Goldman Sachs:

• There is no problem with the Abacus transaction despite the fact that John Paulson was both structuring the deal and betting against it.
• It doesn’t matter who is on the other side of a transaction.
• ABN Ambro was the insurer of the transaction and lost. There job was to assess risk and assign the proper premium however the wrong premium was assigned to this deal.
• Almost all bond insurers lost money during the mortgage crisis.
• A lot of people lost money in housing as the euphoria that the housing market couldn’t go down was unsustainable.
• The biggest losses to taxpayers were at Fannie and Freddie who anwers to Congress.
• Very few were on the bearish side of housing.
• Lloyd Blankfein has done a stellar job of running Goldman and Buffettt would hope he stays on.

Housing Crisis:

Mass delusion- everyone was to blame.

Financial Regulatory Reform Bill:

• You cannot prevent bubbles, extremes will happen (internet bubble).
• This bill could contain damage
• In favor of limiting extreme leverage for individual speculators and investment banks.
• Congress is going in the right direction.
• Funds with FDIC government guarantees should have protection.
• End-users (homeowners) should not be put in the same categories as speculators
• There are proper use of derrivatives for banks that are important.

The Economy:

• Spoke of Matthew Rose, the CEO of BNSF Railway, who commented that all 22 of the commodity groups have been positive in recent weeks.
• The economy has picked up significant stregnth in March and April.
• It will take time to translate economic improvement into job creation.
• This country works, it’s a mistake to bet against it.
• People have regained confidence.
• We are not yet back to where we were 2-3 years ago.
• Unemployment rates come down slower than rates at which businesses improve.
• Residential housing is still poor due to inflated inventory.
• Interest rates increase as deficits increase. We need to diminish our deficits. 
• Deficits of 10% or more of GDP are unsustainable.
• Current policy was essential (as it avoided panic) but will lead to inflation if policy is not changed.
•  We are spending @ 25% of GDP but taxing @ 15% of GDP. The gap should be closer to 2-3%. Cutting taxes does not make sense.
• We need to allow for more recovery before cutting expenditures or raising taxes.

Greece:

• Eurpean countries are sovereign in their own budgets but can’t print their own currency because of their ties to the Euro.
• All currencies are likely to devalue in terms of their purchasing power.
• The outcome of the crisis in Greece and Europe in general, cannot be predicted as we are in unchartered waters.

Summary:

Warren Buffett was generally bullish on our economy and feels that our country always works itself out of a financial mess that it created itself. We must learn from our past transgressions and recognize the global factors that impact our economy and investments.

Event Update:

This Thursday evening I will be presenting an Advanced Workshop at the Plainview-Old Bethpage Public Library Auditorium on behalf of the Long Island Stock Traders Group. The club does not require membership for this FREE seminar. Those planning to attend or need more information, contact me @ alan@thebluecollarinvestor.com.

Top-performing exchange-traded funds:

The BCI team has enhanced its screening process of exchange-traded funds. for our premium members. ETFs in ALL asset classes will be screened weekly for the top 10, 1-month performers. Those that have options and are also in positive territory for the past 3 months will be compared for best 1-month performance and the top 5 will be charted and compared to the S&P 500. Here is a link to the most recent report found in the member resource area of the premium site:

ETFs- Top 5 5-7-10-PDF

Premium members:

This weeks premium report has been uploaded and available for your inspection. As expected, there are  only a handful of stocks that pass our system criteria.

Market Tone:

This weeks huge losses negated the years gains for a year-to-date return of 0.3%. The news for the U.S. economy continues to be positive while the situation in Europe continues to deteriorate. Since we are part of a global economy we must remain extremely cautious and monitor the resilience of the market over the next 2 weeks prior to expiration Friday. A 3-month chart of the S&P 500 and the VIX speaks volumes for what transpired this past week:

S&P 500 vs. the VIX 5-7-10

Notice how the VIX (blue arrow) converges and then shows an increasing bearish divergence from the S&P 500 (red arrow). It is an aberration to see such a dramatic turnaround in such a short period of time.

Summary:

IBD: Market correction

BCI: Neutral position putting no new money into market and managing exisiting positions.

This past week- Commentary:

In the last week we experienced a market drop that neutralized the entire gains for the year. Despite a recovering economy for the U.S., financial issues in Europe, a technical glitch on the exchanges and fraud charges against Goldman Sachs added up to a financial blow to the markets. In my view, the former will be managed and the latter two will be short-lived and explained.

