Step3 Prophet

Test run of Zecco Options Trading

A few weeks ago I signed up for Options trading privileges from my brokerage, Zecco.com, and today my options access was granted.

The basic idea is simple. I have shares of a company in my regular trading account that I'm willing to sell and make some profit on. In the mean time, I intend to sell "covered calls" so that I earn money from the shares until they get sold. Basically, it means that someone will pay me for the right to purchase my shares of stock if it rises to a certain price. The risk is that the stock will rise the call will be used by the buyer. One of the nice things about Zecco is that you can have a pretty girl explain this and other investing techniques to you. Another explanation can be found here: http://www.mindxpansion.com/options/sell-calls.php .

I logged in today full of excitement, and then discovered I had no idea how to actually execute the sale. There are something like 11 fields to input information into, and I need to learn the right way to do it.

  

My starting point is the Zecco.com education section. I know basically, what I want, I just need to figure out how to tell that to Zecco. Sadly, zecco was less than helpful on the specifics of executing the trade. I was able to figure it out with an hour of experimentation and internet research, but it should have been easier.

My trade type options are: BASIC, COVERED CALL, LONG/SHORT ROLL OUT/ MARRIED PUT.  I'm trying to sell a covered call, but it looks like when I select that option it forces me to buy the underlying stock at the same time, which I don't need to do. I'll stick with basic for now.

My transactions options are BUT TO OPEN, SELL TO CLOSE, BUY TO CLOSE, SELL TO OPEN. Once again, I'm not sure so I'll look it up. It turns out that each option transaction has an opening and closing phase, unlike a stock which you can hold indefinitely. Since I'm writing a covered call, I want to SELL my option contract to OPEN the transaction. 

The rest of the fields aren't quite as obscure.

• Contracts: The number of options contracts you are writing or buying. One contract is generally for 100 shares of the stock, so I only want to write one contract.
• Symbol: is the stock ticker symbol.
• Expiration: is the last day on which the options can be exercised. 
• Strike: is the price you will sell (buy) the stock at.
• Order Type: Limit or market. Market means you will pay the best asking price around, Limit means you will only pay a certain price or better. I prefer limit orders because it is easy to know what you will pay.
• Limit Price: Is the maximum you are willing to buy/sell a stock or option for. 
• Duration: Either Day, meaning you will only buy/sell at that price for one day, or GTC, good till canceled, meaning you have to explicitly cancel the order.
• AON: All or none; if you check this all of your order must be executed at the specified price.

To actually execute an options trade I found you had to look up the options chains for that stock, which is step 1 circled in the picture below. You just enter the stock symbol and select the "options chain" link.

 
 

Step 2 is to select the option date and price you want. The default is the closet to expiring options, but you can select future months/quarters. I chose 19Jun2010. As you can see, the higher the strike price, the less money people are willing to buy the option for. Also, as you get closer to the expiration date, the cheaper the options sell for. Once you click trade, most of the boxes are filled in automatically at the top. I couldn't fill in some of the boxes on my own, so it makes me wonder how generic contracts get written.

Step 3 is to enter the type of transaction (Sell to Open) and the number of contracts. I'm only selling one for now, to make sure I really do understand the process and don't make a huge blunder.

Finally I previewed the order:

 

Expected Proceeds of $56.00. Nice. Now I just hope that F doesn't quite hit 13.00, and so I can sell it again next quarter.

Question about a bonus and F-connect test

I'm testing out the F-connect feature of Typepad, which should link my blog w/ my FB account.

Here is a question I pulled from yahoo answers. It caught my eye because its related to military matters and finance: I am reenlisting the the Air Force and receiving a $50,000 bonus. I do not pay any state taxes so I only want to know around how much I get to keep after taxes. I just returned from a combat zone and will not be going back for a long time. I couldn't reenlist overseas because I was just short of my window. Any help would do, but someone who has received the same or near the amount I am getting and could give me a rough estimate would help

Since he can't reenlist in a combat zone, the bonus is taxed at his normal rate, which means it depends on base pay, TSP savings, and how he gets the bonus. I'll make some assumptions here to show how it works.

