Trade in Groups

As an options trader, implied volatility and time decay are two critical components to keep an eye on. This article will focus on volatility for those just beginning to dabble in options. At the end of the article a short explanation of time decay is included.

Markets determine option buy points by using forward-looking pricing models. A number of financial pricing models exist. Two of the most popular models include binomial option pricing and Black-Scholes option pricing, as explained by Penn’s Wharton School of Business in the above link.

Implied volatility is an estimate of an option’s future volatility and is determined (or implied) by live market prices. Because implied volatility can only be estimated it is important to understand the distinction between implied volatility and volatility:

Implied volatility: forward-looking volatility estimates linked to current price.

Volatility: observable historical figures that put implied volatility in perspective. This comparison helps a trader determine if an option is under or over-valued.

Volatility measures an investor’s risk. A financial instrument’s value changes over a specific time horizon. Collectively these values form a population. Volatility equals the positive square root of the population’s variance (or standard deviation for you statistics fans out there). The “time horizon” is typically a year and the “population” is the collection of daily price changes of the financial instrument. So we say that volatility is the “annualized standard deviation of a stock’s daily price changes.”

A fascinating side note about option valuation: did you know that beliefs regarding the movement of an underlying asset’s future value do not factor into an option’s valuation?! Clashing expectations about an asset’s expected growth and returns will not stop two people from entering into an option contract. Only agreement regarding volatility and the risk-free rate of return are necessary. The costs of hedging after writing an option always remain the same regardless of an asset’s price going up or down.

Time decay of an option is the idea that options carry expiration dates. An option is a contract that gives an investor the right to buy or sell a specific quantity of a financial security. They may buy or sell at a predetermined price until the date of expiration. Once the contract expires, it is valueless. Time decay refers to the notion that an option’s value erodes the closer it gets to it’s expiration day. Time decay is accounted for by The Greeks, statistical values that option traders use. Namely, theta represents the absolute value erosion for “one period” of time. For example, if the strike price of an option was $500 and theta was equal to $50, theoretically the option would lose $50 of value each day.

The first step for a newbie option trader is to get comfortable with using statistical values. Using the likes of implied volatility and volatility will help determine if an option is under or over-valued. The next step is developing trading strategies to effectively use those valuations.

Written by Ryan Swift

Part of the political process, cynics might say, is ceding overt support of certain measures to burnish an image. I submit that the most insightful things can be gleaned from what candidates supported before they became focused on their election bid. And so, with the Intrade.com political futures market pricing the possibility of us using the phrase “President Obama” at about 65% come 2009, I thought it would be interesting to look at one of the last measures Obama renounced his support for: coal-to-liquids (CTL).

In June 2007, Obama effectively ended his public support for measures promoting CTL, a means of converting coal into synthetic petroleum distillates. At the start of the year, he had co-sponsored a bill along with Kentucky Senator Jim Bunning (R.) that would have incentivized further research and production of CTL plants – a move that drew fire from environmental groups. Given that his home state of Illinois has immense coal reserves in its southern basin – not to mention that CTL has numerous backers, including the US Air Force – I’m not sold on the notion that Obama has completely given up on CTL.

Support of anything coal certain carries with it an enormous political liability, thanks to the environmental stigma surrounding the fuel. But at the same time, coal is domestically abundant, cheap to produce, and a huge driver of the economic health of swaths of the country. And, if the prices of oil and natural gas grind higher, it would be much more appealing to keep those dollars at home, rather than shipped to geopolitically unstable regions of the world.

This isn’t to say that CTL is a panacea for our energy problems, and it certainly isn’t the cleanest fuel. But it does have potential to be an important substitute – South Africa is an excellent example of successful use of CTL, meeting about 30% of their energy needs with it – and arguments about economical feasibility passed long ago, as CTL’s breakeven point is around $40/barrel oil.