For those of us who have been invloved in the stock market for decades we know that these aberrations rear their ugly heads from time to time but the market always recovers. We don’t like it, but it’s simply part of the game. Investors just starting out usually take this a lot harder, some swearing never again to invest in the stock market. The stock market is not for everyone. Remember golden rule #1 on page 10 of Cashing in on Covered Calls: “You must be able to tolerate some risk”. Investors who maintain a system of investing based on sound fundamental and technical principles as well as common sense will be winners in the long run. We do know this: In the short run, the market can plummet precipitously or advance exponentially. In the long run the market appreciates moderately. This is, as they say, reporting the news not creating it.

Wishing us all a better week ahead,

Alan (alan@thebluecollarinvestor.com)

Disadvantages of using ETFs: The one major, glaring disadvantage is the lower return generated by using these funds as the underlying security rather than individual securities. Expect returns between 1 1/2% and 2% (per month) rather than 2-4%. This is a result of the fact that we are using a basket of stocks which reduces the overall volatility of the underlying, making the option premium less valuable.For this reason I prefer individual equities but will use these securities in certain situations (earnings season and my mother’s portfolio, for example).

Advantages of using ETFs:

• Instant diversification
• No concern about earnings reports or same store monthly retail sales reports
• Requires less of an original investment
• Less management needed

How to select ETFs for your CC Portfolio:

Since we are dealing with a basket of stocks, fundamental analysis becomes less of a science. So I come back to what I consider the most  critical factor to consider: What are the institutional investors doing regarding this security? To resolve this issue I compare a 3-month chart of the S&P 500 (“the market”) to various selected ETFs. I currently evaluate all  of the Select Sector SPDRs, the Qs (QQQQ) and a few others. All ETFs outperforming the S&P 500 are eligible. Here is a chart taken from our premium site that demonstrates such a screen:   

At the last screen reported on the premium site, here is a list of ETFs outperforming the market with their market price at the time this article was written:

1. XLI- $32.62
2. XLY- $34.83
3. XLF- $16.98
4. XLP- $28.03
5. QQQQ- $50.13

Next, let’s assume a portfolio with cash available of $52k. We will set aside $2k for possible future exit strategy execution. That leaves 5 securities and $50k to spend. We will give equal cash allocation of approximately $10k per security as we round off to the nearest 100 (we need 100 shares per contract).  Let’s calculate:

ETF- Calculate Cash Allocation

Since we spent $48, 838, we will have a cash balance of $3,162 from our original $52k.

Next, access the option chains and sell the May, 2010 call options. Here is the options chain for XLY:

ETF- Options Chain

ETFs- The Ellman Calculator

The Qs are an exchange-traded fund (ETF). Let’s define:

This is a security that tracks an index, a commodity, or a basket of assets like an index fund, but trades like a stock on an exchange, thus experiencing price changes throughout the day as it is bought and sold. These securities provide the diversification of an index fund. Using ETFs for covered call writing is a great way to get started for those extremely conservative, those who stress capital preservation with lower risk and reward and for those with small amounts of capital to invest. These benfits are a result of the instant diversification achieved with an ETF and the lower implied volatility associated with a basket of stocks as opposed to a single equity.

The Mechanics of an ETF:

These funds are continuously creating new shares or redeeming existing shares depending on market demand. The shares represent ownership interest in the underlying basket of securities. Only large institutional investors called Authorized Participants (APs) partake in this creation and redemption process. They will buy creation units or sell redemption units over sophisticated electronic platforms. Shares are created when the APs provide a basket of securities to the fund which then creates ETF shares that are handed over to the AP. These ETF shares are then sold on the secondary market (exchanges) to us by the APs.

 On the other hand, when an AP provides the fund with a number of ETF shares (redemption unit), they will receive from the fund the associated basket of securities.

What’s in it for the APs?:

Are they doing this to be nice guys and allow BCIs to take advatage of these funds? I don’t think so either! They are doing it to take advantage of arbitrage opportunities. These are simultaneous purchases and sales of assets in order to profit from a difference in the prices. Here’s how the game is played:

The underlying securities in an ETF are priced every 15 seconds during the trading day. This value is similar to the NAV (net asset value) of a mutual fund which is priced only after market close. When there is a small difference between the intraday NAV and the actual share price of the fund, the AP can buy one and sell the other to generate a profit. This arbitrage process actually serves a useful function for us in that it keeps the fund price and the NAV price very close.

