trading

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In my last post, I mentioned that Berkshire Hathaway was undervalued and a good buy that the current price of $76 per B-share.

It turns out that it’s probably a better buy than anyone expected.

Buffett just announced that he’s spent $10.7 billion buying IBM stock, as well as a few billion dollars on CVS and VISA.

I currently own BRK-B, and I’d like to increase my exposure to it. But I’m strapped for cash.

So how do I make money from being LONG BRK when I’m short on cash?

Time to look at option strategies.

When most investors are bullish on a stock, they buy CALL options on it. They fork over some money (called a premium) and have an option to buy that stock at a specific price (called a strike price) at a future date. If the stock price exceeds your strike price, then you’ve made money.

One problem with this approach is that the recent volatility in the market has increased the premiums on options.

Another problem with this approach is that usually,  investors lose money on options. Most commonly, the options expire worthless because the stock price didn’t hit your strike price. And sometimes investors paid too much premium, so that despite exceeding the strike price, they still end up losing money overall.

Let’s look at an example.

Consider the BRK-B, Jan 2013 $75 CALL option. It’s currently selling for $10.50, which means on each contract (1 contract is 100 shares), you’d pay $1,050.

So, in January 2013, unless BRK-B is trading for more than $85.50, you’ve lost a thousand dollars!

A better way is to use PUT options.

When you buy a PUT option, you’re paying a premium and you have the right to sell a stock to someone at a specific price at a future date. You make money if the stock price declines below the strike price. You would enter this contract if you were bearish on the stock.

However, if you SELL a PUT option, you receive a premium. In return, you must buy the stock if it declines below a certain price. If the stock goes up in value, then you get to pocket the premium. So you would only enter this contract if you were bullish on the stock.

Being bullish on BRK-B, and short of cash, I’ve taken a short PUT position.

As I outlined in my previous post, I think BRK-B is worth $112 and has a floor below $72.

I sold the Jan 2013 $60 PUT for $4.50. This means I collected $450 per contract.

If BRK-B drops below $60 per share, I will be forced to buy the stock.

However, based on the premium I collected up front, my purchase price will be $55.50 or 50% of what I think is the intrinsic value.

Mostly likely, the option will expire worthless and I’ll get to keep the premium.

This also how you can turn around the high premiums to work in your favor.

If I didn’t already own BRK-B, I would go for a higher strike price. Most likely, I would sell the Jan 2013 $80 PUT for $11. This would allow me to collect $1,100 per contract.

Of course, the risk that I would be assigned the stock would also be much higher. But I would be comfortable owning this stock at an effective price of $69 per share ($80 strike price – $11 premium = $69).

Option trading is not without risk.

It’s easy to over-leverage and wipe out your portfolio. I use this strategy with great caution and with a lot of forethought.

You also need the highest level of option trading and a margin account in order to sell puts.

A trade like this one usually has a 20% margin requirement. Which means, I need at least $1,200 in margin. Based on that margin a $450 premium would represent a 37.5% gain in 14 months. Not too shabby.

If you’d like to learn more about option trading, I strongly recommend The Bible of Options Strategies: The Definitive Guide for Practical Trading Strategies. It’s a excellent primer on various option strategies.

Disclosure: If it wasn’t already obvious, I’m long BRK-B. Both the stock and by selling puts.

One of my favorite investors, Nassim Nicholas Taleb, founder of Empirica investment management funds and author of Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, was recently quoted on Bloomberg advising every single human being to short the US Treasury bonds. While this news is about a week old, I thought I’d still comment on it given the fact that it’s a pretty strong statement and that I recently exited a similar paired-trade.

Taleb said investors should bet on a rise in long-term U.S. Treasury yields, which move inversely to prices, as long as Bernanke and White House economic adviser Lawrence Summers are in office, without being more specific. Nouriel Roubini, the New York University professor who predicted the credit crisis, also said at the conference that the U.S. dollar will weaken against Asian and “commodity” currencies such as the Brazilian real over the next two or three years.

The Fed and U.S. agencies have lent, spent or guaranteed $9.66 trillion to lift the economy from the worst recession since the Great Depression, according to data compiled by Bloomberg. Bernanke, who in December 2008 slashed the central bank’s target rate for overnight loans between banks to virtually zero, flooded the economy with more than $1 trillion in the largest monetary expansion in U.S. history.

President Barack Obama has increased the U.S. marketable debt to a record $7.27 trillion as he tries to sustain the recovery from last year’s recession. The Obama administration projects the U.S. budget deficit will rise to a record $1.6 trillion in the 2011 fiscal year.

“The problem we have in the United States, the level of debt is still very high and being converted to government debt”, Taleb said in an interview with Bloomberg Television. “We are worse-off today than we were last year. In the United States and in Europe, you have fewer people employed and a larger amount of debt”.

Moody’s Investors Service Inc. said on Feb. 2 that the U.S. government’s Aaa bond rating will come under pressure in the future unless additional measures are taken to reduce budget deficits projected for the next decade.”.

Do I believe him? Absolutely. So why did I exit my highly profitable trade? Several reasons. During times of global economic uncertainity, there has always been a flight to quality. We saw this during the financial meltdown in 2008, where US Treasury prices soared and yields tanked. Right now, there is uncertainity in Europe regarding the debt of Greece, Portugal, Ireland, and Spain. People are worried this might have lasting consequences on the Euro as a viable currency. These fears are probably overblown, but until everything settles down and we have more clarity, there will be a flight to quality, which means that people will sell the Euro and flock to US Treasuries.

