Goodbye until the New Year!

Folks, its been an interesting year.

I have enjoyed blogging so far and will continue this blog next year.

As I ponder the next few days, I realize I should take time off to focus on family and celebrating the New Year, and leave the world of personal finance behind... for a little while.

Come the first week of January, expect my December '07 networth status, and a complete analysis of my spending pattern for '07. I will also be looking at my spending and searching for ways to save more.

I have yet to arrive upon a new year's resolution, but suffice to say, I started really doing resolutions two years ago, and I have stuck to both of them: (1) track all expenses, and (2) get a job. On the top of my list of course are the usuals: win the lottery, learn to dance, and get healthier. There are also realistic ones, like pass a CFA test and get a promotion. Again, I don't really know, so be ready for that in the new year.

Otherwise, New Year's Eve should be interesting. I've shelled out $200 to try an all-inclusive nightclub outing in NYC. If I can avoid the Irish flu, I'll be back to work Jan 2.

Hope you all have a safe and happy time partying.

PS - Don't spend TOO much!
PSS - And that's the last personal finance advice I'll give this year.

Rally Assassinated

Nothing ruins the economy more than social strife. Nothing could have been worse for the Santa Claus rally than the assassination of Benazair Bhutto, former Pakistani prime minister and leading candidate for this year's election.

With her death, I find myself in an odd place. First, this is my first foray into politics on this blog. Second, it significantly increases the uncertainty of the future, and therefore can only negatively impact the global economy, and as a result, global stock markets.

My politics and economics are always tied together. At a time when the US is gearing up for its primary elections, political unrest around the world will greatly weigh on the minds of average citizens, far more than usual. This will cause voters to consider strengthening our terrorism "war", and thus risking increased anti-US sentiment, which will result in decreased business.

Rather today's news will impact the market for long-run remains with how Mussaraf deals with the riots today, and what he does about the coming elections. I expect martial law to be declared and elections to be postponed. This is the predictable outcome and would calm markets.

However, if Mussaraf proceeds, then any election result will cause massive turmoil in the country, and fears will run rampant for at least the next month, devestating our struggling stock market.

Santa Claus Rally: Can you ride along?

Now that we're in the stretch between Christmas and the New Year, we are officially in the span in which an annual market phenomenon occurs: the Santa Claus rally.

Today was a good, if mild, start to the rally, with technology (and the Nasdaq), leading the way. From now until year end, I'd expect technology and financial services to rise, as they have been the hardest hit.

The big financials still have a huge hole to dig themselves out of. However, I think their future is bright. While they cannot continue making obscene amounts of money from subprime mortgages and the securitization market, they will still truck home cash to every investor.

For this reason, I bought XLF today. XLF is an ETF index of financial stocks, with big names such as Merril Lynch, Goldman, Bank of America, and Citigroup. This ETF has been hammered this year, losing about 17% of its value. I foresee a bounch back in most of the financials within a year.

And of course, my consistent favorite QQQQ (ETF of Nasdaq), continues to be another recommended buy.

Happy Holidays!

Increased liquidity eases fears

Not out of the woods yet, but the extra money being pumped into global corporations is helping to ease market fears.

Markets had another V-shaped day, centered around noon. I've been basing my strategies on that recently. Around noon US EST, England's markets close, and it seems to drive US markets down. As the afternoon rolls around, they go right back up. Its been two days of this (and many times over the last 5 months), and there's no particular reason to believe this won't continue.

For anyone who trades in indexes, this kind of predictability is a real money maker.

Markets Looking Better

After $500 billion infusion of credit from European banks, markets across the world are starting to do better. Maybe the Santa Claus rally will occur after all.

With the market in so ridiculous flux, it is difficult to suggest any good plays in the near term.

In the long term, the markets will get better, so continue buying up those banks and technology stocks that have suffered greatly in the past weeks. In 2-3 months, the markets be much more stable, and those stocks will be back.

Option FAQ, Part 2: Hedge it to Me!

Last week, I began this Option FAQ with a basic introduction to options. In part 2, I will delve more into more advanced hedging functions.

The first hedging function I discussed last week was to put a floor on stock value by buying a put option. Now let's consider the reverse, selling a put.

Selling a put means you are providing someone the option to have their stock purchased from them, by you. This is the opposite of buying a put, and is similar to shorting any given stock (including requiring margin). What does this look like?

This chart is the mirror image from the basic introduction image. Blue represents the stock price, while the red line represents a Jan '08 Put Option @ $700 that you have sold while you hold Google stock.

