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If you have any friends from Europe, chances are they may tease you about how America caused the 2008 financial crisis the world is now facing, and how America’s contagion is spreading through Europe.  It’s true that America bares a large part of the blame for its own financial woes, largely caused by irresponsible mortgage lending to sub-prime borrowers, and reprehensible INACTION by rating agencies and government officials.  But the brewing financial storm showing its head in Europe is about to get a lot worse.  Watch in the coming months as it sweeps through the continent with a vengeance that will make America’s own crisis seem insignificant.  Browse through some of coverage on the European crisis below:

• From a recent Bloomberg article, - “European banks’ lending to emerging markets is about 21 percent of Europe’s GDP and U.K. banks’ loans are around 24 percent of national output, compared with 4 percent for the U.S. and 5 percent for Japan”
• From a recent Christian Science Monitor article - Not my favorite publication, but they do sum up the problem quite well.  Emerging market interest rates are high, so emerging market citizens (Iceland being the most famous) take on mortgage and and other loans in euros, pounds, or Swiss francs.  Once emerging market currencies collapse, emerging market mortgage holders face little chances of repaying the loans denominated in euros. From the article, “Eastern European countries currently hold about $1.6 trillion in foreign currency debt, according to Morgan Stanley, and it’s overwhelmingly owed to Western Europe, whose large banks own 60 to 80 percent of Eastern Europe’s banking sector”.
• From a recent UK Telegraph article - Austria’s exposure to emerging markets is a staggering 85 percent of that country’s GDP.  What chance does Austria have in collecting those loans when the recipients of those loans are now all in line for IMF bailouts?  From the article, “Exposure is 50pc of GDP for Switzerland, 25pc for Sweden, 24pc for the UK, and 23pc for Spain. The US figure is just 4pc”




If you are currently holding european stocks or any accounts denominated in euros, don’t hold your breath waiting for the recovery…

As many people are aware, covered calls are a great way to hedge your positions, and potentially enhance the returns on your portfolio.  I have written quite a bit about them, as well as selling naked puts.  The volatility in these markets makes 2008 the year of the covered call and naked put selling.  For those that understand the theory on options and covered calls, but are stuck on the order entry syntax, here is a primer for a few popular platforms.

Prerequisites for covered calls:

• You understand the concepts of options and covered calls.
• You know how to pick your own strike price and expiration month.
• You have purchased or intend to purchase 100 shares of stock to COVER your call.
• You have an account approved for options.  If not, call your broker and ask for an options form.

Assumptions for the examples below:

• Today is November 7, 2008 and the example below assumes writing a covered call on Apple (symbol AAPL).  Note:  This is NOT a recommendation!
• AAPL trades at 98.24, and the December option chain for AAPL is shown below, per Yahoo Finance:
• Write a 100 strike December covered call on Apple

Steps of writing a covered call:

1. Start by purchasing 100 shares of an optionable security.  Our example uses Apple (AAPL).
2. Decide on expiration month and strike price to sell.  Our example uses a December 100 strike.
3. Open the trade options order form for your broker.   The Scottrade options order form is shown below.
4. In the buy/sell (or similar) box, there are usually four choices - Buy to Open, Buy to Close, Sell to Open and Sell to Close.  For a covered call, select “Sell to Open”.
5. Contacts - For a single covered call involving 100 shares, then the number of contracts is 1.  The money received from selling a covered call is equal to 100 times the quoted price in the option chain.
6. Symbol - This is where syntax matters.  In the image above, Yahoo Finance lists the AAPL December 100 strike as “QAALT.X”.  But the option syntax on the order entry forms for each broker can be completely different.  For Scottrade, it would be entered as “.QAALT”, for Fidelity it would be “-QAALT”, and for Tradeking it would be “QAALT”.  Call your broker directly if you need help with the syntax.
7. Order Type - Market or Limit.  For options trading, I NEVER use market orders! I’ll start with a limit order somewhere in between the BID and the ASK.  If it doesn’t get filled after a few minutes, then I’ll change my order accordingly and try again.  As an example, if my limit order of 8.35 is accepted, then 100 times that amount ($835) gets deposited into my account immediately.
8. Duration - Day order only means that if it doesn’t get filled today, then the order is cancelled.  Good until cancelled means that your broker will keep the order open until it gets filled or until you cancel it.  In some cases, your broker may have a time limit such as 30 days where they will cancel open orders regardless.

