Geldpress

We’ve seen the run to cash in on falling DOT COM bubbles.  Alan Greenspan then acted to turn the technology bubble into a housing bubble.  He ratcheting down interest rates and encouraged banks to make easy and risky loans to everyone with a heartbeat, and sometimes without.  As the financial sector crashed amidst a pile of worthless assets, government acted quickly to stem a run on the banks.   But will foreign governments be so easily persuaded to dump good money after bad in funding America’s debt addiction.  Read what Peter Schiff had to say in  a recent Wall Street Journal editorial:

…the nations funding the majority of America’s public debt — most notably the Chinese, Japanese and the Saudis — need to be prepared to sacrifice. They have to fund America’s annual trillion-dollar deficits for the foreseeable future. These creditor nations, who already own trillions of dollars of U.S. government debt, are the only entities capable of underwriting the spending that Mr. Obama envisions and that U.S. citizens demand.

These nations, in other words, must never use the money to buy other assets or fund domestic spending initiatives for their own people. When the old Treasury bills mature, they can do nothing with the money except buy new ones. To do otherwise would implode the market for U.S. Treasurys (sending U.S. interest rates much higher) and start a run on the dollar. (If foreign central banks become net sellers of Treasurys, the demand for dollars needed to buy them would plummet.)

In sum, our creditors must give up all hope of accessing the principal, and may be compensated only by the paltry 2%-3% yield our bonds currently deliver.

Here is congressman Ron Paul speaking about the same issues of issuing more credit in a feeble attempt to stop the credit crisis.  It’s simple economics, but unfortunately, very few in congress understand it, and even fewer in the financial media.

Also see:

• Peter Schiff Schools Reagan Economic Adviser
• The United States Has Not Had A Balanced Budget Since 1957!

January trading came to a close today, with the market indexes showing the following results:

• Dow Jones was DOWN 11.44% for the month (9034.69 to 8000.86), not counting dividends
• The S&P 500 index was DOWN 11.43% for the month (931.80 to 825.88), not counting dividends.

Not a great start for the indexes!  The Geldpress portfolio, on the other hand, was UP 3.00% for January. How did we do it?

1. Maintain a healthy cash position to deploy when new opportunities present themselves.
2. Take advantage of high volatility to sell expensive premium on covered calls.
3. Use hedging techniques such as protective puts, collars, and inverse ETF’s especially around earnings releases, to protect against major down movements.
4. Play both sides of the market to reduce wild fluctuations in account balances.

Check out the following for more info on my trading style:

Covered calls -

• Time for cover – the covered call
• The VIX index and covered calls
• Covered Calls – Scottrade, Tradeking, Fidelity
• Covered Call Writers Love High Volatility
• Covered calls – removing the covers and going naked

Hedging -

• Portfolio protection – hedging todays roller coaster market ride
• Selling Puts For Income, Or As a Cheaper Investment
• Married Puts, Collars, And Hybrid Hedging
• Bring Your Collar Into These Volatile Markets
• Understanding the bear call credit spread
• Modeling theta time decay in a bear call credit spread
• Stellar Week For Direxion 3X Bear

Long and Short -

• Balanced and hedged portfolio using proshares
• Proshares and Profunds leveraged ETF’s
• Trading strategy – hidden jewel in the shorts

I also highly recommend the following books:

The Options Course Second Edition: High Profit & Low Stress Trading Methods (Wiley Trading) by George A. Fontanills

The Trader’s Guide to Equity Spreads by Randy Frederick

The latest Case Shiller index values through November 2008 were released on January 27th.  Despite the continual cheerleading from the National Association of Realtors (NAR), housing prices continued on their downward paths.

The Case Shiller index values are the only objective housing measure worth looking at.  The view below is a quick snapshot showing the following:

• Peak Month and Value - The case shiller index values were 100 at the January 2000 reference month.  A value of 155.04 signifies that prices were 55.04% more expensive for the month listed.
• Last Value – Data currently available only through Novembe 2008.
• Peak Decline – Percentage decline from the peak month and value listed.
• M-M Decline – Percentage decline from October 2008 to November 2008.
• Y-Y Decline - Percentage decline from November 2007 to November 2008.

