Geldpress

Watching the option chains can often reveal what some of the big money traders are up to.  Check out the April option chain for General Electric below, with volume snapshot information taken on March 19, about 1 hour prior to the market close.

Take note of a few items from the chain above:

• Today’s April 11 Strike CALL volume (29,372) is over half of the entire open interest (55,360)
• Today’s April 10 Strike PUT volume (32,522) surpasses the entire open interest (26,277)
• The highest volumes of option activity appear at the 11 Strike CALL and the 10 Strike PUT, implying somebody (or a group) may be placing a HUGE STRADDLE BET on GE.

What is a straddle, and what is a strangle? - Option straddles and option strangles are used when traders expect a BIG MOVE in the market, but they are unsure about which direction.  A long straddle is the simultaneous purchase of both a CALL option and a PUT option at the SAME STRIKE price.  A long strangle also involves simultaneous purchases of both CALL and PUT options, but at DIFFERENT strike prices.

While its not possible to tell exactly who is making up the bulk of the option volume in the GE April options, there is a strong indication that someone or some group is placing a large bet on the GE April 10/11 straddle.  If we assume that 20,000 units of calls and puts are part of the straddle, then the total size of the bet is about $3.3 million. There are certainly other combination possibilities (Butterfly call spreads or butterfly put spreads, vertical spreads), but it is probably safe to say that there is definitely a chunk of volume dedicated to the GE 10/11 straddle.

Risk reward for the GE straddle:

• Assuming $.65 for the $11 call and $1.00 for the 10 put, the total cost of the straddle is $165 per straddle
• The profitability range would occur if GE is $1.65 ABOVE the $11 call strike, or $1.65 BELOW the $10 put strike at expiration.
• Naturally, there are unlimited possibilities to morph the trade into a new strategy, or even close the trade early (prior to expiration) for a profit or loss.

Other items to note in the GE option chain (put call ratio) – The put call ratio is another item that option traders like to look at when considering their own option trades.  The idea is that the big money is often right so if you follow the big money, you may also be right.  There are many ways to calculate the put call ratio, but my preferred method is to add up the open interest of the 2 strikes nearest the money for both calls and puts.  This comes to 175,656 on the call side and 32,886 on the put side.  This implies that there is a stronger BULLISH sentiment on GE based on the option open interest.

Disclaimer: The above information IS NOT TRADING ADVICE.  It is simply an observation of option volume on a security.  As always, TRADE at YOUR OWN RISK!

The S&P 500 has been on a steady uphill climb over the last week, from the near death 671 level to its close of 799 today.  In the sub 700 level, there was constant talk of the S&P being “oversold“, and since the run-up, that talk has turned to descriptions of “overbought“.  Both of those terms have nothing to do with the fundamentals of the S&P 500 components.

Considering only the fundamentals, the S&P still has plenty of room on the downside.  The latest earnings estimates for the S&P 500 for 2009 are only $35.  With the S&P at the 800 level, those $35 in earnings correspond to  a price to earnings ratio of nearly 33, a staggeringly high number considering the rampant fear and uncertainty in today’s market.  And at the low of 671, the $35 in 2009 S&P earnings estimates correspond to a p/e ratio of 19, still pretty high in this environment.

But as I said, those “oversold” and “overbought” adjectives flying around are technical analysis terms used to describe the current market SENTIMENT.  And the STOCHASTICS are the technical indicators used to measure market sentiment.  The chart below is from Yahoo Finance, and it depicts the SPY (S&P 500 ETF) year to date pricing, along with the fast stochastic and slow stochastic indicators.

Similar to moving averages, stochastics can be calculated with your preferred choice of parameters – %K and %D.  It’s best explained with an example.  The slow stochastic graph above is calculated using a %K of 15.  This means that each point on the %K graph (blue line) is calculated with that day’s closing price, and the closing prices of the 14 preceding days.

%K = 100 * ((Recent Close – Lowest Low(n) / (Highest High(n) – Lowest Low(n))

The “n” in the equation above represents the last 14 trading days.

%D is calculated using a 5 day moving average of %K.