Let's say you are single, E-4, have over 4 years of service, and no TSP contributions, which makes for a base pay of $2094/month or $25,129 a year. BAS and BAH are not counted since they are allowances. Special pays and bonuses are taxed, so you just have to figure it out what your expected income is for the year.

This year the 15% tax bracket is between $8,350 to $33,950, and the 25% bracket is between $33,950 to $82,250. (you can find these on page 101 of the i1040 pdf.)

You get roughly $10,000 in exemptions and deductions if you are single with no dependents, which makes your starting taxable income about $15,000, which means you start in the 15% bracket and each additional dollar is taxed at that amount until you exceed that bracket.

If you get your full bonus this year, the first $19,000 will be taxed at 15% so your tax will be $2850
($15,000 regular income + $19,000 bonus = $34,000 limit on 15% bracket)

Your remaining $31,000 bonus will be taxed at 25%, so you will owe $7750 on that part.

Including Social Security & Medicare @ 7.65%:  $3825

Your total tax liability is $7750 + $2850 + $3825 = $14,400 in taxes.

In this scenario, taking your bonus over 2 or more years would save about $2000

Downsides of Home Ownership

I've been playing around with yahoo.com answers quite a bit recently, and I came a cross a question asking about the negatives of home ownership. Home ownership has been on my mind alot recently because I may end up buying a house in the next year or two, and I'm not enthused about it. Here are some of the reasons why:

-It costs lots of money to buy and sell a house. Granted, houses have a fairly steady value, but I can't buy it without financing and selling costs are horrendous.

-It costs lots of money to finance a house, starting with the loan origination fees and ending with you paying more than the value of the house in interest payments.

-You have to pay property taxes, which will probably be overvalued due to the housing bust.

-Homeowners insurance is much more than renters. 

-Homeowners association fees + HOA's themselves. While it's annoying to have some little neighborhood group tell you what you can and can't do with your house, the scary part is that they can legally seize your house under very petty circumstances. 

-Upkeep costs. In my last rental home the sewer drainage pipes under the yard started backing up. The homeowner sent Roto Rooter to find the problem, which they sort of did, and Roto Rooter offered $5000 to dig up a 4x4x4ft patch of yard and fix the problem. The homeowner decided to do it himself, and he did a good job, but I never would have been able to do it. Also, a second hole was required. If I had owned the house (and I would have bought it too if I had been offered that at move in), I would have had to pay $10,000+.  Also, every 10-15 years homes need new roof, floors/carpet, appliances, etc.

-Home values will probably be fairly constant for a while due to the housing bust, recession, and the fact that any increase in interest rates will depress the median home price due to more stringent lending standards. 

There are many good benefits of home ownership as well, but I'm just being negative at the moment.

Dabbling in Options

I've been catching up on a number of finance blogs that I used to read quite regularly, and came across and interesting article from DoughRoller called "A Simple Yet Profitable Call Option Strategy". Much like DoughRoller, I haven't really considered dealing with options until now. Normally they are only good for two things:

• Managing risk in a portfolio.
• Wild Speculation.

Options are basically a promise to buy or sell stock (or other goods) at a certain price by a particular date. You have the option to buy or sell at that price regardless of the current value of the stock.

When used to manage risk, you can do things like preserve value of your assets even if the market takes a steep dive. This is good for someone who has a short term need to persevere value such as an estate executor maintaining an inheritance for someones heirs or a trust fund for a minor. Since options used in this manner generally limit your upside gains and cost money that you usually will never see again, I have avoided them.

You can also use them to increase your leverage by making promises to buy or sell stocks that you don't actually own. Wild speculation like that gets many people in trouble with options because if you make good bet, you can win lots of money with very little down but if you bet poorly, you can lose more than you would think possible. For that reason options trading accounts have a little more stringent rules than your normal stock brokerage accounts. Anyone considering options trading should put more than due diligence into their research to understand the risks and rewards. This article on investopedia has a good overview of why people use options, but don't let their talk of rewards and risk management cloud your judgment. Options are not a long term strategy. 

