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.

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.

Maximizing Savings Through Your Work

One of the best ways to save for retirement is through your work. If your company offers a 401K or similar program, it's hard to beat the tax advantages that saving that way can offer. I've been contributing regularly to the governments TSP(Thrift Savings Plan) program for years now, but never in any great way. They don't offer matching contributions for military members, so I've been more interested in investing in a Roth IRA and limiting my TSP contributions.

This year however, I've already made my full annual IRA contribution. That means more money each paycheck for me! Alternatively, I could take the extra money that I would have invested in my IRA and switch it to TSP. Of course, there is the holy grail of retirement saving: Maxing out my TSP contributions. For 2009 that limit would be $16,500 (the same as a 401K). That is quite a chunk of change. It comes out to $1,375 per month. Can I possibly afford to save this much? Currently I'm saving about $500, and combined with the money I'm not contributing to an IRA that would be about $900. That means I'd have to devote an additional $475 each month to long term saving.

It's tempting, and I'm pretty sure I could pull it off, but right now my entire life situation is in a state of flux since I'm moving to another country. There are a few unknowns that could come back to bite me, so I'll be a little careful here. I'm definitely increasing my contributions, but not quite to the max. Once I'm settled in my new local, I'll reevaluate my situation.

IRA Bonanza

I sold my Acura last week and the check finally cleared my bank account, so now I've been figuring out what to do with the proceeds.

The first thing I did was pay off the remaining balance on my first 0% APR credit card. This is the portion I wasn't able to transfer over when I switched to a new 0% APR card. I also setup automatic payments on the new card so that I wouldn't forget to make a payment and incur horrible penalty payments and interest.

My other major decision was to max out my IRA in one big lump sum this year. In previous years I've thought this was a bad idea for a number of reasons. First, I didn't have the cash to do it. Second, I wanted to take advantage of dollar cost averaging for my contributions.  [In retrospect, with a continually rising  market like we had for the past 6 years, buying it all early would have been better]. Dollar cost averaging is certainly easier on the check book.

So this year I find myself with the cash and a yearning to invest while the market is down. Granted, the bottom could still be lower yet, but I'm not good enough to call it and investing now has some advantages. I've been wanting to increase my REIT holdings for a while, but since that fund is held in my IRA I've been limited by the annual contribution limits for 2008. So this January has seen a nice confluence of factors and I bought into the Vanguard REIT fund VGSIX.

I like this fund because it, like all Vanguard funds, has low cost and low turnover. REIT funds also have impressive dividend returns. In fact, the most recent dividend payout for my REIT fund was greater than from my S&P 500 fund even though the S&P fund has significantly greater assets. Because of the higher dividend payouts, it's a good idea to keep REITs in a tax sheltered account like an IRA. Buying at the begining of the year means greater dividend payments throughout the year.

On a side note, I just found out that bonanza means an exceptionally large and rich mineral deposit (as of an ore, precious metal, or petroleum). Hopefully this IRA turns out to be a dividend bonanza!

Is it time to buy American?

A few weeks ago I posted my thoughts on the financial sector as part of an instructional guide on what I look for in buying an ETF. I actually ended up buying 4 shares of VFH(Vanguard Financial Sector ETF) for about $33 a share. It looks like I timed it to well for my own good, because it has gone up to $41 a share and now I don't want to buy it any more. So what next?

Well, I saw an article on Yahoo! Finance called "Will Ford and GM Run These Funds Off the Road?". The gist of it is that US Auto makers have taken a beating on the stock market recently, and funds that own them may also perform poorly. Poor performance! Thats just what I'm looking for!

Down on their luck

Looking for poor perfromance? I'm sure you think I'm crazy, but I'm a contrarian investor. That means I look for stocks or sectors that have been punished for no good reason ( or for temporary reasons) and whose stock value has been driven lower than it probably should be. That is the time to buy. The highs and lows of a stock are unpredictable, and choosing which startup company will be the next Starbucks or Google is pretty darn tough. But seeing that an otherwise good company is down on it's luck is not that difficult right?

Well, there are somethings to watch out for. No company it too big for bankruptcy. If bankruptcy is coming up or being talked about, don't buy! Stock holders have about as much claim in backruptcy court as obese teenagers suing Mcdonalds. But seriously, stock holders are pretty much last priority, and most likely the stock will be entirely reissued.

Also, it's impossible to call the bottom. I learned this with Moneygram International (MGI). I noticed their stock when it had lost about half it's value. I bought 6 shares at $15. Now the stock is about $1.70. I decided to keep buying on the way down. They were hit pretty hard due to the credit crisis, but I think they still have good prospects for the future. Because I buy in increments of $100, I now own over 300 shares with an average price of $2.13. I'm also a long term investor, so I can wait years for the company to recover its finacial footing.