While CTL might be on the political backburner for Obama at the moment, an election victory would free him of the pandering needed to secure votes and allow him the chance to make practical decisions about the future of the country. Coal-to-liquids could have a role, so how to profit? Three plays on CTL are:

-Syntroleum (SYNM), a small company that nonetheless has a contract with the US Air Force to explore use of the technology
-Sasol (SSL), the South Africa petrochemical giant that pioneered much of the commercialization of CTL
-Headwaters (HW), a building materials company with an interesting alternative energy unit

The stock market can be an exciting place; but for the novice investor, and perhaps even the seasoned one, it’s all too easy to make one bad step and watch your hard-earned money disappear.

If you’re looking to dabble in the wheeler-dealer world of stock options, but either don’t have the time to devote to building your portfolio or don’t have any experience of the markets then it may be wise to consider joining an online brokerage in order to maximise both your time and your money. With a vast number of online brokers around, finding the best one for your money is vitally important to your wealth. So what do you look for?

Firstly, look for one that registered with a regulatory body. FINRA (Financial Industry Regulatory Authority) is the largest non-governmental regulator for all securites firms operating in the United States. After all, if you’re going to parting with money, you’ll want to be sure that your money is secure and that in the event of a dispute you have legal recourse.

From hereon in, choosing a brokerage is a matter of choice, so to help you make your choice, first visit some brokerage websites and have a good look around. How user friendly is the site? Can you find the information you need quickly? The answer isn’t always ‘yes’. What’s more, consider your own level of expertise in the stock market; does the site baffle you with jargon, or does it use plain, understandable sentences? What about a section for beginners to learn more in-depth about the various options and trades? Perhaps a community where a user can meet other traders and gain advice into market dealings, or simply to have a chat.

What about calculating your return on an achieving option? Or your loss on an underachieving one? Does the website give you the tools to perform these calculations, or will you be left scratching your head while musing over a notepad and calculator, deciding whether or not to cut loose your option or ride it out in the hope it picks up? And fees; what about fees? How much are you likely to have to pay when it comes to finally trading?

Tradeking is an online brokerage that has been in business since 2005 and has already amassed awards for excellence, including SmartMoney Magazine’s #1 Discount Broker and featured in Barron’s Top 5 Best Web Brokers. With a website to match the accolades earned, Tradeking could well be an ideal starting place for novice investors.

The Tradeking website is an extremely clean and easily navigable website, with all relevant information readily available. For novice investors, or those who want to brush up on the terminology, Tradeking offers a comprehensive Education section which features in-depth articles in both text and .mp3 format covering a range of market jargon as well as a wealth of online tools to calculate various options, profit & loss and probability among other resources. Educational web-casts and e-books are also available to help you get the most out of your trading.

Activity charts showing the current state of play in the markets can help you identify trends, good performing stock and underachievers, helping you plan your trading accordingly and accompanied by several other tools and resources, users can get a firm grasp on current market happenings and gauge probability of success of planned trading strategies.

Unlike most other brokers, Tradeking operates a flat fee structure, rather than a pricing structure. This means that regardless of how trade options perform, users know exactly how much they will be charged. What’s more, a standard margin rate commission is levied, meaning you get to keep more of your profit.

Throughout history, as a new president takes office the stock market declines in anticipation of the new leadership. Normally, under both Democrat and Republican, the stock market increases and life goes on as usually. This does not mean that all sectors will do wonderful and have increases. Investors drive the stock market. Either investors put their money in tried and true companies or buy up stocks on speculations of what companies will be give them more profit. Now, with McCain as our Commander in Chief, there are some sectors that will begin to see profits over the next few years and a few that might be decrease.

McCain’s tax cut ideas would help corporations and individuals alike. The tax cuts that are in place by the Bush administration, McCain wants to keep and then decrease corporate taxes from 35% to 25%. This would aid companies in hiring more people and bringing down the unemployment rate. He wants to get rid of the Alternative Minimum Tax and increase dependents’ exemptions to $7,000. Along with this, he proposes a new way of filing for Americans. Under the new options, Americans can file as we have every year or choose to file with a flat rate of around 25% to 15%. With more money in their pockets, Americans will be able to spend more money, thus helping the stock market increase. Retail sales, car sales, and even home sales will increase with more money on the table for corporations and individuals.