I still remember and episode of "Saved by the Bell" where the class plays with stock portfolios during a lesson and Zack ends up selling the stock and buying potato futures on margin. When the potato market crashes, somehow he is left with a parking lot full of potatoes.

The third thing options are good for is generating extra income by selling options contracts on stock I already own aka, a "covered call". Basically I'm letting someone buy the right to purchase my stock at a particular price before a certain date. Since I'm inclined to sell some of my current stock anyway, I think writing options contracts and making a profit on the income is a win-win for me. Whatever happens I get the contract price. If the options expire without being exercised, I still have my stock. If the options are exercised and my stock gets sold, then I make a profit( or maybe take a loss?) that I was going to take anyway.

My preferred stock broker is Zecco.com because of their free trades. They don't have as many features as some of the more expensive brokers, but I don't really need those features for my basic stock trades. To make things simple I'll keep my options account with them as well.

  At Zecco

• Options fees are $4.50 + 0.50 per contract.
• You must complete an options agreement form, which is basically a risk assessment form followed by 2 pages of legalese, and mail it in to Zecco. You can do this anytime during or after account opening. 
• You will be given a level of 1,2,3, or 4 based on what you want to do and the risk Zecco feels comfortable taking on you. For my basic purposes I only need a level 1 clearance, but I'll apply for level 2 to "keep my options open"(haha).

Levels 3 and 4 require margin accounts, which is basically a line of credit or loan used for purchasing stock. It's another form of leverage. Level 4 requires a minimum account balance of $250,000 and allows the riskiest trades such as uncovered equity(naked) options where you do not own the stock you are promising to buy or sell.

I'm mildly annoyed that I have to snail mail the form in but I remember having to do that for my inital account opening as well. I guess I'm spoiled by the interent age and want instant gratification.

IRA 2010 decisions

I've been giving a lot of though over the past two weeks to what I should invest my IRA money in this year. Last year I did pretty good investing in the Vanguard REIT fund, but this year the fund is up quite a bit, just like everything else. With pretty much all asset classes rising phenomenally in the past year, it's hard to find what is undervalued. Granted, bonds didn't rise as much as stocks, but they are not really expected to. I'm not that confident in my bond assessments yet anyway. Headlines like this could give anyone pause " Mamas & Papas To Streamline Recruitment Process With Applicant Tracking Software Bond Talent. " WTF mate? So I've decided to let my asset allocation strategy be my guide. Currently here is where I stand:

	Current	Goal
S&P total	28.28%	25.00%
Loans	8.73%	10.00%
Small Cap	5.85%	10.00%
International	19.58%	20.00%
REIT	11.89%	15.00%
Stocks	19.81%	10.00%
Bonds	5.85%	10.00%
SUM	100.00%	100.00%

As you can see, the allocation is grossly out of sorts. I'm not going to try and force the numbers to match my allocation exactly, because that usually incurs extra fees and taxes. I'm going to pour a little more of my investment money into certain areas, namely small cap, loans, and REIT, and sell a little bit of my individual stock holdings. I won't touch bonds for the moment because I only invest with them through TSP, and I don't want to change my allocations there just yet. For the small caps stocks, I'll look at adding a small cap fund to my vangaurd IRA, or maybe using their brokerage services and getting an ETF. An ETF would probably offer lower expense ratios, and because I'm making a big one time purchase the brokerage fee would not be as big a factor.

Since I think stock prices in all areas are still overpriced, I'm not in a rush to make changes right away. I predict we'll see a drop toward the end of January and into February. My goal is to have all my IRA money invested by the end of the first quarter, so I have a little time to research funds and to time when I put my money into them and my current REIT. Loans are good to invest in any time, but I'm not going to use them in my IRA just yet, although I probably should since they are high interest generators.