Meanwhile, the NAR continues its desperate attempt to re-inflate the bubble. Their methods are two-fold:

1. Ignore the data and present misleading data to unsuspecting potential home buyers.  Their latest report states that “Sales jumped 6.5% in December”.   Next thing they will tell us is that their weight increased 2,000% (since childbirth!).  Read the NAR reports carefully before buying a new home.
2. Beg congress to punish responsible taxpayers by bailing out irresponsible lenders, builders, and home speculators.  Beg congress to give your tax money to first time home buyers.  Beg congress to do everything possible to PREVENT market forces from working in an efficient manner.  Their latest statement is here:

NAR expressed support for Chairman Barney Frank’s, D-Mass., proposal, H.R. 384, the TARP Reform and Accountability Act, introduced last week. This bill contains key components of NAR’s Housing Stimulus Plan, including enacting a mortgage buy-down program to reduce interest rates below prevailing rates, increasing foreclosure prevention and mitigation efforts, and providing needed liquidity to the residential and commercial mortgage markets to ensure that financing is available. “We also applaud the chairman’s efforts to strengthen accountability and increase transparency in the use of TARP funds,” McMillan said.

Also See:

• Seattle Housing Declines, NWMLS In Denial
• More Seattle Crazy Real Estate Ads
• Seattle Housing Declines, NWMLS In Denial

Bucyrus manufactures heavy machinery for the mining industry.  They were the darling of Wall Street until about September 2008, when they, along with most of the rest of the market, took a nosedive down to earth.  At last glance, their shares are trading at $17.24, well off their 52 week high of $79.50.

I like them as a fundamental long term recovery play, but in the short term, I would rather trade them in a well hedged environment.  Volatility is still very high, as shown in 1 year VIX chart below.  But the markets are up today, and volatility may be close to breaching below the 40 level.  As volatility (^VIX) goes down, the price of stock options for both calls and puts go down with it.

Before jumping into a short term trade, its good to know the earnings release dates of your chosen company, and their competitors.  Bucyrus is scheduled to release earnings on February 19th, just one day before the February options expiration.  CNH Global (symbol CNH) already released their earnings on January 21st.  Joy Global (symbol JOYG) released theirs on December 17th.

The Bucyrus play I like is the following:

• Purchase shares of Bucyrus in 100 lot increments
• Take advantage of still high volatility to sell covered calls today(SELL TO OPEN).  The March 17.50 covered call will bring in about $240  per contract, and the March 20 will bring in about $140 per contract.
• To protect against February earnings, it may be useful to add a February protective put (BUY TO OPEN) on Bucryrus.  Buying a February 15 will cost about $80 per contract.  But as noted earlier, the market may continue heading up in the short term, and volatility may come down more.  If those conditions hold true, and as time premium continues to come down, it may be possible to get the February 15 Puts for only $40-60 per contract over the next week. Playing with the timing of the covered call and protective put separately turns the trade into a hybrid collar.

Analyzing the possible outcomes – Lets assume that an investor buys 100 shares of Bucryrus for $17.40, sells a March 20 covered call for $140, and buys a February 15 protective put for $85.  In this scenario the initial total cash outlay is $1740 – $140 + 85 = $1685.  If Bucyrus completely tanks after February earnings and goes to ZERO, then the February PUT would be worth $1500, and the net loss would be limited to only $185, not counting commissions, or dividends.

On the flipside, lets assume Bucyrus rockets higher after February earnings, and closes out March expiration above the 20 strike.  The shares would be called away for $2000, and subtracting the initial outlay of $1685, that would leave a profit of $315, not counting commissions or dividends.

And of course there are all sorts of scenarios in between, depending on the when and for how much covered calls and protective puts are entered and exited.

Disclosure: Currently long Bucyrus with a covered call hedge.  Intend to add protective put in the coming days.

Disclaimer: Trade at your own risk.  This is NOT advice.

Also see:

• Married Puts, Collars, And Hybrid Hedging
• Portfolio protection – hedging todays roller coaster market ride

The market is heading up this morning, but I’m still not to eager to risk it all on the upside.  Portfolio hedging is still crucial in these markets.  There are many ways to hedge a portfolio, such as the collar.  The collar trade is a three way combination of purchasing shares out right, selling a covered call against the position, and also buying a protective put against that same position.