ETF Pros:

·       Diversification

·       Lower annual taxable distributions

·       Lower costs

·       Lower management fees

·       No 12-b-1 fees (marketing and distribution costs)

·       Trading flexibility

·            can be purchased on margin

·            can be bought and sold @ intraday market prices

·            can be traded with stop and limit orders

·            can be sold short

ETF Cons:

·       subject to market risk like investor sentiment and global conditions

·       market pricing discepencies (between NAV and actual share value) particularly in less liquid funds

·       tracking discepencies- returns may be more or less than the benchmark for the follwoing reasons:

·            a fund may sample the benchmark rather than duplicate it exactly

·            dividend distributions from a fund may differ from the equities themselves

·            the expense ratio reduces profits

·            regulations require no one company represent more than 25% of the fund. This may not represent    the actual fund allocation.

ETFs and covered call writing:

The conservative approach would be to get the most diversification so that out-of-favor securities can be picked up by the others. Usually, the greater the diversification, the lower the premiums, due to the lessened volatility. But this seems to suit the needs of conservative investors.

Two popular ETFs with tremendous diversification are:

VTI- Total Stock Market

SPY- S&P 500

For greater premiums but also greater volatility:

QQQQ- Nasdaq 100

IWM- Small Cap

Other popular ETFs:

DIA- Dow 30

MDY- Mid-Cap 400

I have been using the Qs in my mother’s account for years with excellent success. For the most conservative approach, look @ VTI and SPX and expect a return of 1-2% per month in normal market conditions.

Conclusion:

ETFs are vehicles that can benefit both institutional and retail investors. For writers of covered calls, the main asset is its instant diversifiction that permits a conservative approach to an already conservative strategy.

Where’s Alan??????????

I will be out of the country this week with limited email access. I’ll try to answer some emails and post on the blog and catch up after I return. All books will be shipped in the timely manner you are used to however, DVDs, CDs and Companion Workbooks will be shipped on February 1st. Blog articles have been written in advance and will be published weekly.

Last Week’s Economic News:

The market took a major hit this week as President Obama announced new regulations on the banking industry. Other signals were mixed:

·       jobless claims (nonfarm payrolls) were up

·       new housing starts fell 4% when an increase was anticipated by analysts

·       producer prices rose due to inflation in food and energy products

·       the Conference Board’s index of leading economic indicators was up  for the ninth consecutive month

For the week, the S&P 500 was down 3.9% for a year-to-date return of -2.0%.

Next Week’s Economic Reports:

·    Monday: exisiting home sales

·       Tuesday: consumer confidence

·       Wednesday: Fed decision on short-term interest rate, new home sales

·       Thursday: durable goods

·       Friday: 4th quarter GDP report, unemployment cost index 

_____________________________________________________________________________________

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My best,

Alan

alan@thebluecollarinvestor.com

Some books and courses on options suggest that when you sell a covered call option, you are investing more money but getting similar returns as when you sell a naked put. Therefore, the latter makes much more sense than the former. I must respectfully disagree. First some background information and definitions:

Covered Call options- We buy a stock and sell a call option on that equity, giving the right, but not the obligation, to the option buyer to purchase the stock from us at a specified price by a specified date. That option generates a premium, our profit. For example, we buy a stock for $30 and sell the $30 call option, generating a return of $150 per contract.

Naked put- Here we are selling the right, but not the obligation, for the buyer of the put to sell a stock to us, at a specified price, by a specified date. In return for undertaking this obligation, we also receive a premium. For example, a stock is trading at $30 per share and we sell a $30 put and receive a return of $150 per contract. The returns in these scenarios are usually pretty similar and if the put is exercised, we are required to buy the stock for the same $30, the call seller paid in the covered call example. So what’s the difference and why should we have to buy the stock and lay out all that cash?

Here are the reasons I prefer covered call writing to naked put selling:

1- Many brokerages want the assurance to know that you have the ability to purchase the shares you are obligated to buy when selling the put. Therefore, they will require you to have an adequate amount of cash in your account to cover such an event. You will then have sold a cash-secured put and set aside the same amount of cash as the CC seller.

