Buy and Hold Plus

Look for Stocks to Gain After Better than Expected Jobs Number

2010-09-03T13:16:02Z

The Labor Department released its employment situation report this morning, and it showed that private sector employers added 67,000 jobs in August. The number of jobs private sector jobs added in July was revised upwards, to 107,000.

These numbers beat the consensus estimate of a gain of 40,000 private sector jobs. Estimates had ranged from a decline of 12,000 jobs to a gain of 120,000 jobs in the private sector. Due to the decrease in temporary census workers, economists are using the private sector jobs to determine what's going on in the labor market.

The latest report should shut up those who claim that the only jobs that are being created are government jobs. Government payrolls dropped by 121,000, with the federal government shedding 111,000 positions.

Also, it should teach people not to listen to pundits with a political viewpoint to push. We've included a link to Michelle Malkin's "Obama jobs death toll," which was based on the ADP report released a couple of days ago. Apparently, Malkin hasn't been paying attention to the jobs reports, which have shown gains in employment in the private sector throughout the year. But then, what do you expect from an Asian American who actually said that locking up Japanese citizens during World War II was a good move?

The better than expected jobs numbers should end the talk of a double dip recession. According to the chief economist at UBS, "the double dip talk was probably misplaced." However, he added, "things are still soft."

If traders agree with his view, then stocks should gain during the day. Jobs are the key to the recovery picking up steam. We're seeing growth, but slow growth, and until companies start hiring again, that trend is likely to continue.

For more articles like this, please visit Buy and Hold Plus.

Qualcomm Pops, One Trader Thinks It's Going Back Down

2010-09-02T01:11:05Z

Image via CrunchBase

One of the most actively traded stocks today during the big rally was Qualcomm, which is one of the companies that we own. Qualcomm shot up by $1.30, which was a pop of 3.4 percent. That's better than the Nasdaq's gain today of around three percent.

Still, despite the big gains in Qualcomm today, one options trader has a a very different opinion. The stock's been bouncing between $38 and $40 for the past couple of months, which is great for those of us who sell covered calls. This means if we sell a call with a strike price just outside the trading range, we are likely to collect the premium income and not have our position called away. We're also likely to be in a position where we don't lose out on capital gains beyond our strike price, because the stock's range bound.

This options trader, however, set up a big long put spread on Qualcomm. They bought 347 Qualcomm January 2011 puts with a strike price of $37. And they turned around and sold 347 January 2011 puts with a strike price of $32.

That means that this trader has just put in a big bet that the share price of Qualcomm will fall, but not below $32. That means that they'll make money on the $37 puts they purchased and collect income from the $32 put they sold. They're hoping that the stock will drop to just above the $32 strike price of the puts they sold.

In order for this to happen, Qualcomm's stock will have to drop by 19 percent. Is this likely to happen? In the mind of the trader who set up this long put spread, the answer is yes. However, with the demand for smartphones continuing to increase and Qualcomm's technology being a key part of these, that could be a bad call.

For more articles like this, please visit Buy and Hold Plus.

Consumer Spending and Housing Glimmers of Hope?

2010-09-01T03:49:25Z

Lately, the economic news has been bad. Initial jobless claims jumped back to the 500,000 level, a level no economist expected. Housing sales dropped, but this was expected since the tax credit for first time buyers expired. And Intel, just a few weeks after projecting strong sales and margins in the upcoming quarter, dialed down expectations.

Naturally, the markets reacted to the bad news. Investors will be happy to close the books on the month of August. For the month, the Dow dropped 4.3 percent. The S&P also fell, declining by 4.7 percent. And the Nasdaq made these declines seem tame by comparison, plunging by a painful 6.2 percent.

Even though the news was mostly bad, there are still silver linings in the clouds of economic data. First, home prices rose in June, with the Case-Shiller index of 20 metropolitan areas climbing by one percent between May and June and increasing by 4.9 percent between June 2009 and June 2010.

But even here, economists warned that the relief could be short lived. One at Capital Economics said that prices will likely fall five to ten percent when the effects of the tax credit are gone. That, he warned, is likely to create a reverse wealth effect and "if households feel less wealthy, they will spend less."

