Aug 17 2010 A Continuation of More Good News than Bad
The following is an extract from today’s news. “We’ve got a cornucopia of good news. We had upbeat guidance from the largest retailer on the planet, M&A activity is picking up, and economic data that blew away all concerns about deflation,” said Art Hogan, chief market strategist at Jefferies & Co.
The major indexes hit session highs after Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central bank does not have new doubts about the recovery
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A commentator even said that real estate in Florida was stabilizing and prices have slightly risen.
So this week there was a bunch of bad news reported which I will not repeat as everyone has read or heard these reports, as well as a bunch of good news, some of which is quoted above. I summarize some of my previous comments by simply stating
• that we had a big financial meltdown,
• that a lot of people have suffered tremendously,
• that the world is still functioning,
• that many sectors are showing signs of life, and
• that we will be range-bound until the NEXT BIG THING hits, and a lot of new wealth will suddenly appear.
Using LEAPS
If you agree that the financial world will stumble along until the next big thing hits, you might wish to consider purchasing LEAPS. The Cymorfund is a vanilla fund and does not purchase any derivatives. The Cymorfund is a value investing fund. However, the reader might consider for their own personal investing, that perhaps it is time to consider using LEAPS.
A LEAP is simply an option (a call or a put – the right to buy or sell a stock at a specific price at a specific time in the future) but it differs from normal options in that it extends further into the future.
Each underlying stock might have a LEAP that extends a year or 18 months, or longer into the future.
To explain it in basic terms, I will restrict this paragraph to Calls only. Essentially one pays a sum of money to buy the right to buy the underlying stock at a specified date in the future. That option is purchased and sold in lots of 100. That is, by purchasing 1 Call, you are buying the Call on 100 shares of the security. The Call trades and varies roughly with the price of the underlying security until the Call expires. You are able to buy or sell it at any time during its life.
When the Market Takes Off, LEAPS Can be Very Profitable
For example, look at BP. The stock was $60+. Now it is under $40. One might consider paying a few dollars to buy the right to buy BP stock in 18 months. The cost would be the price you pay + the price of the BP stock that the Call specifies. Say $5 + $45 (just hypothetical numbers) for a total cost of $50. If BP stock improves to where it was at $60, you have earned $10 per share. You sell the Call at $15 making $10 profit, or if you wish, just wait for expiry and buy BP at the $45 per share. If it goes higher, the profit increases. The worst that you can do, is to lose the $5. If BP is trading at less than your Call price, the Call just expires and your investment is worth zero. But there is no further risk.
So will BP stock increase in price? Is there a growing need for oil in the world? Does the price of oil continue to escalate in spite of the downturn? BP had a disaster in the Gulf, but did it discover a major pool of oil? Is the total exposure of BP to costs of the Gulf disaster equal to one year of BP earnings? Or 3 years? Is the only danger whether there are criminal charges which would dramatically increase the costs and exposure? Does BP have assets around the world?
One should look for unique situations, examine the cost of the option, and consider whether in a year or two, the particular stock will be high enough to make a profit on the Call. BP is only one example of several that have similar characteristics and are good candidates.
Thanks for your interest