• Bring Your Collar Into These Volatile Markets

A collar limits the risk to the downside through the use of the protective put.  But it also caps the upside premium due to the covered call.  For those that want to protect to the downside, but leave the upside potential untapped, then a married PUT is the way to go.  A married PUT is the combination of buying shares in a security, and also buying a protective PUT to protect the position.

Hedging positions with either covered calls, collars, or married puts requires decisions on several factors, including:

• The strike prices of the covered calls and/or married puts
• The expiration months of the covered calls and/or married puts

There are many guidelines to help answer those questions, but experience, and your own risk tolerance are the best guides.  Protective puts can be very expensive.  For this reason, those with higher risk tolerance prefer to either go without them, or use them at lower strikes and close in expirations months.

Another portfolio hedging method that I often use is more of a hybrid model, with the expectation to adjust the hedging along the way.  I may start off with long shares held completely naked without any hedging.  If I’m nervous prior to earnings, then I’ll add a short term protective put (near term) just to get through earnings.  Protective puts can easily be removed after earnings.  If there is an artificial price spike then a covered call can be put on at or below the perceived price resistance level.

For a more in depth view of stock options and adjustments, I highly recommend the following book:

The Option Trader Handbook: Strategies and Trade Adjustments (Wiley Trading) by George Jabbour

California is swimming in RED INK and is going broke.  With the debt markets still frozen, the state can not issue new bonds fast enough to cover its spending obligations.  It’s been rumored for months that California would start issuing IOU’s  to pay state workers, contractors, and perhaps even private citizens tax returns.

The IOU’s have not been issued yet, but according to marinij, at least $57 million in payments have already been halted to cover Marin projects.

With California rapidly approaching the point where it will have to start issuing IOU’s to vendors, payment has been halted to more than 75 projects in Marin totaling more than $57 million…Novato schools Superintendent Jan La Torre-Derby said she is waiting for $22 million in reimbursements from the state for improvements completed recently to facilities throughout the district. The district is also doing without another $1.5 million already allocated for three new projects: a biotechnology lab at San Marin High School, an industrial technology and design lab at Novato High School and a television broadcast studio at Novato High…

Last week, the state Legislative Analyst’s Office, which acts as a budget watchdog, warned that the state government will run out of cash sometime in February if nothing is done about California’s expected $42 billion budget deficit.

If that happens, Derby said, normal operating funding from the state would become unavailable to meet the Novato district’s $4 million monthly payroll.

To be clear, the problems in California did not spring up as a result of the 2008 financial crisis.  These problems were a direct result stemming from decades of fiscal recklessness.  During the DOT COM boom, California had ample opportunity to get their books in order from the unplanned windfall in corporate taxes.  Instead, they extrapolated the additional tax incomes out to infinity and made unreasonable projections on future growth.  The unrealistic growth expectations never materialized, but the spending was already in place and to difficult to reverse.  And the end result is that California, like many states in the union, are lining up directly behind banks, brokerages and automakers to BEG for BAILOUTS.

Also from Geldpress:

• California’s Exploding Debt Problem
• Washington state debt history – does Dino Rossi understand it?
• The United States Has Not Had A Balanced Budget Since 1957!
• CNN Continues To Report On Budgets It Does Not Understand

They don’t call themselves “Fools” for nothing.  The Motley Fool guys reiterated their favorable position on McDonald’s today after a disappointing quarter.

True, fourth-quarter profit did drop at McDonald’s. Net income fell 23% to $985.3 million, or $0.87 per share. However, bear in mind that last year’s fourth-quarter earnings were boosted by a $0.33 per share tax benefit. Operating income increased 11% to $1.50 billion.

Revenue dipped 3% to $5.57 billion, with the decline resulting from a weaker dollar. However, McDonald’s comps continue to be impressive, despite these difficult economic times. Global comps surged 7.2%, with U.S. comps up 5%, Europe up 7.6%, and Asia/Pacific, Middle East, and Africa up 10%.

The fool’s and their readers can go ahead and buy McDonald’s but I won’t be touching it anywhere near today’s closing price of $58.31.  I will say that I agree with the Fool’s that McDonald’s is a decent company with long staying power.  But at these prices, they are PRICED BEYOND PERFECTION.  And in this environment, perfection is a hard target to achieve.