This may mean that the higher than anticipated gains in consumer spending, which increased 0.4 percent in July, will fade. The increase, which was the highest since March, was seen as evidence that the economy will continue to grow, although slowly. After seeing the consumer spending numbers, the chief economist at Pierpoint Securities said "we'll see very slow growth, but it's a far cry from a double dip." Added an economist at Scotia Capital, the increase in spending "is allaying near term double dip concerns. It nonetheless showcases very lackluster growth in the U.S. economy."

The only good news from the plunge in stocks in the just closed month for us is that our options, which we were worried about being called away, are very likely to remain out of the money. While we don't like the pain of seeing our positions decline in value, the pain is lessened by the premium income we collect.

For more articles like this, please visit Buy and Hold Plus.

Deleveraging Isn't All It's Cracked Up to Be

2010-08-23T03:31:34Z

Deleveraging. We keep hearing about this, and it's something that the pundits are pointing to as the reason why the economy's growing slowly. With both consumers and companies not taking on more debt, we hear, spending's constrained. Thus, the economy can't grow as rapidly as it did when individuals and companies were running up their debt and spending money.

It's a great theory, but it's not borne out by the facts.

A column by Gene Epstein in Barron's shows what's actually happening. When businesses borrow money, they generally invest in plants and equipment with the proceeds. So if businesses were not borrowing, then we'd see a big decline in the amount of money they spent on these investments.

The opposite is actually what's happening. According to Epstein, private sector plant and equipment increased by 7.8 percent in the first quarter. In the second, investment surged by 17 percent, although it's likely that a revision will drop that number down to a still incredibly strong 15 percent.

While it's possible that companies are funding that investment with cash on hand -- the amount of cash on hand at S&P 500 component companies has soared -- it still means that they're investing in long term assets that require additional sales in order to be worthwhile. And if the rest of the economy was growing at the same rate, we'd be talking about how miraculous the recovery we're seeing is and how the Fed is going to have to raise interest rates soon and how a half point increase in the discount rate was likely.

How about the consumer? Have high unemployment rates and a weak housing market caused consumers to stop borrowing? According to Epstein, the answer is no. While it's true that the savings rate has jumped from negative numbers at the height of the bubble to 6.2 percent in the second quarter, that's lower than the 7.2 percent we saw back in the depths of the recession.

Of course, a big part of consumer credit is tapped when people buy homes. And the housing market is still weak. But other things that consumers buy on credit -- durable goods -- aren't showing the same weakness. In fact, consumer spending on durable goods jumped by 8.8 percent in the first quarter of this year and 7.5 percent in the second. Wouldn't it be nice to see that kind of growth in the rest of the economy?

What are consumers spending their money on, in addition to durable goods? One thing is smartphones. These are expected to account for 20 percent of all cell phones by the end of the year, and growth in sales of smartphones climbed by 15 percent in the second quarter of the year on the heels of a 21 percent growth rate in the first.

But be careful before jumping into investments in this market. "Because everyone wants to be in smartphones, competition is predictably driving down profits," said an analyst at the ISI Group. So instead of buying stock in companies like Research in Motion and HTC, it may be smarter to buy companies who make the chips or sell the handsets.

For more articles like this, please visit Buy and Hold Plus.

Fannie and Freddie: Huge Problem, No Easy Solution

2010-08-18T14:57:37Z

Image by Getty Images via @daylife

As you know, one of the consequences of the implosion of the housing market was the nationalization (okay, they're calling it guardianship but it's really not) of mortgage giants Fannie Mae and Freddie Mac. For decades, these two quasi public entities were boring companies that made their money by buying mortgages from lenders, aggregating those, and selling them to investors. They benefited from an implicit guarantee from the government -- in other words, while their bonds weren't quite like Treasuries, they were pretty close.

One of the downsides of being a publicly traded company, though, is that shareholders are always demanding increases in both revenues and earnings. And management constantly feels the pressure to increase those and to meet Wall Street expectations.

That caused Fannie and Freddie to branch out. The boring -- and safe -- 30 year fixed mortgages weren't generating enough profits to make their shareholders happy. So, what those companies did is put together what was essentially a government backed hedge fund. They thought their expertise in the housing market would allow them to invest on much more risky assets without too many problems. They were wrong.