The insurance sector will see an increase in profits. Offering tax credits of $5,000 to families to help them in finding their own health care coverage with give Americans that added boost to seek out healthcare plans they can afford. With more people buying health insurance, insurance companies along with the medical field will see increases.

Research and development efforts to aid against the fight of global warming will be there, but not to the degree that some may wish. McCain will listen to experts on both sides of the global warming issue and work to find solutions that will benefit Americans without draining their pockets.

Oil and gas is of course a huge sector and it is on the minds of every American as they fill up their tank. What happens here has a lot to do with how McCain can work with other countries in order to fill our need for gasoline. McCain will put more money into research and develop so America can find an alternative to gasoline or ways in which to drill and refine to reduce our dependence on foreign oil. Of course, this action will take time and gas prices are sure to go up for awhile longer before we see a change at the pump.

Overall, the market will do quite well with McCain at the helm and see a glide upward instead of downhill.

Written by Anita Johnston

The genius of the United States of America lies in sacrifice. Your 2008 vote must put the interests of a new generation and its successors front and center. Support that Presidential candidate who presents the most credible agenda for the future evolution of your country. How can the next incumbent of the White House be held directly accountable to you? There are no guarantees that the lures of the Oval Office will not tempt even the most hermetic of the candidates in the fray. However, unqualified and consistent commitments to the following causes give you best chances that a new leader of the nation will work to build an estate for you to bequeath.

Throw your entire weight behind Ralph Nader. 

Capitalism creates the most wealth for the greatest number of people. A look at socialist regimes throughout history can attest to that. In large part, capitalism is responsible for the United States’ greatness (and the economic freedom that should go hand and hand with it). Last time I checked, capitalism requires capital. Labor depends on capital investment, not the other way around. From an economics perspective, stripping investors of capital will not promote prosperity; any view of prosperity including job growth. Let us now wrap our minds around higher dividend and capital gains taxes. How will stripping investors and business owners of capital promote economic growth? A break down of Senator Barack Obama’s tax plan can be found here:

European Levels of Taxation: Barack Obama’s Tax Plan

A John McCain presidency will be welcomed by the stock market. The country is searching for psychological relief.

The consumer has not been left behind yet. Spending is up 3% at an annual rate over the past three months. March and April saw individual increases in spending that preceded distribution of rebate checks. The consumer low occurred in February. Basically, consumers keep on trucking despite lowering consumer confidence (increasing economic fear) data from the University of Michigan Consumer Sentiment Index. S&P 500 earnings continue to beat expectations outside of financials. Forward earnings for five of the ten S&P sectors are at all-time highs. That includes sectors insensitive to inflation: health care, consumer staples, and information technology. The two-year plunge of housing wealth, a 52-week 98% increase in oil, and hammered retirement accounts haven’t slain the consumer. One might think it would have happened by now. On top of those huge factors, defaults on revolving credit lines have stayed fairly level. The stock market is treading water but wants to see pro-growth  policies locked in for the next presidency.

The University of Michigan’s index is a strong indication that economic fears abound; namely rising inflation expectations, a battered financial sector still searching for liquidity, and an uncertain energy future. Of the two presidential candidates we’re left with, McCain will be most helpful to the stock market. He will resist raising taxes. McCain’s fiscal conservative colors have been questioned but he’s the Ronald Reagan of election ’08. Increased off-shore drilling is a part of McCain’s energy plan. Both candidates call their plans “comprehensive,” but Obama’s has no place for increased domestic oil exploration or clean coal. Obama has also waffled on nuclear. Do Americans honestly believe an energy solution is possible without nuclear and clean coal? Most of us believe in conservation, fuel efficiency, and other demand-reducing mechanisms. Unfortunately the increasing hunger of developing economies drives global oil demand more so than the U.S.

France powers 77% of their electricity from nuclear energy and stores the waste safely underground. Ukraine and Sweden supply almost half of their energy from nukes.

Obama has said, “I have not ruled out nuclear…but only [would support it] so far as it is clean and safe.” Obama can visit France to see their nuclear system. Until then, nuclear will be a part of McCain’s solution.

In Norway, revenues from offshore oil production account for 30% of GDP. Oil production has made Norway a prosperous country and taken away foreign dependency on oil all the while being environmentally safe in the North Sea.