Aftermath of writing a covered call - In theory you could do nothing and just wait.  If Apple is above 100 per share at December expiration, your broker will automatically take your 100 shares away from you, and deposit an additional $10,000 in your account.  If Apple is less then 100, your shares But you do have other options.  You can close the contract early by using a “BUY TO CLOSE” order.  Doing so would leave you with just your 100 Apple shares and you would then have the option to sell a January, or other covered call and collect additional premium.

Appearance in your account - There are two things that confuse first time covered call writers.  The first is that covered calls appear as a negative quantity in your account.  Once you sell a December Apple 100 strike, it appears in your account as a quantity of negative 1, with a corresponding debit value (i.e. -$835).  Second, options are less liquid than stock.  It is possible that even if a stock rallies 10 or 20% on a single day, the last option may not have traded for several days prior.  In those instances, the value of the options in your account usually reflect the last traded amount, and not an amount resembling the current BID/ASK values.

Other Geldpress articles on covered calls:

• Time for cover - the covered call
• Covered calls - removing the covers and going naked
• Interesting covered call on AIG - 150 percent return (No longer relevant, but interesting to read)
• Covered call writers love high volatility

Also, I highly recommend the following book on covered calls.  Free articles are great, but if you are going to trade, then you need to get serious and spend a few dollars on a good book.

Don’t delay!  Buy it NOW!  You’ve lost enough money already!

The $81.90 is a worthwhile investment to slow or stop the bleeding in your accounts, and the 4% Amazon commission will help support this site.  Also, check out the Geldpress bookstore for other great options books.

Covered Calls and LEAPS–A Wealth Option + DVD: A Guide for Generating Extraordinary Monthly Income (Wiley Trading) by Joseph R. Hooper

Leveraged ETF’s, despite their significant risks (counterparty risk correlation risk to name a few), are gaining in popularity.  There are several institutions offering double exposure ETF’s, and now a new entrant is even offering TRIPLE EXPOSURE ETF’s.  Here is a sampling of the leveraged lineup:

• Proshares - offers single and double exposure index, sector and international ETF’s.  Also offers inversed double exposure ETF’s.
• Rydex - similar offering to that of proshares, with 14 double exposure ETF’s.
• Powershares -In general, their ETF’s hold fewer positions than traditional ETF’s, but they are not leveraged as of yet.  But I do like their dollar bull ETF (symbol UUP).
• Horizon Betapro ETF’s - Offers HBP Bull+ ETFs for double the daily performance of their underlying equity index or commodity, and HBP Bear+ ETFs for double the daily performance opposite that of the underlying index or commodity.
• Currencyshares - Not quite a leveraged lineup, but certainly worth mentioning.  These ETF’s offer a convenient way to bet on foreign currencies.  Personally, I’m more of a dollar bull then ever, but I do like the Japanese yen strength these days.  The symbol is FXY, but buy it at your own risk!
• Direxion Funds - Currently offers 1.25x and 2.5x leveraged ETF’s.
• Direxion Shares - In an industry first, they will soon offer triple leveraged (300%) ETF’s.  There will be 16 available, including the Large Cap Bull 3X (BGU), Small Cap Bull 3X (TNA), Large Cap Bear 3X (BGZ) and the Small Cap Bear 3X (TZA).