In the end, that caused them to collapse. They had to be nationalized and that implicit guarantee became an explicit one. To date, the government has pumped $148 billion into the two companies. This is painful, but it's necessary, because the companies hold around $5 trillion in mortgages.

Why not just let the two mortgage giants fail? There are some who suggest that, such as representative Mike Pence. "It is past time to rid the American taxpayer of the liabilities of these financial institutions," Pence said.

That's a nice soundbite from Pence, but keep in mind that Pence is screaming about the deficit but just as adamant about keeping the Bush tax cuts in place without any plans to pay for them. So his credibility is just about nil.

Instead, we should listen to people who actually know what the hell they're talking about, such as Pimco's Bill Gross. Gross was dismissive of comments by politicians by Pence, saying "to suggest that there's a large place for private financing in the future of housing finance is unrealistic. It won't work." His assertion is backed up by the current situation in the mortgage market. Fannie and Freddie, along with the Federal Housing Administration, back up more than 90 percent of all new home loans. So if you want to really see the housing market collapse and suffer the consequences, just do what politicians like Pence say. They're good for soundbites, but not solutions.

One thing that everyone should be able to agree on is that Fannie and Freddie cannot be allowed to return to what they were before the housing bubble burst. There can't be the perverse situation where private companies can be allowed to profit from their government guarantee. As Treasury Secretary Timothy Geithner said, the Obama administration "will not support" a system where taxpayer funds are used to generate gains for private shareholders.

And as Gross said, the government can't get out of the mortgage market. "Full nationalization" should be an option, Gross said.

One potential solution to the problem? Fully nationalize parts of Fannie and Freddie, and allow the rest of the companies to be bought by private sector firms. The mortgage securitization part of the companies is something that is in the national interest, especially when it comes to homes for the middle class.

The nationalized parts of Fannie and Freddie could service only conforming loans, where individuals put down at least ten percent of the value of the home and where the debt to income ratio is no more than the traditional 30 percent that's been used as a gauge for whether a payment is affordable. And the value of loans would be no more than 150 percent of the median house price for the MSA where the house is located.

This would allow these parts of Fannie and Freddie to get back to doing what they did very well for decades -- buy mortgages from lenders, aggregate them, and sell them to investors -- for middle class home buyers.

The high end of the market and the speculative side of the businesses would be sold off to the private sector. Here, the margins are likely to be higher, which would attract private capital. And the government and the taxpayer wouldn't be on the hook for any potential losses.

I don't think that Geithner, Pence, or Barney Frank, who's called for Fannie and Freddie to be phased out, read this blog. But instead of a poitical solution that rallies the base but is bad policy, this would be a good place to start.

That'll Leave a Mark...On The Portfolio

2010-08-12T05:50:58Z

You've read about our trade in Himax, and how the stock reacted just like we expected it to after the ex-dividend date. We had a small net profit after that happened, and we wrote that we'd hold on to the stock. We thought that better than expected earnings would push the stock higher.

We were wrong. Badly. Despite reporting earnings that came in at $0.07 a share, higher than the consensus estimate of $0.058, the shares got pounded. We bought the shares at $3.06. We sold them at $2.47. The dividend offset part of that loss, since it was $0.25 a share. But that still wasn't enough to make up for the loss in the trade.

Our mistake here? We got greedy. When you're trading a stock for its dividend, and you've got a chance to make a trade that locks in a net profit, it's time to pull the trigger. We could have sold the stock for $2.88, and locked in net gain of $0.09 on a $3.06 stock, which would have been a gain of 2.9 percent in three days. That works out to an annualized gain of 358 percent, which we should have booked and moved on.

Instead, our greed, and our hope to make a bigger profit due to the earnings report cost us. It's a mistake we will learn from and hope to keep from making again.

Another trade that didn't work out for us was our trade in Walter Investment Management. We bought the dividend here, and we got in at $17.80. The share price went up, as we expected, since it was the day before the ex-dividend date. We expected the share price to fall, but not like it did.

How much of this was due to the carnage in the market and how much of this was due to the ex-dividend date arriving is something we don't know. But the share price, which we figured might drop by the amount of the dividend, instead plunged by more than a buck a share. WAC closed at $16.63 a share.