Simple enough, right?  Sure it is, but to make it even simpler, just use your favorite charting software to toggle the display of the stochastic indicators, and voila, you now have  a view of market sentiment and can determine for yourself if it is overbought or oversold.

What is overbought and oversold? – Market technicians haver differing views on this.  Some will say that any reading above 80 is overbought and below 20 is oversold, presenting good selling and buying opportunities.  Others prefer to wait for a confirmed reversal.  When the stochastic indicator crosses below 80 (after hovering above it), its time to SELL.  And when the stochastic indicator crosses above 20 (after hovering below it), its time to BUY.

But whatever decision you make, remember that it’s your money, and it’s YOUR RISK!

Other random posts from Geldpress:

• Technical Analysis – Simple, Complex, and Black Swan
• How To Buy Preferred Stock Shares
• Free Government Grant Info
• Best Book For Understanding Option Greeks
• Options Play – Bucyrus Hybrid Collar
• Sponsor An Executive Video

Have we become a nation obsessed with bank bailouts, and taxpayer funded mortgage subsidies? Or is there hope for the American Dream? According to Barbara Ehrenreich, it’s nearly impossible for anyone to move up from lower to middle class in America. Her book, called Nickel and Dimed, tells the story of how she temporarily gave up her middle class life, and with only $1000 in cash and a laptop computer, started on her quest for $7 per hour jobs to test the waters.  The end result was her conclusion that living check to check on unskilled labor jobs was just to difficult.  Apparently many universities have agreed with her, and allowed her to deliver her pessimistic remarks at graduation ceremonies.  For the full story, check out her book.

Nickel and Dimed: On (Not) Getting By in America by Barbara Ehrenreich

Adam Shepard was one such student who did read her book, but opted to try the challenge himself. He picked a random city, and with only $25 in his pocket, and NO LAPTOP, he started his quest. How did he do? Quite well! He started off living in a homeless shelter, secured himself a low paying job, and within a few months was able to afford a used truck and an apartment. Check out the 20/20 interview of him, where he recounts his story, and even offers a few criticisms of Barbara Ehrenreich’s approach. Apparently, while Adam sacrificed comfort by living in homeless shelter, Barbara was staying in hotels and buying new $40 jeans.

If you like the video, be sure to purchase Adam’s book, entitled Scratch Beginnings.

Scratch Beginnings: Me, $25, and the Search for the American Dream by Adam W. Shepard

After reading the book, then ask yourself – Is the American Dream really dead? Must we continue on our quest to a welfare nation?

Technical Analysis defined – an investment or trading technique that bases buying and selling decisions on historical market data and trends.

Fundamental Analysis defined – investment or trading decisisons are based on the study of historical fundamental data such as earnings, cashflows, peer company studies, and general economic trends.

The technicians and the fundamentalists are like doctors and lawyers – constantly pointing out the flaws in each others logic, while claiming superior systems themselves.  In reality, there are plenty of bozo technicians and fundamentalists out there.  But the best and most successful traders are equally gifted at both fundamental and technical analysis.  Here are a few thoughts on technical analysis.

1)  Moving average – This is one of the simplest ideas in technical analysis.  The idea is to create a smoother curve from market pricing points.  For a 30 day moving average, each point on the curve would be the average of that days closing price and 29 preceding days closing prices.  In theory (don’t try this at home!), you could BUY a particular stock when it closes ABOVE the moving average, and SELL the same stock when it is BELOW the moving average.  Here is a chart of ISRG showing the extreme run up in its shares, followed by a plateau period, and a sharp share price decline.  Perhaps the moving average indicator would have in fact worked here, but in most other cases, using only the moving average as your BUY/SELL indicator will probably lose you money.

2)  Analysis Paralysis – Some people like to use and seek confirmation from multiple technical indicators before placing their BUY or SELL orders.  Other people (a lot more than you think) use so many damn indicators that all they do is stare at the screen and paralyze themselves from any action.

3)  Sometimes all those funny Technical Analysis indicators form funny Black Swan images.