2- The seller of a covered call captures all dividends distributed by the underlying corporation, the put seller does not. We’re not talking about a huge windfall here, but the cash is better in our pockets than someone else’s.

3- Selling covered calls allows the investor more flexibility. The most profit a naked put seller can generate is the premium on the option sale. A covered call writer can profit from the option premium PLUS additional share appreciation if an out-of-the-money strike is sold. That choice is available to the covered call writer but not to the naked put seller.

4- Early assignment is not an issue for CC writers because the option premium is not affected and possible additional upside appreciation is incorporated into your profits if an O-T-M strike was sold. For naked put sellers, early assignment could be a disaster. Imagine a stock gapping down, and the stock “put” to us at the $30 strike. The stock is plummeting and heading for the teens! The put seller wants to sell the stock before it loses more ground but perhaps the shares haven’t even hit his account yet. He may have to wait until the next day to sell the shares. One way of getting around this issue is to sell the shares short (selling before actually owning them). The problem with this solution is that average Blue Collar Investors will have a difficult time getting “shorting privileges” from their brokerage firm and may lack the sophistication necessary to manage such situations. Besides, who needs the headaches?

5- Those interested in option investing in tax sheltered accounts, will have an easier time establishing such accounts using covered call writing than any other form of options trading.

Conclusion:

There are many ways to make a profit in the stock market and certainly selling naked puts is one of them. The risk/reward profile of CC writing and naked put selling are similar but just like looking at the will versus the revocable trust, there are differences. Each investor must be well-informed about all strategies and approaches before deciding on which road to take with his(her) hard-earned money.

UNG- A Fund to keep on our radar screen:

I have had several email questions regarding if there are ETFs that return higher yields than the Qs or more conservative indexes. The answer is yes but it comes with a price. That cost, of course, it increased volatility. Those with low risk tolerance, take note and stay away. Those looking for greater profits with a fund that may be heading north, take note and keep this one on your radar screen.

UNG is an exchange-traded fund (ETF) entitled the US Natural Gas Fund. Natural gas is one of this country’s greatest natural resources. With such energy experts as T. Boone Pickens pushing for government policy to utilize this commodity to help solve our energy dependence and economic crisis, there is a strong possibility that this fund can reverse its course and head north.

 Currently the chart pattern of UNG tells a mixed story:

UNG as of 7-24-09

• The 20-d ema is trading under the 100-d ema.
• The trend is NOT our friend as it has been declining precipitously.
• Both the MACD and the Stochastic oscillator have turned positive. 

Because of the volatility of commodities in general and natural gas in particular, the options premiums are quite high. At the time of  writing this article UNG was trading @ $13.13 with 4 weeks remaining until expiration Friday. These are the returns that could be generated at that time:

$12 strike: 3.1% with 8.6% downside protection

$13 strike: 5.9% with 1% downside protection

$14 strike: 4.2% with 6.6% upside potential

$15 strike: 1.9% with 14.2% upside potential

Please note that these are all 4-week returns.

With an inexpensive security such as this, many investors may sell multiple contracts and can therefore “ladder” the strikes wherein they sell both I-T-M and O-T-M strikes. Once again bear in mind that this is a high- risk, high-return investment with the technical picture improving but not as healthy as we would like. I will keep this one on my radar screen and report back as the technicals improve.

Last Week’s Economic News:

The Conference Board’s index of leading economic indicators increased for the third consecutive month. Fed Chairman Bernanke said that the economy is improving….”Aggressive policy actions taken around the world last fall may well have averted the collapse of the global financial sysem.” Also, he stated that the Fed plans to keep interest rates near zero until unemployment declines. Another positive was that sales of exisitng homes incereased by 3.6% in June, the highest level since last October. For the week, The S&P 500 rose by 4.1% for a year-to-date return of 10%.

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Wishing you the best in investing,

Alan (alan@thebluecollarinvestor.com)

A risk reward profile is a  chart of the theoretical maximum profit or loss a particular investment can have in your portfolios. For example, let’s look at the risk-reward profile of stock ownership:

Risk-reward profile of stock ownership

This graph demonstartes that, in theory, profit is unlimited, it can go to the moon! You can also lose your entire investment. For savvy investors, will either of these events ever occur? No. Even, the most solid of companies will hit bumps in the road and give us reason to sell some or all of our shares (hello GM!). Furthermore, which educated, prepared investor will allow his stock price to drop to zero?