Ouch. That will leave a mark on our portfolio.

We'll take our beating, learn from it, and move on. Since we don't have another position that we're anxious to move into, we may hold off on closing our position in WAC. The stock pays a pretty good dividend of $0.50 a quarter, and that may be something we use to break even on the position. Or, if we see something better, we'll move into that one.

For more articles like this, please visit Buy and Hold Plus.

Himax Stock Acts As Expected

2010-08-05T04:44:49Z

As we wrote previously, we purchased shares of Himax Technologies in order to get the dividend. The stock went ex-dividend today, and it acted pretty much as we expected it to. The shares dropped to $2.88, down from the $3.10 they were trading at yesterday. That's pretty much the amount of the dividend, which was $0.25.

However, we got in a couple of days before the ex-dividend date, and we paid $3.06 a share. So at this price, despite the drop in price, we still come out ahead.

We're still going to hold on to our position, because the company will report earnings on August 9 after the close of the market. Management provided guidance about earnings about a month ago, and they expect earnings to come from $0.06 to $0.08 a share. Given that the consensus estimate is for $0.058 of earnings, there's a good chance that earnings will beat the consensus.

If that happens, it's likely the stock will move up. And if that occurs, then we'll get to profit from both the dividend and the earnings report.

If that doesn't happen, we'll take our gains from the dividend, close our position out, and move on to the next trade.

For more articles like this, please visit Buy and Hold Plus.

Big Lies about Tax Cuts

2010-08-03T18:37:21Z

As everyone who's paying attention knows by now, the Bush tax cuts are set to expire at the end of 2011. This has caused a frenzy among some politicians, who say that hiking taxes in the middle of a recession will destroy the economy. Well, first of all, these politicians need to look up the definition of a recession. Recessions are periods of negative GDP, not periods when the GDP is increasing by 2.4 percent. That's growth. It's not impressive, but it's still growth.

Second, we've heard these claims before. Right when Bill Clinton's budget passed in 1993, we heard politicians talking about how the tax hikes were "a deadly virus." Or we were told "this will lead to a recession next year." Or that the tax hikes would "put the economy in the gutter." In something that sounds strikingly appropriate for the current economic situation, one politician said "the problem with our economy is that there is too little employment and too little growth. This plan will do nothing to improve that condition and will actually make it worse." And, we were warned that a tax hike would have a "devastating" impact on job creation and "there simply won't be jobs for the next two to three years to go around to our young graduates across the country."

Of course, we all know what happened. Is there anyone, other than someone who bought Nasdaq 2,500 puts in December of 1999, who wouldn't trade the economy of the 1990s for the economy of the decade just closed?

Given all that happened, we decided to look at just what really did happen. What did the Clinton tax increases do to the economy, and what did the Bush tax cuts do? Did the Clinton tax hikes really destroy jobs? Did the Bush tax cuts increase revenue as promised? What does the data show?

Let's go to jobs, which is the first thing on everyone's mind. During what we'll call the Clinton tax period of 1993 to 2001, according to the Bureau of Labor statistics, payrolls increased by 39.2 million. That's an average of 4.4 million jobs created per year. What happened during what we'll call the Bush tax period of 2001 to the present? There were 15.8 million jobs created, with an average of 1.8 million jobs created per year. So during the Clinton tax period, we had 2.6 million more jobs created per year than during the Bush tax period.

Now, I know that ideologues will say, but we had the dot com boom in the 1990s and September 11 hit. I'll say that we had the blow up of Long Term Capital Management in 1998 and we had the real estate bubble in the 2000s. The bottom line is if there were any truth to the mantra repeated by ideologues that tax cuts spur job creation, we'd have seen it in the numbers. And we don't. The Clinton tax period beats the Bush tax period, hands down. It's not even close.

Okay, the ideologues will say, maybe tax cuts don't really create jobs (yeah, right) but they increase revenue and thus pay for themselves. Well, let's look at the numbers. If they are right, then right after a tax cut is enacted, revenues should go up. Conversely, right after a tax hike goes into effect, revenues should go down.