The most interesting fromt he list above are the new 3X leveraged ETF’s.  From the prospectus, there are numerous risks associated with these ETF’s.  The ones that stand out to me are:

• Correlation risk - In a nutshell, it’s virtually impossible to achieve exactly 3X the performance of the index, so don’t be surprised if the underlying goes up 1% and the 3X ETF only goes up 2.5%, and vice versa.
• Counterparty risk - Direxion uses counterparties that have access to financial instruments used to target those 300% returns.  There is no guarantee that those counterparties are, or will remain solvent in the future.  (Hint:  Bear Sterns, Lehman Brothers)  From the prospectus, “The Funds will not enter into any agreement involving a counterparty unless the Adviser believes that the other party to the transaction is creditworthy“.
• Credit risk - From the propsectus, “A Fund could lose money if the issuer of a debt security is
  unable to meet its financial obligations or goes bankrupt”.

More on correlation risk - In general, the leveraged ETF issuers do not disclose their methods for achieving 2X or greater leverage.  With the 2X funds, my own speculation tells me that the counterparties involved are either double short or double long the underlying.  The counterparties pay significant margin interest which is then passed on to the issuing fund (proshares or rydex for example), and eventually to the investors.  But with 3X funds, it’s more likely they need to access the futures and options markets to achieve the triple leverage.   If so, that could significantly increase the correlation risk for the following factors:

• Time decay - Options and futures have time premiums and time decay, which could cause more correlation differences in the 3X funds.
• Spread risk - The BID/ASK spreads on options and futures is increasing with the increasing volatility of the markets.  The institutions certainly would get the best prices, but the spreads are still not free, and the options/futures spreads are certainly larger than the spreads on stocks and ETF’s.
• Liquidity of options and futures market - It’s great for amateur investors, but if these 3X funds take off, they could find it difficult to roll contracts due to the volume involved.

Also check out:

• Correlation Error With Leveraged ETF’s

This youtube video is one of the most important videos you can watch prior to making your vote heard in the 2008 presidential election.  Many people in government and on the streets will tell you that the financial crisis we are facing today was unavoidable and that nobody could have predicted it. But in reality, the 2008 financial crisis has been discussed at length for at least the last 10 years.  There were countless economists, savvy investors, book authors and blog writers warning of such a collapse to our financial system.  The only issue is that 90% of our government chose to ignore the warnings because they were to busy cheerleading for the phony debt based economy.

We need smarter people in government and advisers just won’t cut it in today’s economy.  I have heard some people defend McCain’s economic illiteracy because he will probably “choose a good economic adviser”.  Now that the 2008 financial crisis is in full swing, those people really need to watch this video of former economic adviser Arthur Laffer being schooled by Peter Schiff.

Don’t wait and hope to determine who the next president chooses as their economic adviser.  Instead, vote for the more intelligent presidential candidate, and preferably a well researched candidate amongst ALL of the choices, not just Republican and Democrat.  We can’t afford 4 more years of economic illiteracy in the White House and congress.  Please vote responsibly!

If you liked the video above, you will also like the following book by Peter Schiff:

Crash Proof: How to Profit From the Coming Economic Collapse (Lynn Sonberg Books) by Peter D. Schiff

Telegraph UK on the Iceland financial crisis - Put the financial sector on steroids and pass out loans like candy on Halloween, and eventually you have over $100 billion in liabilities in a country with a mere $14 billion GDP.  Add to that a massive consumer debt problem, fueled by consumers who took on foreign currency home and auto loans to “escape” the high 15.5% interest rates of the Icelandic banking system.  Those “escapes” resulted in near doubling of principal balances as the krona, Iceland’s currency, collapsed by more then 50% and ceased trading on world currency markets.

Bloomberg reports on Iceland cutting interest rates from 15.5% to 12% - Those Icelandic foreign currency CD’s used to be very popular to U.S. residents looking to gain a leg up on the meager dollar based returns.  Purchasers of such instruments are now getting a hard lesson in risk assessment.

The Globe and Mail’s take on Iceland’s problems - Summarizes Europe, American and Icelandic bank nationalizations as a form of “corporatism”, and not “socialism”.

Daily Newscaster reports on Iceland food shortages - Iceland’s number one discount grocery store only had enough food left on shelves for 2 weeks of normal use.  Food inflation goes up 50% overnight, imports nearly cut off, and officials ask for IMF help to stem the crisis.