Buying in small increments helps protect you from losing too much at any one time. Sometimes, you lose out on more of the upside like I did with VFH, but I sleep better knowing that I bought 6 really expensive shares of MGI, and a lot of cheaper ones. Of course, if the company is going down, the shares are expensive at any price.

Down, but not out

So back to American auto makers. They've had a bad quarter. Actually, looking at the charts, Ford's stock has been sinking since 2000, so they've had a bad decade, and this past quarter is just the iceing on the cake. So why an I optomistic.

I can see several senarios that work in my favor. First, gasoline prices. They were high, but now are coming down. This will have two effects. The auto companies got a shock when people stopped buying big SUV's and trucks. Therefore, they will work to make better small cars in the future to regain market share. Also, after a while people will forget about how high gas prices and start buying trucks and SUV's again.

Second, the losses this quarter shocked investors. This means people irrationally sold the stock without evaluating long term trends. Therefore, the stock should be undervalued. Value is difficult to determine when profits are negative, but I don't believe profits will be negative forever. Also, the losses this quarter include a number "special charges". I think the auto companies are taking their lumps all at once, and future quarters will not be so bad.

I'm still new to investing in individual stocks, so hoping that auto makers read the signs and shift gears may be in vain. However, I'm an optimist. That's why I'm going long on F and GM.

Some random thoughts on stocks

I"m reading a book right now called "A random walk down Wall Street" by Burton G. Malkiel. I highly recommend it to anyone interested in directly investing in the stock market. The author's basic premise is that it's a losing game if you try anything other than a broad investment strategy such as a total market index fund. All his talk about the behavior of stocks (and stock investors) has got me thinking about the nature of stock. The following are some random musings on my part.

The whole premise of stock investing is that over time stocks go up in value. This has been shown to be true since stock markets began, but the amazing thing is that they go up in value faster than just about anything else around! The value rises exponentially, at an average rate of 9% per year(historically). Thats astounding. Consumer price inflation rises at about only 4% per year. I wonder why there is a disconnect between the two. The value of most everything else rises much more slowly than stocks.

Inflation itself is a tricky beast. Why does the price of everything go up over time? Because people think it does! Sounds crazy, but it must be true. The value I get from, say, a can of tuna doesn't change from one can to the next. The amount of work to produce that can of tuna doesn't change appreciable either. But over time, I pay more for each can I buy. I think it stems from people wanting more, which also explains why prices rise exponentially.

Corporations want more profits, so they raise the price of their goods slightly. A free market would punish those who raise prices by producing competitors who sell the same goods at a lower cost, which I guess is a driving factor in keeping the inflation rate down. However, everybody desires more money for their goods and services. Employees want a better salary so they go the firm that pays the most. Delivery drivers want more compensation for delivering the goods, workers want more for producing the goods, and construction companies want more for building the factories. The increases are relatively small each time, but over years they compound and thus we have inflation.

Why does the cost of goods rise exponentially vice linearly? Because of the way humans perceive difference. For example, if you were in a store and needed to buy item selling for $15, and you knew it was selling for $5 at another store, you would go to the second store. But what if your where buying a plasma television, and saw it at the store your were in for $1010 and the other store for $1000. You probably wouldn't bother. The difference is that your mind perceives the first item at a 66% discount, while the second item is at a 1% discount. People are geared to perceive the relative difference, not the absolute difference. If you  made $30,000 a year, and got a $1000 raise, you would probably be quite pleased. But if you made $70,000 and only got a $1000 raise, you would probably be ambivalent or even displeased( because it isn't keeping up with inflation!)

Oh well, just be glad we aren't Zimbabwe. According to wikipedia the current inflation rate as of April is an extimated 165,000% and they just issued a $50,000,000 dollar note(US $1.20)

Still, I wonder what drives stock values up more quickly than other prices. If it weren't for stock splits, some of the older companies would be priced right out of individual investors range( such as  Berkshire Hathaway, which closed today at $127,200)

Moving accounts

I've been thinking about moving my Sharebuilder account over the Zecco for quite some time now. I stopped my automatic investments with Sharebuilder awhile back, and any new money I wanted to direct into stocks has been through Zecco because of the zero commissions aspect. When I fist signed up for Zecco I considered doing a brokerage account transfer from S->Z , but at the time there was no incentive. It would have required mailing in paperwork and waiting for more than a month for the brokerages to sort things out. Now though, with Zecco's change in policy such that only accounts > $2500 get free trades, I have a better incentive. On Friday I did a little research into making the switch. I was halfway into filling out the forms for the transfer when I had a few questions(The instructions where non-existent). Turning to the internet for help, I discovered fellow finance bloggers who had made this transition before. Particularly The Sun's Financial Diary was useful since he detailed each step of the process, and brought to my attention the fact that Sharebuilder charges a $50 fee for account transfers. Since I had no free cash in my account, shares of my stock would have to be sold to cover the fee along with the partial share that I own since Zecco only transacts with whole shares. On the other hand, sharebuilder does charge to close an account.