In 1992, total revenue to the federal government was $1.154 trillion. If the ideologues are right, then after the Clinton tax period started, that would have gone down. Remember, the tax increases were supposed to devastate the economy and drive revenue down. Did that happen? Nope. In the first year of the Clinton tax period, we saw total revenue to the federal government climb to 1.259 trillion, which is an INCREASE of 9.1 percent.

Well, maybe that was a one time fluke. Okay, it could have been. So let's examine the flip side of the argument. Cut tax rates, and revenues go up, according to some. Does it really happen?

No, it does not. The Bush tax cuts were enacted into law in 2001. So, according to the ideologues, revenue collected by the government should have gone up. The numbers show otherwise. Tax revenue in 2000 was $2.025 trillion. In 2001, it declined to $1.991 trillion. That's a drop, although a small one. What's interesting is that tax revenues did not return to the Clinton period level until 2005, or four years after the Bush tax period began. And that's before accounting for inflation.

But wait, the ideologues will argue. That includes all sources of revenue. What about just individual income taxes. That's where you'll see the effects the best, they'll say. Ignoring for a second the ridiculous nature of that argument -- if you say tax revenues go up when you do something, it has to happen -- let's examine that.

It gets even worse for these ideologues. Personal income taxes contributed $476 billion to the government coffers in 1992. In 1993, the beginning of the Clinton tax period, they accounted for $510 billion in tax revenue, or an increase of 7.1 percent. The Bush tax cuts, however, had the opposite effect. In 2000, individual taxpayers contributed roughly $1 trillion in revenue to the government. After the Bush tax period began in 2001, that was down to $994 billion. Again, it's a small decline, but it's a decline nevertheless. And personal income tax revenue did not return to its pre-Bush levels until 2006. That also is without an adjustment for inflation.

It seems that some ideologues are intent on repeating the 1990s, and fighting a battle over lies. This is extremely dangerous. Informed readers need to look at the data to see if what any ideologue -- republican, democratic, green, labor, or communist -- is saying is true. It's clear the the supply siders are wrong and the data backs this up. We cannot allow a failed economic theory to prevail if we want growth and prosperity.

What does this have to do with investing? A lot. Unless the economy grows and the deficit is managed, both companies and consumers will be nervous. That is bad for job creation, bad for profits, and bad for investors.

For more articles like this, please visit Buy and Hold Plus.

Buying Himax's Dividend

2010-08-03T00:02:35Z

One of the biggest developments in technology recently is the obsolescence of the CRT for televisions and computer monitors. If you to go an electronics store, good luck trying to find a traditional CRT television. Same thing for a monitor if you go to a computer store. And this trend will only continue. Smart phones, anyone? What do they all have in common? It doesn't matter if they are running Apple's operating system, Research in Motion's, Droid, or WebOS. They all need the screen.

A good way to invest in a trend is to not try to pick the winner in the end product. There's a lot of speculation that the iPhone will kill the Blackberry, or that the Droid operating system will kill the iPhone. Who knows what will actually happen? Nobody actually does.

But one thing that we do know is that all these smartphones, televisions, monitors, and laptops will require LCD panels. And we know that Himax makes the display drivers for all of those panels.

Himax is one of the bigger players in this field, with a market share of around 16 percent according to iSuppli. The leader in this field is Corning.

So why did we choose to invest in Himax instead of Corning? We did this for two reasons.

Dividends.

And earnings.

Himax's ex-dividend date is August 4. It will pay a dividend of $0.25 on August 20. We were able to get the shares for $3.06, so that yield works out to 8.2 percent. We went back and looked at what happened to the shares the last time Himax had its ex-dividend date, and surprisingly, the stock went up! Normally, when the ex-date passes, the stock will drop by the amount of the dividend. That didn't happen last time. We'll see if the past is prologue.

Another event is coming up that could make this trade even more profitable. Himax will report earnings on August 9. The consensus earnings estimate is for $0.058 a share in earnings. Himax gave an update to investors on July 7, where they said they expected revenues to increase by seven percent, instead of the previously projected 10-15 percent due to supply constraints. However, they kept their projection for earnings the same, estimating that earnings would come in between $0.06 and $0.08 a share.

Now, it may seem silly to get excited about beating an estimate by so little, but that's what many traders do. Beating projections results in stocks jumping, and missing them results in the stock getting killed.