4) The Simplest Investing Rule – If you want a good system for trading the S&P 500 on a longer term basis, then perhaps you may be interested in Karl Denninger’s simple rule.  The rule advises to SELL when the 20 week moving average goes BELOW the 50 week moving average.  And the BUY signal occurs when the 20 week moving average goes ABOVE the 50 week moving average.  The image below is from Yahoo finance, and depicts SPY (ETF for the S&P 500), along with a 140 day moving average (20 week), and a 350 day moving average (50 week).

For another even simpler explanation of the simplest investing rule, check out the MAS informative and humorous take on the subject.

And if you still insist on learning more about technical analyisis, then check you should BUY and READ the following classic book, combining trader psycology with detailed technical analyisis information.

Trading for a Living: Psychology, Trading Tactics, Money Management by Dr. Alexander Elder

Ian Brenner – the “edicated intellectual entrepreneuer” – was at Town Hall Seattle tonight to kick off the start of another book tour.  His latest book is called The Fat Tail: The Power of Political Knowledge For Strategic Investing. Ian spoke about the book for 40 minutes and then took audience questions for the next 20.  He even managed to crack a few good jokes while speaking, and then interrupted our laughter with a remark like “I really didn’t think you would laugh at that one”.  The fat tail is not an investing book, but it just may be the most important book worth reading for all CEO’s of multi-national companies.  And for those lucky enough not to be CEO’s of multi-nationals, it’s an insightful book that just may help you understand how the political risks in the world can affect the markets.

The Fat Tail: The Power of Political Knowledge for Strategic Investing by Ian Bremmer

Other great books by Ian Bremmer are:

• The J-Curve:  A New Way to Understand Why Nations Rise and Fall
• Managing Strategic Surprise
• Nations and Politics in the Soviet Successor States

Click here for the up to date Town Hall Seattle calendar.

Also check out:

• Warren Buffett And Hank Paulson – Negotiator And Thief
• Any Rebound Potential In the Sub Two Dollar Stock Club?
• More Seattle Crazy Real Estate Ads
• Married Puts, Collars, And Hybrid Hedging

Thank you Comedy Central for a great compilation of CNBC stupidity.  If it were not for your remarks on Santelli, the video would be perfect.  Rick Santelli is the one of the only smart, honest and insightful guys left on CNBC.  For the record, Santelli is a reporter, not a CEO bailout recipient.  Yes he is opposed to homeowner bailouts, but he was also opposed to financial and automaker bailouts as well.  But nonetheless, great video compilation.  Enjoy.

Here is the cover of Businessweek magazine on August 12, 1979, proclaiming the death of equities.  As it turned out, the end of 1979 was the start of one of the greatest bull markets in history.

With the Dow Jones currently at 6594, and the S&P at 682, is it time for Businessweek to do a Death of Equities Part Two?  Is the recovery just about to begin, or is this downward spiral just getting started?  You decide, but whatever you do, be careful trading them there markets!

Also from Geldpress:

• Bailing Out Poker Players
• Obama Flip Flops On Fiscal Discipline And National Debt
• Commercial Property Developers Are Latest Bailout Beggers
• Lose Money With Free Bad Advice
• Portfolio protection – hedging todays roller coaster market ride

Jonathan Jarvis put together an excellent animated video explaining all aspects of the credit crisis, and essentially pinpointing the start of it to Alan Greenspan’s error of jacking down interest rates after 911.  Thank you Jonathan for a great video! Be sure to check out the Crisis of Credit website, and buy some “Sub-Prime” t-shirts.

Part 1 of the Crisis of Credit Visualized. (7.5 minutes)

Part 2 of the Crisis of Credit Visualized. (3.5 minutes)

Preferred shares are becomming surprisingly more attractive these days, even among retail investors.  One reason for the renewed interest is because of the world’s financial crisis, and a general mistrust of governments constant market rule changes.  Preferred shares are also being talked about almost daily on CNBC, especially for insolvent financial institutions that were deemed “to big to fail“, but not “to big to bailout“.   For insolvent financial institutions, it is readily believed that the common shareholders will eventually all be wiped out.  But with what seems like unlimited government backing (at taxpayers  expense, of course), investments in preferred stock may still come out ahead.

