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Thursday, September 13, 2012

 

The Dem convention; options part 3

The link below is to Haverford's website with an interesting research story for environmentally oriented folks concerning the exciting prospect of separating and diverting carbon dioxide from burning fossil fuels.  The idea of course is to extend the useful lives of fossil fuel burning plants, especially since the advent of new drilling techniques has made so much more fuel available.

Whether one is concerned about the possibility of man-influenced climate change or not, we all should be pleased that techniques will be discovered to reduce the emission of suspect gases.  Of course, I anticipate a breed of environmentalist who would reject any such solutions, since the agenda of such people is really curtailing industrialization and corporatism.  Such discoveries may finally expose those creatures, as opposed to the ones really concerned about protecting the environment, who would welcome developments like this.

Haverford Researchers Create Carbon Dioxide-Separating Polymer - Haverford College News

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The Democratic convention was a progressive's tour de force, showing off the party stars to their best advantage, tightly scripted, predictably over the top criticisms of the opposition, and nauseating to the rest of us because of the constant mischaracterization of the GOP positions and objectives, and even worse misrepresentation of history and the "achievements" of the inept Obama administration.  I have to admit, I could only take it in small doses, try as I might.  But Obama's progressive and socialist fans ate it all up - just look at the left wing blogs - and so did the leftist biased media.  They put everything in a positive light, after being at best indifferent but more typically critical of what went on in Tampa.  But conservatives have lived with that handicap for 50 years.  At least now there is Fox News and Conservative radio to shore up the base.

 Yes, the Dems got a bounce in the polls.  The media happily reported that.  Let's see how quickly they'll acknowledge its fading, which has already started according to today's polls.  Part of the reversal had to do with the horrendous jobs report Friday.  But that's real - the bounce was a fraud.
Nevertheless the time has come for those who want to see a change in administration to get involved.

You do this by talking about the election with friends and acquaintances as tactful opportunity presents itself.  We are all centers of influence for some number of people.  It's easier to come over to our side if you hear people you like or respect talking about how it's ok to make a change.  Now I know many are so turned off (understandably) by politics that the idea of raising the subject (generally a social taboo) is anathema, but political participation is vital in a democracy or republic.  By the way, if Obama is your man, I would similarly encourage the same kind of participation, though please don't bother trying to convince me (and if you do, I will take advantage of the opportunity to explain why you should be on my side).

By the way, there are ways to do this and ways not to.  At bridge Saturday, one South we came to displayed a piece of note paper that said simply "defend Freedom, defeat Obama."  I have to admit this caused an awkward moment, and I responded simply "as my Dad would say, vote early and often."  That non-partisan rejoinder relaxed the table and ended the inappropriate political discussion before it really started, so that we could play the hands.

The Romney campaign is not doing especially well.  They have been slow to spend their money and run their ads in the swing states, and need to sharpen their positions (I had some suggestions in the prior post) and take advantage of the daily torrent of bad news for this administration.  When the Dems say something patently absurd (such as that they have been strong supporters of Israel, or did not reverse welfare to work), the Romney campaign should call them on it and cite chapter and verse.

But another key point - it matters who has the lead now.  Early voting starts in September in several swing states.   So NOW is the time to turn things around - not after the debates.

As if we needed more food for fodder, the sad and violent murder of our ambassador to Libya, greeted by a State Department comment blaming the producer of the short film that allegedly incited the mob, instead of the perpetrators, was rightly commented on by Mitt Romney.  His comments critical of both the State Department official making the stupid apologetic comment, and the President's weak MidEast policy that encourages such activity (we have talked many times on this blog about how terrorists only respect strength and gorge on weakness) elicited a White House rebuke, to the effect that the candidate had no business politicizing (or even commenting) on this foreign policy matter.

This is so absurd that it is hard to believe that even this myopic White House believes it.  First, it is so typical of Obama, and progressives in general, that rather than actually address Romney's criticism, they responded with an ad hominem attack but also questioned whether his comment was appropriate.  Well, if Romney hadn't said anything about such a serious incident, wouldn't we all have been wondering what the candidate was thinking?  But second, every American has a first amendment right to comment.  In fact, wasn't it Dems who asserted this right (correctly) during the Vietnam era, not to mention ad nauseum with respect to Iraq.   And if every American has that right, how dare the President question whether his opponent has that right?