So my plan of action now is this: sell all my shares at sharebuilder for a $10 fee on real time orders, take the money from the sale and transfer it to Zecco( through my checking account), where I can buy the same stock or any other one I please. The downsides of this plan are the trade fee (which is less than an account transfer fee since I only have 1 stock), and any tax consequences I might incur. Since I first bough this stock a little over a year ago, some of my sale would be taxed at the long term capitol gains rate, and some at the short term(< 1 year) rate. However, because or recent down turns in the stock market, my sale of this stock should result in a net loss, which may be favorable to me on my tax return next April 15(Probably not by much). Since I've never sold any of my investments before this will be an interesting exercise.  I'll have to figure out my cost basis, and how the sale will actually affect my taxes next year. My loss will probably be about $300 dollars, so not to big an effect either way. Slogging through IRS publications is not my idea of a good time, but it looks like I'll become acquainted with publication 550.

The cheapest way to invest long term

I said in an earlier post I'd cover the absolute cheapest way to invest, so here it is. The answer is Zecco and ETF's. How so you ask? Well, ETF's are exchange traded funds, basically mutual funds that trade on the stock exchanges just like any other company's stock. The basic structure of an ETF allows for very low fees , somewhere on the order of 0.25% or less for all of Vanguards funds. The ETF is usually cheaper than the actual fund if you were to buy it from the company. Considering the average mutual fund expense ratio is 1.4%, you are paying 4-6 times less for an ETF. So why are mutual fund companies still in business? Brokerage fee's.

To buy an ETF, you must go through a broker just like any other stock transaction. Even with the rise of the discount broker you pay $4-$7 per transaction, which translates into 4-7% of a monthly $100 investment. Sharebuilder is your best bet for dollar cost averaging using ETFs, as long as you are putting in $200+ per month to keep the investment cost ratio down. So how does Zecco fit in?

Zecco is a company that offers zero cost commisions(hence the name zecco) on regular stock transactions if you meet there requirments. Right now that mean >$2500 invested gets you 10 free trades a month. Less than $2500 and you pay $4.50 a trade. Once you meet the minimum cash limit, suddenly ETF's become cheaper than mutual funds due to the low expense ratio. Since the goal is to accumulate wealth, you won't be selling anytime soon, and the $2500 will be met with in year, or two.

Over a 30 year period, the difference between even 0.15%(Vangaurd 500) and 0.07% (Vangaurd Total market ETF) can be $3000 for every $10,000 invested. The only drawback right now is that Zecco does not offer an automatic investment program. You can open an regular or IRA account, but you must make the stock purchase every month yourself. If have the discipline to do this, you can save big in the long run, but until they offer an alternative, I'm sticking with Vangaurd mutual funds, because you just can't beat having the money taken out automatically. Still, I use Zecco to play around with stocks small time. Check them out at Zecco.com

Words of Widsom from my father(he's a pretty smart guy)

Today is a guest post from my father. He wanted to emphasize a few points about saving for retirement

He Says:

"I would recommend that one first invests in a 401(k) up to the
company match limit.  You can't beat an instantaneous 50% (or in some
cases 100%) return on investment.

Next, I would invest up to the max limit in a Roth IRA.  This is
especially true for those who are early in their career.  Early on,
you're not making much and your marginal tax rate may be, for example,
10-15%.   The fact that you must use after-tax dollars is not a big hit
early in one's career.   And 40 years from now, if they have followed
your advice, the income they derive from investments might be
substantial.   Sure is nice to be tax-free....

Next:  if any of your 401(k) is paid in company stock, diversify at your
earliest convenience.   The law now allows you to do so.   All of my
company match is in Crane stock....and at least once a year I go in and
transfer it to a different diversified equity fund.

After that, it gets a little hazier.   I continue to fund my 401(k) to
the max because I am so fortunate to be in a 25% tax bracket now.  It
makes sense for me to shield income now, as I don't expect to make
nearly so much in retirement.  Also, in true couch potato fashion, it's
just a mindless way to invest.   I never see the money, so it doesn't
get spent.   The downside of 401(k) investments is they are not
accessible until retirement, or you pay a 10% penalty to access the
money.   So it's not for everyone."

Thanks for the advice Dad. He also recommends (and so do I) the Scott Burns articles. He's a writer for the Dallas Morning News where He answers questions and has common sense financial advice for the average person. Check it out at Assetbuilder