As the graph shows, by selling a put option, you have created a ceiling for your portfolio.

Now lets talk about call options.

Call options provide the ability to buy an underlying equity. If you buy a call, you are purchasing the right to buy an equity at the specified price. If you sell a call, you are selling the right to buy from you an equity at a specific price. So what do calls and stock look like for your portfolio? I'm going to teach you to work it out for your self with fancy term called "Financial Engineering".

Technically, this is the design of various financial products that decrease external risk, and help you get a financial instrument with the exact risk you are looking for. As applied to options, this is like putting puzzles together.

Let me decompose those portfolio value charts that I have made, and provide you with what each option type actually looks like:


Now you've seen me combine stocks with the put options for portfolio value, so I will walk you through a combo stock + sell call. Remember a stock follows a diagonal line. So let's put these two lines onto one graph.

(Due to spacing issues, the graph I'm referring to may be lower on the page) The blue line is Google stock, the red line is the option, and the purple line represents the combination of the two. As you can see, prior to hitting the strike price, a combination portfolio has more value than the stock, primarily because of the money received for the sell of the option.

Past the strike price point ($700), the portfolio value flattens, while the components head in different directions.

This is the basis of a hedge. You want two instruments that move in exact opposite directions.

Now go out there and play with each of the four option possibilities, and we'll discuss the tried and true options combinations.

Behind the scenes: What's in store for this blog

The 10 months that I have been blogging has been an incredible time for me. I wanted to take this time to reflect:

First and foremost, blogging has really provided me a forum to increase my own understanding and application of financial theories to practice. In every post, I attempt to provide the most accurate advice/comment/suggestion through intensive research. This research has certainly enriched me.

Second, the blog has changed slightly from its original purpose. I started the blog to attempt to catalog each new personal finance issue I was faced with and then to give readers my solution. However, as I finalized my move from college life to real life, I realized there really wasn't going to be such a regular plethora of personal finance issues. I grappled with three possibilities: only posting when I had a new problem, start blogging about mundane PF issues, or start branching out into my investments. I settled upon investments because it provided the most regular material to blog about, and investments are a huge part of anyone's personal finances.

Third, as the new year begins, and as my blogging experience increases, I will begin blogging in a more organized fashion. I will start having mini-series on PF and investment issues, delving deep into a problem for a week or two.

The first of these series I started last week on options trading. I will work hard on fleshing out this topic for the next 5 days.

Bogged down with work

Per the norm, overloaded with work = getting colds. Sick as a dog and still working.

These crazy volatile market days aren't helping.

Upward trend continues, but roller coaster rides are getting more and more dangerous.

Wow, that hurt

A very unexpected move yesterday by the Fed. 25bps cut for both the Fed Fund target rate and the discount window.

The market just jumped off the edge into oblivion after the announcement. However, I don't believe that 25 rather than 50 bps to the Fed Fund target rate is really the big issue. Instead, I think its the 25 rather then the expected 50bps cut in the discount window that really caused the issue.

There is a large credit problem for banks right now, and a 50bps cut would have allowed them to get that credit cheaply.

In the coming days, the clear market reaction is that more cuts are needed, and the Fed looks poised to respond. I think the market will rally again before the year is over.

Wait and see

Today's market was upward trending, yet cautious. Why? Everyone is still waiting to see what the Fed will do. 25bps is in the bag. 50bps? Maybe.

Tomorrow is a day to ride it out until 2:15pm. Then, the market will almost certainly see a big bump, followed by a drop either a few hours later or the day after.

The best way to play tomorrow is to take some gains quickly, especially short-term bets, but hold on to long-term bets, as the economy is definitely turning for the better.

Two Words on the Market this week: Cautious Enthusiasm

It's coming.

Not Christmas, Santa Claus, or even the Easter Bunny.

This is much bigger.

On Tuesday, the Fed is set to announce its decision on interest rates. The question for the last week has been of "How much?". Most of would say 25bps would be on target, while 50bps would show the Fed trying to get ahead of the market.

After last Friday's excellent job data, there is less of a chance for a 50bps cut.

So what are the plays for the week? I think regardless of what level of a cut, the market will have a positive bounce for the week. I am still a huge fan of high-tech, as well as retailers, and even banks for the long run.

Options FAQ, Part 1: What art thou?

Recently, a reader asked for more discussion of what an option is, how to trade it, and how it has value. As an short-term options trader, what I present here is not necessarily how I make money, but rather, what the option product is typically used for.