So not only do we have the chance to pocket a hefty dividend here, but we have a chance to profit from a potential pop in the stock due to earnings.

That's the kind of trade we like to make. We'll see how it turns out, but as long as the shares trade above $2.81 -- a level that would represent a drop of 12.6 percent from today's close -- we'll be okay.

We thought about selling a call with a $2.50 strike price on this, but we decided not to. We'll take the dividend, hope for a boost from earnings, and take our chances. On the day before earnings are announced, we will likely put in a one cancels another trade. We'll put a stop loss order in at 10 percent below the closing price, and we'll put a sell order in at 10 percent over the closing price.

There is risk involved in this trade, but we believe it is worth it.

For more articles like this, please visit Buy and Hold Plus.

Listen to the Economic Data, or Company Projections?

2010-07-29T15:05:39Z

Recently, there's been a real split in the outlook of the general population, economists, the Federal Reserve, and many companies. So the question becomes, who do you listen to?

Do you listen to the Fed, which said "the pace of the expansion over the next year and a half was expected to be somewhat slower than previously predicted. The intensifying concerns among investors about the implications of the fiscal difficulties faced by some European countries contributed to an increase in the foreign exchange value of the dollar and a drop in equity prices, which seemed likely to damp somewhat the expansion of domestic demand?"

You've also got economists talking about a double dip recession. According to the well respected Robert Shiller, the economics professor at Yale University who is also one of the developers of the Case-Shiller home price index, "the probability of [a] double-dip is more than 50 percent." He added that he actually expects one to occur.

Should you listen to the Fed and Shiller? Or do you listen to companies like International Paper, which said in a statement accompanying its earnings release "operating rates are strong, inventories are low, and input costs are moderating. All of these factors position us well for a stronger third quarter." They weren't the only ones. Intel, in reporting its best quarter ever, said "the PC and server segments are healthy and the demand for leading-edge technology will continue to increase for the foreseeable future."

General Electric was also optimistic, though possibly not as much as International Paper or Intel. In its statement accompanying its earnings release, the company said "GE's economic environment continues to improve." UPS, while saying that the economic outlook was less than stellar, said "we experienced strong revenue growth across the board, with substantial margin expansion in our U.S. and International segments."

So who does an investor listen to? Should they throw their money in with the optimists like Intel and International Paper? Or should they listen to the Fed and people like Shiller?

How about both?

One of the most cliche sayings about investing is "it's not a stock market but a market of stocks."

So in any economic times -- recession, recovery, boom or bust -- there are stocks that you can buy which will deliver strong earnings growth. Those are the companies you want to buy. As an investor, you need to be aware that there might be challenges to delivering the growth that companies like International Paper, Intel, General Electric, and UPS say they'll be able to deliver.

But if they're predicting continued growth in sales and strong profits, then aren't they the stocks you want to buy? Aren't they going to be the ones that perform well in any economic environment short of a repeat of the Great Depression?

And if worries about a double dip recession have pushed their share prices down, that makes them an even better buy. Intel, for example, soared as high as $22.28 after its earning announcement. Yesterday, it closed at $21.33, or only $0.32 higher than its close before earnings were announced. Is this because of fears of a double dip and a steady drumbeat of less than stellar economic news? It could be, but do you care why? You shouldn't.

You know that you've got a company which says it's expecting to see continued growth in sales and profits, even after the best quarter in its history. And it's a company with a history of beating its projections. Why wouldn't you want to own that stock, especially if it comes at a slightly lower price?

The bottom line is that investors do need to pay attention to the macroeconomic conditions, but even in a period of slow growth, they can buy companies that will deliver strong earnings and revenue growth. Sometimes, they can take advantage of the fear to buy these stocks at lower prices.

For more articles like this, please visit Buy and Hold Plus.

Earnings, Options, and Predictably Irrational Behavior

2010-07-24T04:10:25Z

There's an entire field of study called behavioral economics. This field contends that humans routinely act in ways that are not based on rational thought. One of the books that is considered a must read in this field is Predictably Irrational, by Dan Ariely.