To take this country’s economy back we need nuclear energy, clean coal, natural gas to liquid, hydrogen, wind, solar, and oil exploration. McCain’s plan is best equipped to do this despite his reluctance to drill in ANWR. We can be energy independent at long last and provide high paying jobs to this economy.

Oil speculators set the market for forward contracts that allow businesses to lock in long-term prices for their oil (think airlines). An energy plan to increase domestic production would lead to speculators selling oil futures short and that would turn into lower spot prices for barrels. All around, McCain’s tax and energy policies will allow the market to let out a long sigh of relief. Uncertainty regarding the dollar and tax policy is holding the stock market down. The Fed and the Treasury are responsible for promoting the dollar and corralling inflation and lets hope they do. Along with a strong dollar, McCain’s tax policy will help unleash the greatness of America’s stock market.

Written by Ryan Swift

It is curious to see what an Obama presidency might mean for the stock market, and for investors.  Barack Obama proposed to impose taxes on “excess profits” of major oil companies, and distributing these monies to ordinary citizens in the form of stimulus checks.  The E&P (Exploration and Production) companies may see a hit in their stock price, in anticipation of such taxes.  Obama has not been bullish with respect to offshore drilling, and does not seem to propose opening the Alaskan fields to new drilling.  America would be hard pressed to find additional sources of crude, and the increasing demand from developing countries likely means continued increase in the price for oil.  This week, crude rose to a record $143 per barrel. 

Will oil reach a range of $200 to $300 a barrel under an Obama presidency?  Estimates of $200 per barrel predict at least $6.65 per gallon at the pump.  American will be headed for a nasty case of inflation under this scenario.  Additionally, an Obama presidency, will likely translate into higher individual, corporate, and capital gains tax rates (with the aid of Congress).  Particularly, investors that disdain high tax rates on capital appreciation will take their equity elsewhere.  Higher individual and corporate tax rates will lessen investment in U.S. stocks, putting pressure on valuation and multiples.

We are seeing several cuts in the financial sector all across the world such as what was reported on June 23 by Reuters that Citigroup Inc would be cutting thousands of trading and investment banking jobs. Plans reported previously stated that Citigroup would cut about 10% of its investment division; however, that percentage has now risen. The hardest sector that will be hit will more than likely be mergers and acquisition banking.

You may hear many analysts yelling that an economic depression is on the way, however, this may not be the case. America was in a similar situation during the Clinton administration. During the late 1990’s, there was a bubble in technology companies such as we saw with the real estate boom. The technology bubble burst the 3rd quarter of 2000 and the economy was in trouble as it is today with the burst of the real estate bubble.

If we pay attention to history, we will be able to get out of this spiraling downhill slide into economic disaster. The Bush administration took over at the beginning of 2001. During 1999 and 2000, President Bush was hard at work campaigning for an individual income tax relief program. Congress signed the Economic Growth and Tax Reform and Relief Act of 2001 in June of 2001. Of course, this did not stimulate the economy quickly but it did begin to heal.

Now, here we are once again heading in the wrong direction. The real estate bubble was great while it lasted. However, the reason we are in this dilemma is that home builders built homes in the $350,000 and up range without regard to who was going to purchase these homes. Lenders jumped on board the real estate bubble and began giving loans to individuals that could not afford their mortgage payments. The bubble hit hard when foreclosures began to appear due to homeowners not being able to afford their homes or due to the fact, they were in loans that were on an adjustable rate mortgage, which caused prices to increase above their means. Either way, homebuilders just kept building until there were more new homes on the market than there was demand. When homes are not selling, builders could not afford to pay their loans back to the bank, homeowners could not afford their mortgage payments, and the result was banks without money to stay open.

Another look at the economy during the Clinton administration showed, “Policy makers kept slashing borrowing costs until September 1992, when the rate fell to 3 percent. When the 2001 recession ended in November, the rate was 2 percent; the Fed didn’t stop lowering its target for the fed funds rate until it reached 1 percent in June 2003,” from Fed Feint on Rates Fails to Persuade Goldman, Lehman (Update2) By Daniel Kruger.
Today, you see the US Federal Reserve lowering the benchmark interest rate form 5.25% to 2%.