Part 1: What are thou?
What is an option? To pull a cliche, I will quote from a dictionary (Wikipedia):

"Options are financial instruments that convey the right, but not the obligation, to engage in a future transaction on some underlying security."

What does that actually mean? In high finance, every contract involving money is a "financial instrument". It merely means money is involved. A security is kind of contract or product that is traded for money.

So essentially, Options are financial contracts that give the right, but not the obligation, to trade a product for money. An options primary purpose was to hedge a bet. We'll get to that soon.

Options have 4 fundamental characteristics:

1. type of option
2. strike price of option
3. expiration date of option
4. underlying security (asset).

First, let's choose an underlying security, for instance, Google stock (GOOG).

Next, let's choose an option type. There are two, calls and puts. Calls give the option to buy. Puts give the option to sell.

But at what price can we choose to buy/sell? That's the strike price.

Finally, option contracts have expiration dates, typically at most 12 months as a time.

Now that you know the basics, how can you use it to hedge your stock portfolio?

Say you own 100 shares of Google at today's close price of $715.26. You're fairly certain that in the next month, Google stock will rise, but you want to guarantee that you get at least $700 for your stock.

What do you do?

You can buy one (1) Jan '08 $700 Strike Price, Google Put (typically, options are traded in 100 contract blocks, so buying one = 100 contracts). The current price of each contract is $22.80, which makes this put option worth $2,280. Let's look at a graph to see how this can be useful:

The x-axis is the value of Google stock, and the y-axis is the value of each stock in your portfolio.

The blue line represents ownership of the stock. The value of the stock to you increases and decreases in a 1 to 1 ratio with the actual stock.

Now, with a put option, indicated by the red line, the value of each stock can not drop below $700 a share, because if it does, you can exercise the contract, and sell your shares at the strike price. In effect, buying the put option has guaranteed you a floor, or at least, $700 / share.

Is spending $2,280 worth locking in at least $70,000? It depends entirely on what you believe is the chance that Google stock will decline, as well as how much money you want to make on this trade. A simple way of thinking about it, is that the money is spent to insure your asset.

For now, this is a very basic introduction to the classic use of options to hedge a portfolio. The next part will focus on more advanced hedge functions.

Market Thoughts

It was a positive day today, with economic indicators showing the economy is not nearly as bad as people have been thinking. Frankly, I have been of this opinion for a while now, but I still think there is plenty of fear out in the market, and its still very much a wait and see situation.

For those risk takers out there, I would start buying up cheap stock ahead of the Fed rate cut announcement.

Another respected economic indicator will be released tomorrow: jobless claims. Although typically this does not have a great affect on the market, the mass hysteria in the market could take a spike in claims as a negative sign and just crash. Just as likely however, is a spike downward, causing continued faith in the market.

A light dusting, icy roads; use caution

Ever think a weather forecast could provide market advice? This week's has.

Monday I woke with a terrible cold and promptly went back to bed. I woke late in the afternoon to realize that the market was stumbling like an out of work writer (when does a writer ever have work?), after a night's worth of "inspirational" drinking. It weaved back and forth, back and forth, finally settling down on the curb to mull the comfortableness of gravel.

There we found it Tuesday as well. And the weather forecast popped back into my mind. After snow, there are two types of weather: incredibly bright and sunny, or days more of ice and snow. That's where the market is right now.

We all know salvation is at hand. Next week, the Fed is going to cut rates again, perhaps by 50 bps, but almost certainly by 25. But this week, we're still suffering from subprime-November, with the financial companies all getting rating downgrades.

Week outlook? Icy roads, use caution.

[Edit] I have also received reader feedback that they wish to be walked through a real example of option trading. I will be working on that for posting by the end of this week.

Networth Update

I am so incredibly excited about my networth this month, that I have chosen to stay awake after a night at the casino in order to update it!

This month saw my security deposit returned to me, and the opening of a Roth IRA savings account. Also, increased poker activity helped to offset some living expenses.

Compared to last month's networth update, I have seen a 0.28% increase in my networth, or an increase of $2,821.96.

I am incredibly happy with this growth, as if this trend continues, I will be in the positive networth range by the end of January. Then come tax season, I expect huge tax refunds because of my over-taxed sign-on bonuses, and also because I have been taxed as someone working for the whole year, rather than the 75% of the year that I have actually worked.

This brings my networth to -$5,007.60, or -0.50% toward my million dollar goal.

Since there have been enough months, I am also including a bonus chart of my networth progress since I started blogging in March '07.

This graph also shows my monthly trend, which is to increase my networth by about $2,400 a month on average.