock.
• Cross Border Disputes affecting a particular Company’s price which has nothing to do with its main operations.
• Wars and Hostilities that can affect the competitors of your current favourite stock.
3.Look out for excessive exuberance
Contrarian Investors know that downturns can also be profitable if you use Put options which pay you when the underlying stock declines in price? The best way to predict such a downturn would be to look for in the words of the former Chief of the Federal Reserve Allen Greenspan, “excessive exuberance”. This means basically that while prices are still rising furiously, the number of buyers would start decreasing and a market correction might follow.
Some indicators of such excessive exuberance include:
• When you see financial analysts being very rosy on highly speculative stocks.
• When the stock market indexes start rising close to record highs.
• When you notice that trading volume diverges with the price, meaning that while prices are rising, the trading volume is dropping.
Contrarian investing is thus a mindset where the individual looks for trading opportunities which can yield profits. A contrarian investor thus looks out for economic, political and other factors which can cause a large market movement in the particular financial instrument that he is trading in and can make a large capital gain from his investment. This form of investing can be part of a larger investment strategy and one should consider contrarian investing as part of his online investing warchest today.
Copyright © 2006 Joel Teo. All rights reserved.

Contrarian Investment Strategy as PE Arbitrage

admin — Tue, 24 Nov 2009 23:15:47 +0000

As a mathematical physicist and an actual arbitrageur (as opposed to armchair arbitrageur), I have a broader view of the arbitrage concept than many people. The original concept of arbitrage, its purest form, is simultaneous long buying and short selling of similar objects with no risk. For example, simultaneously, buy U.S. dollars with Euros, in London, and sell U.S. dollars for Euros, in Jakarta, for two slightly different prices to make a so-called spread, the difference between the prices in the two markets. Another type of currency arbitrage, which can be done in one market, is triangle arbitrage, using three currencies that are somehow out of alignment with one another.

As another example of arbitrage, we might conceive of buying convertible bonds and short selling the stock into which the bonds will convert. In that manner, you can create a virtually riskless position. It is a matter of looking at yield difference between the stock and the bond and creating an instantaneously riskless position. If you can earn a higher return than the riskless rate, you are ahead in the investment game. Moreover, because of the rules on securities holding for broker/dealers, you can also leverage such a position and put up only around 10 percent of the underlying long bond position, in this convertible arbitrage long-short position.

In merger arbitrage, there is risk: the risk that the merger will not go through. The arbitrage comes from an analogy for the special case of a share-for-share exchange merger. For example, XYZ Corporation might offer 2 shares for each share of ABC Corp., in a share exchange merger. That type of merger structure also has a tax advantage for shareholders, with the exchange not counting as a sale of shares. For the exchange ratio to be effective, the value of 2 XYZ shares must be greater than the price of ABC shares, trading in the market directly before the merger announcement. Then, if ABC’s shares had been trading at $30 before the announcement, and XYZ’s shares were trading at $25 per share, then, 2 shares of XYZ is $50. To set up a merger arbitrage position, in this case, the arbitrageur short sells 2 XYZ shares and buys 1 ABC share. In that manner, he locks in a definite spread, which will be earned, if the merger closes. Indeed, it does not matter if XYZ goes down after the position is taken on because ABC will follow. When the merger closes the arbitrageur will be given two shares of XYZ for every ABC share he owns, and the position, in his securities account will be short and long (called “short against the box”) and equal number of shares of XYZ.

In fact, the merger arbitrageur might also engage in capital gains tax arbitrage by “aging” his position and closing it out only after the gain has become long-term. Moreover, under capital requirements for broker-dealers, on a short against the box position, there is no capital requirement. Thus, the aging short against the box position is a zero investment riskless position with greater than a riskless return, at that point. As a result, a share exchange merger can become an arbitrage on top of an arbitrage.

We can look at brokers as doing a sort of riskless zero-capital arbitrage, in that they hook up a buy with a sell and get a riskless commission for so doing. Dealers and market makers are also engaging in a risky sort of arbitrage. They put up bids and offers on a security to earn the bid-ask spread, and, as long as they are able to trade flat every day, ending with no long or short position, they make the spread. There are arbitrages between commodities and their futures, as well as among stocks and their put and all options, and among the options. At the other end of the trading spectrum, a LBO firms are doing an arbitrage between the public market for corporate control and the private market for public control. A corporate raider is doing an arbitrage between a packaged public corporation and the private markets for its corporate parts. We recently did an article in buzzle.com that explained the Chinese export phenomenon as purchasing power arbitrage. We could go on with more examples and explanations of arbitrage, but we really should get to the point, so, we refer the reader, instead, to our website’s In Country Analysis page for further reading.