A loyal reader has asked for the Musings view on taxes and whether we would support any increases.  I will explain that position in the next post in, I believe, convincing fashion.  The posts will also be coming thicker and faster as we move into the heat of the campaign.
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 For this post, we need to finish our series on options and options trading.  This last installment is on index options.

We have previously provided a primer on the mechanics of options trading, and then a discussion of the hedging strategy utilizing covered calls.  For the third and last installment on this series, we will discuss index options.

Theoretically, options could be traded using any asset with a trading market as a reference point.  Once everyone understood this, the attractiveness of trading options based on indexes, like the S&P 500 or the Dow industrials, became obvious.  What makes option trading sexy, especially for speculators, is volatility and leverage.  However, the first to use indexes were hedgers.  The idea was that you could sell a basket of stocks in the form of an index to hedge an actual portfolio of stocks (long positions) or buy an index to hedge a short position.  Once the indexes were being traded in this fashion, the next obvious step was to increase leverage to attract speculators.  Options increase leverage, because like futures, you control a lot of assets with a relatively small cash outlay. 

Once the Street realized there was a lot of money to be made selling options on indexes, they set about constructing indexes with more volatility, and factoring those indexes by ten if necessary to increase volatility and option premiums.  The more volatile S&P 100 (OEX) quickly surpassed the S&P 500 in popularity for option traders.  How would this work? Let's say we have an index trading at 1300.  If I am bullish on the market, I might want to buy an option to buy the index at 1340 (roughly a 3% gain) expiring in four or five months.  Depending on the historical volatility of this index, it might cost me about 10 to buy this option.  So to buy 10 options will cost $10,000 plus commission.  Now the index needs to climb above 1340 theoretically to get into the money, but actually, if the index could bounce to 1315 or so over the next week, the price of the option might go to 12.  I could sell the options then and net $2,000, minus the commissions.  In other words, this works exactly like options on a stock, but the speculator is betting on the market direction, not on the action in a single stock.  If the stock didn't move with the market, the stock option's value would waste away (see the first installment), even though I might have been correct to take a bullish view of the market.  With an index, if I guess the market correctly, I'll make money, assuming I have a careful selling strategy.

Just like with stock options, index options come in both calls and puts, and in theory, they can be shorted, though this is too dangerous for retail investors, and most brokers wouldn't allow them to do it.  It's interesting that brokers will tell you that most speculators are either wired to be bullish or bearish.  The bulls buy calls when they are comfortable with the market or sit out.  The bears are only comfortable buying puts when they think the market is too high.  Very few people are sharp enough to play both puts and calls successfully.

Perversely, the Street believes that most retail option players are as unsuccessful as retail stock players.  So a ratio that is watched closely is the put to call ratio.  When the ratio gets high, indicating investors are bearish, that is considered a contrary indicator that the market is about to rally.  When the ratio gets low, indicating the call players are more active, that is a bearish sign for the market. 

Options have become an important part of the market - they've been that way for over 30 years, certainly since the advent of index options as a retail product.  For a retail investor (as opposed to a speculator), they are a tool to be aware of but not necessarily to use, other than covered calls under the conditions and with the limitations I described in installment 2.  The redwavemusings investment formula does not use options at all currently.  In fact, I haven't bought or sold an option of any kind in 20 years.  Sure its exciting to make a thousand dollars in a matter of hours.  It's also a pretty sick feeling to have an option go the wrong way and watch your whole purchase price get lost over days, weeks, or a few months.  I've had both of those experiences.  For that kind of roller coaster ride, I strongly suggest a casino. At least you know going in that the odds are against you, no matter how smart you think you are. 

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The stock market continues to treat us very well.  On 9/4, we sold 900 shares of Frozen Food Express (FFEX) at 2.33.  We paid 1.25 on 11/10/11.  On 9/5, we sold 200 shares of Pulte Homes (PHM)  at 13.69.  For 38 shares, we paid 8.70 on 6/29/10, and for 162 shares, we paid 8.13 on 10/22/10.  On 9/7, we sold 100 shares of Teleflex (TFX) at 68.42.  We paid 37.95 on 5/22/03.  Finally, on Monday, we bought 100 shares of Protective Life Preferred (PLP) for the IRA  for 24.50.

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