At least thats my hypothesis and I sold all my positions (except Berkshire Hathaway), shorted the Euro and also the S&P500. The one thing I didn’t do is go long the US Treasuries, since inherently I feel Nassim Nicolas Taleb is correct. At some point, I’ll most likely re-enter my short US Treasury trade, but in the meanwhile I happy to see how the European Union handles the issues of excessive debt.

This guest post comes from Kevin at 20smoney.com, a blog covering financial topics such as investing, money management and the development of income streams.

Despite the fact that most people tend to think that a market that has already booked a 60%+ rally is a great time to be invested in stocks, I tend to lean the opposite direction.  With such a massive run already in place, the risk/reward scenario is not nearly as good as it was when compared to earlier in the rally.  So, how should you play the current environment?

The sectors with some of the largest gains this year have been technology and financials.  As such, these sectors warrant extreme caution if you are currently long or are getting long any companies within these sectors.  If you want to be long the sector, but aren’t sure of specific stocks, consider mutual funds or ETFs such as Financial Select Spider (XLF) and Technology Spider (XLK).

If you’re looking to gain exposure in these sectors, I strongly encourage you to monitor some basic technical signals so that you can identify a clear exit point in case the broad market and/or these sectors reverse and head lower.  Watch the 20 and 50 day moving averages.  If the stock (or ETF) breaks through these key averages, be ready to exit the position.  If you don’t feel comfortable with such a strategy and want to take a more long term focus, I would then wait for a significant pullback, at least 5%, to enter your position.  Remember, you’ve already missed a large run in stocks, and you need to be careful entering a position at these levels.

If you have held stocks this year, especially in the sectors named above, you may consider actually selling some of your positions to lock in profits.  Taking profits is never a bad idea, and if you don’t want to pull out completely, simply sell half or maybe a third of your position.

If you are looking to enter other long term positions, I would point you towards dividend paying companies that will pay you to hold them.  This will help offset any losses in share price if there is a reversal in the markets.  Also consider multi-national companies that generate a significant portion of their earnings from abroad (this will help you hedge against weakness in the U.S. economy).  In this category, consider Philip Morris International (PM), Wal-Mart (WMT), McDonalds (MCD) and perhaps Microsoft (MSFT).

For me personally, I’m pretty bearish on the economy and the markets.  I’m skeptical on the strength and durability of the recovery and the stock market rally.  I believe that we have structural issues with our economy that have not been addressed and therefore will prevent real growth.  I’m not adding to any positions in the current environment, rather I’m “keeping my powder dry” waiting for much more attractive buying opportunities.  I do own gold related instruments such as GLD and GDX because I think gold has the potential to perform well in both an inflationary recovery and a deflationary environment (pretty much the only asset with this ability).

As I mentioned above, if you’re looking to try and make a few bucks on the continued rally in the broad markets, be extra careful and be ready to exit by monitoring some key technical sell indicators.  Protecting your money is a better strategy, in my opinion, than chasing returns, especially today.  If you’re a long term believer in the recovery and the future of the economy, get long some solid companies, but don’t be afraid to be patient and wait for better entry points.

General Motors (GM) announced a $39 Billion loss last week. Considering that its Market Cap is around $18 Billion, that’s a  loss that is twice the value of the entire company!

 The CEO tried to soften the impact of the loss by claiming it was a tax-related, non-cash write-down.  They were infact carry-over tax losses that the bean-counters insist GM consider as a loss. Typically, tax losses are carried as assets (or so I’ve heard) and are used to offset the tax impacts of profits.

But GM has had a loss in the past 19 out 20 years (I think I read somewhere that the losses totalled $275 Billion), its market share has been dropping every year and its losing money on every car it sold. The only money it was making was from its very profitable financing department GMAC that was used to finance cars and houses. But the financing profits are starting to dry up as the economy starts to fall apart.

Its being forced to borrow more and more money every years in order to stay afloat. And the cost of its interest is rising.

It seems the accountants decided that GM cannot make a profit in the immediate future and is likely to go bankrupt. So they forced the company to take the “non-cash tax-loss” as a write-down, since there won’t be any profits to write them off.

So I think its time to start shorting GM.  I haven’t always had success shorting stocks. I shorted Countrywide (CFC) and WCI Communities (WCI) a few months too early and took losses, instead of large profits.  So I’ll be a little cautious about entering the trade on this one, but I still think there’s a chance GM might infact go bankrupt.

I just closed down my account with TDAmeritrade. I transferred everything to Izone.com.

Funnily enough, Izone is owned by TDAmeritrade and offers EVERYTHING that my regular TDAmeritrade account offered. Infact, the user-interface is identical. Its so identical, that the new username and password I created at izone.com even works at tdameritrade.com!!!!

 So whats the difference? All the commissions are half-priced as compared to TDA.

But whats the catch? There’s no phone support and you need to have a couple of years online trading experience in order to open an account. Actually, I’m not sure about the ‘no phone support’ policy – I suspect that if you call up the customer support number for TDA and give them your izone username, it just might work. In any case, I usually asked my questions via email at TDA, so there’s no difference for me. And izone also has a live ‘customer support chat’ feature during normal business hours which has less wait time than the phone lines.

 I did an internal transfer since my old account was at TDA. It took place at 11:45 pm so my regular trading wasn’t affected at all! Now thats some decent service!

Let me know if you want to open an account and I’ll send you a referral email. I think we both get 10 free trades.