In the 1990’s, I took a dilapidated 18th century property, fixed it up, put my extensive collection of art and antiques in it, and turned it into an internationally recognized country inn. It was, in fact, just a double arbitrage. It took a collection of art and antiques and preformed private collection to public art viewing and retail markets arbitrage. I bought the art in the inter-dealer market, got an implicit rental for it, sold some at retail prices and sold the end of the collection with the property. I also did an arbitrage between mortgage payments on a residence and rental payments for overnight accommodations. Arbitrages are more numerous than people might first imagine.

The concept of Contrarian Investment Strategy was brought into the public awareness, in the late 1970’s by David Dreman. As any professional investor knows, one actually finds good investments in places where other people are not looking, either because of lack of general awareness, or lack of understanding. In that regard, the general mandate of contrarian investing is to invest, not willy nilly, in stocks of companies that are out of favor or that lack coverage by securities analysts, so that they are not in the public investment consciousness. In the end, those types of stocks are undervalued because of a lack of buying attention. That also means that they will have relatively low PE ratios, relative to other in-favor companies in their industry.

Normally, then, a contrarian investor does his own homework, mining these undervalued, low PE stocks and filtering out those that have low PE ratios, not because of any real financial problems, but because they have no investment following. The typical strategy, thereafter, involves going long the undervalued, low PE stocks. In so doing, the investor is, in another light, engaging in a sort of PE arbitrage, buying the low PE versus the industry standard PE, which he is implicitly, though not actually, short. This strategy has given wrought good investment returns, most of the time, but it is an unhedged, pure long strategy and, therefore, is still left open to the vagaries of the markets. That is a lesson that even the father of this strategy, David Dreman, has learned, this year. The idea that there is implicit protection lies in the fallacy that the stocks have already been beaten so low, that a down market should not hurt the naked long positions, too much.

A better way to implement this PE arbitrage, would be to also find those stocks, within the industries of the chosen long low PE stocks, with relatively high PE’s. Then, the contrarian PE arbitrage strategy would be to build a portfolio of long, low PE stocks and short an equal dollar value of high PE sticks, paired with the longs. In that manner, not only will the portfolio be a hedged portfolio but, also, to take full advantage of the PE arbitrage opportunity, earning a PE spread as both stocks, high and low PE pairs, gravitate to the norm. Moreover, even if the market goes up or the market goes down, the long-short pairs will counterbalance one another.

In the end, value investing is investing, not arbitrage. Value is defined in many ways, but it usually focuses on psychology. Another method that has been tried, involving this general psychological value focus, does take a two sided arbitrage approach, for example. A phenomenon observed by researchers [Victor Bernard & JacobThomas, "Post-Earnings Announcement Drift: Delayed Price Response or Risk Premium?" Journal of Accounting Research 27 (1989)] is called post earnings announcement drift. It has to do with a market inefficiency that information is not immediately correctly processed by real human beings. If the stock market is efficient, either expected earnings should already be reflected in stock prices, and an earnings surprise, one that is better or worse than the forecast expectation, should be rapidly assimilated into market prices. However, the reaction is actually stretched out for a whole fiscal quarter (60 trading days), in other words, until the next earnings announcement. There is some anticipation before the announcement, but abnormal returns continue even after the news has been announced. The phenomenon has been in the markets for decades. A strategy of going long a portfolio of the highest decile stocks with so-called standardized unexpected earnings, and short a portfolio of the lowest decile, those with bad earnings surprises, produced an average CAR, cumulative abnormal profits, of 4.2 percent over the sixty day period after announcement, or about 18% annualized. In addition, the effect is more pronounced for small firms, which are less covered by analysts and less followed by the investment community, resulting in a zero-investment strategy CAR of 5.3 percent, or over 21 percent annualized. Although the effect does last, on average, past the 60 day limit, it does seem to finally disappear by the end of a 180 day, or three quarter, period.

In the end, the only type of investment that will not be upset by an unexpected market crash is some sort of arbitrage strategy. We just use a broader definition of the term and the strategy.