What can be done? A look back to the beginning of the Bush administration will give more answers than most people realize. When The Jobs and Growth Tax Relief Reconciliation Act of 2003 was passed in 2003, the GDP grew 1.2% and by the second quarter the economic growth had gone to 3.5%. Finally, by the third quarter the economic growth was at 7.5%.

By taking a look backwards, we should be able to see that the economy can rebound as long as we have those in power working towards a solution. History is repeating itself only in a different sector. The Bush administration accomplished the task once before, however; he did not have a Democratic Congress picking apart the proposals. Working together to provide accurate programs for businesses, banks, and individuals to ensure their success instead of failure is the only way out of this dilemma.

Written by Anita Johnston

A sustained and severe credit crunch means that it is harder and more expensive for companies, institutional investors, and consumers to obtain loans in order to fund operations, purchase assets, or acquire companies. Lack of confidence in the financial services sector, partly due to the subprime mess, means that lenders are less willing to risk their capital, in order to avoid further defaults. There is less capital available for the purposes of lending. Buy-out firms and private equity groups are having a harder time securing debt. Transaction service providers that facilitate lending and acquisition transactions are seeing less business.

A credit crunch means there are less lending and acquisition business for buy-out firms and transaction services companies (such as investment banks, due diligence professionals, etc.). Accounting, law, and consulting professionals who provide third party transaction-related and due diligence services are also affected. It is harder for a private equity fund to put together a deal during a credit crisis; some firms cannot secure enough leverage to fund a company purchase, meaning that millions of dollars in fees do not materialize for transaction service providers and intermediaries. Recently, Citigroup announced its intent to slash up to 10 percent of its approximately 65,000-member investment banking group. Less work means management must cut overhead. In these times, those that find themselves being “spit out” by Wall Street may end up obtaining a MBA, or switching careers. Wall Street, former employees, and the world, move on.

Warren Buffett famously described Wall Street as a “community in which quality control is not prized” and which “will sell investors anything they will buy.” For approximately three years between early 2004 and the middle of 2007, a demand for mortgage paper greased the loan underwriting process led to a huge decline in the requirements for getting a loan, and it became very profitable to originate, repackage, and resell pools of mortgage loans.

Like most shoddy business practices, the consequences eventually catch up to those responsible. And, as this neat graphic from a New York Times article shows, quantifying asset writedowns against profits from 2004 through the first half of 2007 implies that about half the profits from the six largest investment banks have been erased. This ranges from a high of 153% of profits at Merrill Lynch (MER) to “just” 12% at Goldman Sachs (GS). More data from Bloomberg gives a better perspective on the magnitude of the problem; worldwide, banks have taken credit losses totaling $400 billion and have been forced to raise $300 billion in new capital, much of it at terms less than advantageous to existing equity shareholders.

As these kind of financial results would suggest, financial institutions have been cutting employees on formerly profitable trading desks, and investment banking has seen cutbacks as well because of a slowing deal environment; without access to debt capital, it becomes almost impossible to execute the leveraged buyout deals that brought in such great I-Banking fee revenue from 2005 to mid-2007. According to the last Bureau of Labor and Statistics (BLS) report on non-farm payrolls, unemployment in the financial sector increased 27% year-over-year. Still, with unemployment in the financial sector low relative to other areas at 3.7% and banks almost assured of going through substantial deleveraging that will lead to lower profits for a multi-year period, either jobs will continue to be cut in the industry or compensation will have to be dramatically lowered.

Based on my conversations with people close to the capital markets, there is still a significant lack of liquidity that is hampering a recovery, and despite predictions about a return to normalcy in the second half of 2008, they are planning for several more quarters of reduced deal volume. Even on the other side when things return to a “new normalcy,” the existing business models of many of the larger financial institutions is going to have to pass a tough examination of how profitable they can be with reduced leverage available. The ability of banks to earn a higher spread on assets, and not leveraged equity, will be the new litmus test facing the industry, and will determine in large part how quickly rehiring and restoration of confidence in the capital markets occurs.