As for shorting McDonald’s, I won’t do until at least the $62.50 mark.  There are just far to many moronic fund managers ignoring fundamentals and driving prices higher.  These fund managers are the same idiots that were paying over $60 a share for Lennar – the company whose motto was “Buy any non buildable scrap of dirt for sale, and offer 200% of the selling price before someone else buys it first!”.

Bottom Line:  McDonald’s is still a DON’T BUY.

Disclosure: No current position on McDonalds.

Also worth reading:

• McDonalds Options Action Ahead Of Earnings
• Calculating Fair Value For a Stock – Rule Number One

More financial turmoil is occuring in Iceland today, but you wouldn’t know about it from CNN, which largely ignored the news.  The Associated Press had a limited view, from this article:

Iceland’s coalition government collapsed on Monday after an unprecedented wave of public dissent, plunging the island nation into political turmoil as it seeks to rebuild an economy shattered by the global financial crisis…

Iceland has been mired in crisis since October, when the country’s banks collapsed under the weight of debts amassed during years of rapid expansion. Haarde’s government has nationalized banks and negotiated about $10 billion in bailout loans from the International Monetary Fund and individual countries.

The value of the country’s krona currency has plummeted, hitting many Icelanders who took out special loans denoted in foreign currencies for new homes and cars during the boom years. In addition, Iceland must repay billions of dollars to Europeans who held accounts with subsidiaries of collapsed Icelandic banks.

Here is a youtube video from today’s Iceland protests:

Also worth reading:

• Volatility And Iceland Interest Rates
• Iceland Crisis – Failed Banks, Currency Collapse, Food Shortages

Zimbabwe is still undergoing rapid hyperinflation in their country, which shows no signs of abating.  Their solution is to continue printing, adding more and more zeros to their currency.  Here is an image of their newest 10 trillion dollar bill.  It will soon be followed by 20 trillion, 50 trillion and 100 trillion dollar notes later this year.

Newsweek recently did an interview with Gideon Gono, governor of the country’s reserve bank.  When probed about our own president Obama, here is what he had to say:

Do you feel optimistic about Barack Obama’s incoming administration? I don’t want anyone to put unnecessary pressure on Obama and hold him to supernatural powers. He’s coming into a situation that is untenable already. By the very same standards, I don’t like anybody saying if President Mugabe was to go tomorrow, the fortunes of Zimbabweans will change for the better, as if he is personally liable for our situation.

The Dow Jones Industrial Average was created in 1882 by Charles Dow.  Contrary to popular belief, the original focus was on 11 growth stocks, and not industrial stocks.  The index originally included 9 railroad stocks, a steamship line and a communications company. In 1896, transportation and industrials were split into 2 averages, one of which was what we now know as the Dow Jones Industrial Average.

To calculate theoriginal index, it was as simple as adding up the prices of the 11 components, and dividing by 11.  But much has changed over the last 127 years since the average was first created.  Component companies have disappeared, new companies have been added, and numerous stock splits have occured.  One thing has not changed, and that is the use of the simple price weighted average.  Only the multiplier has changed to factor in all the component changes.

The Dow Jones today consists of 30 companies.  The multiplication factor used to calculate the average is 7.964782.  For each component, regardless of market cap, the last price is multiplied by 7.964782.  The sum of all these factors is the new average.  There is also an unwritten rule of thumb that states that stocks in the average must be over $10 per share, or risk being removed from the average.  As of this writing, there 4 stocks below $10 (Alcoa, Citibank, General Motors, Bank of America), but they remain in the reported average – for now.

Based on the above information, here are a few interesting calculations:

• If Citibank, General Motors, Bank of America and Alcoa all go to zero, the Dow only drops to 7906.
• If everything on the left side (Citbank through Merck) go to zero, the Dow only drops to 6146.
• If everything on the left side loses 20%, the Dow only drops to 7691.
• If everything on the right side loses 10%, the Dow only drops to 7462
• If everything on the right side loses 20%, the Dow only drops to 6848.

If you are a bear, keep these figures in mind as you weigh your decisions to bet to heavily against the Dow.

Other interesting reading:

• Balanced and hedged portfolio using proshares
• Portfolio protection – hedging todays roller coaster market ride