Theoretical Risk-Reward Profile for Covered Calls:

Let’s analyze this graph:

Risk-Reward for an Unmonitored Covered Call

When selling a covered call option, we are placing a ceiling on the share appreciation; our profit is limited to the option premium plus any stock appreciation up to the strike had we sold an O-T-M strike. The downside is dramatic as we can lose all our equity value and retain only the cash from the sale of the option. If we were to base our decision regarding the efficacy of covered call writing soley on this profile, we would reject it immediately. It appears that the odds are against our success. Fortunatley, there is a major difference between theoretical and practical applications of risk-reward profiles. Enter the wonderful world of exit strategies.

Practical Risk-Reward Profile for Covered Calls:

Let’s now analyze an enhanced graph that has application in the world of the informed and prepared investor:

Risk-Reward Profile for a Monitored Covered call Position

The actual profit potential can actually be elevated in some instances by “hitting a double or triple”, rolling down, or “converting dead money to cash profits”. Certainly the potential losses can be minimized by utilizing any of the aforementioned strategies. Here is the key point uneducated investors miss: This horizontal line that represents potential loss can be elevated close to the zero line by instituting appropriate exit strategies, selecting the best strike prices, factoring in market tone and equity technicals. These are the marks of true Blue Collar Investors and is what sets us aside from all the others. When evaluating information to make an intelligent investment decision, we must know the limitations of that tool so we can apply it in the proper manner. Viewing the last graph as compared to the one before it demonstrates the significance of this point.

Exchange-TradedFunds (ETFs)- Informative links:

Many of our readers use ETFs in their investment portfolios. These informative links were sent to me by a knowledgeable Wall Street Insider:

NYSE.com features an Exchange Traded Products Screener which allows investors to search for ETFs, ETNs (Exchange Traded Notes) and ETVs (Exchange Traded Vehicles) that trade on NYSE Arca. The Screener allows investors to search for an ETF using a keyword or symbol and provides a link to the issuer’s website. ETFs may also be filtered by issuer and classification. The Screener can be found at: 

http://www.nyse.com/screener/. 

Specific to each ETF, NYSE.com also offers a profile page with a detailed description of the product, current and historical trading data, news announcements pertinent to the product and links to SEC filings. To access this information, type the symbol in the “get quote” search box located on the top, right-hand corner of the home page. 

Two other informative links:

Corporate action postings, including new launches and dividend distribution information can be found at: 

http://www.nyse.com/equities/nysearcaequities/1231845027892.html 

A spreadsheet providing weekly updates of ETF trading volumes for each product can be found at: 

http://www.nyse.com/attachment/Weekly_ETP_Volume.xls 

To those of you who use or may incorporate ETFs in your investment plans, feel free to bookmark these links. I hope you find them helpful.

Last Week’s Economic News:

Positive surprises continue to give us hope of a strengthening economy and a normalization of the stock market. A positive increase in the measure of the U.S. services industry from the Institute for Supply Management’s index of nonmanufacturing goods plus a slowing in the rate of consumer debt were both plusses for the economic environment. Also, the U.S. global trade deficit declined to its lowest level since November of 1999. Many economists have suggested that, given this data,  the economic downturn has bottomed and will start to improve in the later part of this year.

BIG CHANGES COMING IN AUGUST:

Due to the tremendous volume of my mailing list, I am no longer able to handle my updates and contacts to you. In August, this task will be turned over to a professional mailing service. There will be no change in the content or the mission statement of The Blue Collar Investor to create a forum for average investors all over the world to share information and untimately lead to our financial freedom. I DON’T WANT TO LOSE TOUCH WITH YOU! To stay in touch is simple…opt-in at the follwoing link if you haven’t already:

http://www.thebluecollarinvestor.com/joinfrnds.shtml

This will also entitle you to receive a special report I wrote about the Ten Greatest Mistakes Covered Call Writers Make and How to Avoid them. These reports will be sent out every few weeks based on the date you signed in. 

Where’s Alan?

This coming weekend a group of investors is flying me out to California for a private seminar. The traveling and presentation day will slow down my email responses to you. I expect to catch up during the course of the following week.

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My best to all,

Alan (alan@thebluecollarinvestor.com)