What is preferred stock? – From wikipedia,

Preferred stock, also called preferred shares or preference shares, is typically a ‘higher ranking’ stock than voting shares, and its terms are negotiated between the corporation and the investor.

Preferred stock usually carries no voting rights, but may carry superior priority over common stock in the payment of dividends and upon liquidation. Preferred stock may carry a dividend that is paid out prior to any dividends being paid to common stock holders. Preferred stock may have a convertibility feature into common stock. Preferred stockholders will be paid out in assets before common stockholders and after debt holders in bankruptcy. Terms of the preferred stock are stated in a “Certificate of Designation”.

Notice two important points from above:

1. As more and more dividends are being wiped out in common shares, many preferred shares are still paying on them.
2. Preferred shares have PRIORITY of payment over common shares.

There are some other key differences in preferred shares, as explained by this USAToday article.  First, dividends from preferred shares may not qualify for the lower dividend tax rate (currently 15%).  Second, investing in preferred shares can be confusing, because they are really like a mix of stocks and bonds.

Other advantages of preferred shares are less price volatility than common shares, and greater liquidity than corporate bonds.  Other disadvantages of preferred stock are lack of voting rights (if you care), interest rate sensitivity, and callability.

CNBC’s Karen Finerman (the smartest one on the Fast Money show) has announced she is using preferred shares in her hedge fund as a long/short strategy.  She mentioned she is LONG Bank of America preferred shares, and SHORT the common shares. For an explanation of the “long/short strategy”, check out the geldpress article on hidden jewel in the shorts.

Buying preferred shares is pretty straightforward and very similar to buying any other shares in common stock.  As for picking preferred shares, its a little trickier, and requires on specialty websites that host preferred share content, such as QuantumOnline (registration required).  And for those of you who like the idea of preferred, but simply can’t be bothered to pick among them, there are easier (although not necessarily better) methods, such as investing in the ishares U.S. Preferred shares index fund (symbol PFF).  Similar offerings may also be available at other brokerage institutions.

Finally, if you are serious about investing in preferred shares, there are some good books to help guide you.  I would recommend this recently released Preferreds as a start, by Ken Winans.

Preferreds by Ken Winans

The “Great Depression” is the talk of the town, and there are no shortage of books on the topic. In fact, great depression books are making their way up the ranks on the Amazon top selling charts. Here are a few.

A Bubble That Broke The World is one of the newest on the list, released in June 2008, and written by Garet Garrett. It is a short read with chapters on the anatomy of the bubble, saving Europe, rescuing Germany, the gold invention and book of the debts.  It was originally published in 1932, but was republished last year due to strong interest and demand.  From Amazon, “This book presents a cosmology of a mass delusion which affects the mentality of the world. This takes place following World War I where the Federal Reserve System, for the first time, allowed flexible currency.”

The Panic of 1907 was written by Robert Bruner and published in 1907, as a 100 year dedication to the book’s subject.  From Publishers Weekly, “The chronicle follows one speculator’s attempt to corner the copper market, which leads to panic, the failure of banks and trusts and the impending bankruptcy of New York City.”  (Geldpress comment:  AIG is now failing because of one man’s stupid attempt to insure reckless lending and borrowing in the mortgage market).

The Forgotten Man was written by Amity Shales and last published in 2008.  It’s now available in paperbook for less than $10, and worth a dedicated spot on everyone’s bookshelf.  As of today, it’s Amazon sales rank is 79! From the booklist review on Amazon,

…a prominent conservative economics journalist, considers why a decade of government intervention ameliorated but never tamed it. With vitality uncommon for an economics history, Shlaes chronicles the projects of Herbert Hoover and Franklin Roosevelt as well as these projects’ effect on those who paid for them. Reminding readers that the reputedly do-nothing Hoover pulled hard on the fiscal levers (raising tariffs, increasing government spending), Shlaes nevertheless emphasizes that his enthusiasm for intervention paled against the ebullient FDR’s glee in experimentation.