A perfect example of what Ariely contends happens all the time took place this week in one of our holdings, Qualcomm. On July 21, Qualcomm closed the day at $36.16 a share. That's a little below where it began the week, with the stock closing at $36.77 on July 19. But then after the market closed on July 21, the company announced its fiscal third quarter earnings. Earnings topped expectations, coming in at $0.57 a share versus the consensus estimate of $0.54 a share. Revenues also exceeded expectations, with the company reporting $2.7 billion in revenue, a slightly higher number than the $2.63 billion.

The company also projected revenues of between $2.67 and $2.93 billion for the fourth quarter, with earnings projected to be $0.55 to $0.59 a share. Analysts had expected $2.73 billion and $0.57 a share in profits.

So, the shares popped. On July 22, the shares closed at $39.11. That's not an irrational reaction. The shares should pop on better than expected earnings. We can quibble about whether or not a gain of 8.2 percent on earnings that were 5.6 percent better than expectations is warranted, but some kind of gain was.

What then, you're thinking, was irrational when it came to Qualcomm?

The options trading.

At one point, August calls with a $39 strike price were trading at $1.46. Think about that. In order for the trader who bought those calls to make money, the shares would have to climb to $40.47. That would represent a gain of 11.9 percent from the pre-earnings release price. It would represent a gain of 3.5 percent on top of the 8.2 percent gain that we saw right after the earnings release.

Now, it's certainly possible that a stock could appreciate by 11.9 percent in a month, although that's more than the S&P 500 has historically returned on average in a year. Qualcomm itself went from $72.38 to $124.38 in March 1999. That's a gain of 71.8 percent in a month. But that was during the dot com bubble, and we certainly aren't likely to see a return of those days.

So was it rational for a trader to expect Qualcomm to jump to $40.47 in less than a month? Absolutely not. But because the trader saw Qualcomm pop, he didn't want to miss out. So he likely overpaid for the option. Qualcomm traded essentially flat today, closing at $39.08. The theoretical value for the August $39 call is $1.07. So someone paid 36.5 percent more than the theoretical value of the call because he didn't want to miss out.

That is irrational behavior, and it's exactly what Ariely's talking about.

Our initial thought when we saw Qualcomm push past the $39 strike price on the August option we sold was "buy it back." But we held back, and we thought about it. We decided it would be far better to wait until we get close to the options expiration date to buy the call back -- if we even have to. There's slightly greater than 50/50 chance, according to an analysis from Thinkorswim.com, that Qualcomm's stock will fall below the strike price.

It's far better to wait until August 19 to buy the call back, if we have to, than to buy it back now and pay more. That is the rational way to act, instead of our initial thought of "buy it back now."

For more articles like this, please visit Buy and Hold Plus.

Unemployment Benefits Debate Highlights Congressional Idiocy

2010-07-20T17:46:17Z

As you all know, the extension of unemployment benefits has been stalled in the Senate. The new Senator from West Virginia was sworn in, and it's likely the proposal will get the 60 votes it needs to pass. The debate centered on whether or not these benefits should be paid for under the pay as you go rules or if they should be added to deficit spending.

The "debate" over whether to pass the extension of benefits as emergency legislation, and thus exempt it from the pay as you go rules, or to require some spending to be cut in order to pay for it highlights the absolute stupidity of Congress.

The amount of money we're talking about here is relatively small. The total amount of money that's required to give a whopping $309 on average to millions of unemployed workers will total around $35 billion for the year. In a country that's facing a trillion dollar deficit, that's chump change.

And the charge that the passage of the bill will inflate the deficit would have more validity if it came from a party that actually exercised fiscal responsibility when it was in control of Congress and the White House. It'd have more credibility if it came from a party that wasn't pushing for the extension of the Bush tax cuts, something that costs a hell of a lot more than the amount required for the extension of unemployment benefits.

It'd have a whole hell of a lot more credibility if the politician the party chose to unveil the proposal to keep the Bush tax cuts had an answer about how to pay for them. When asked repeatedly "how are you going to pay the $678 billion?", Senator Jon Kyl had no answer. Keep in mind that exchange came on the republican leaning Fox News.

That's Congressional stupidity in a nutshell. You've got a Senator crying like a stuck pig about something that will run $35 billion for a year. And yet, that same Senator wants to push for keeping a series of ineffective tax cuts that will cost nearly 20 times more. Some ideologues keep on repeating the lie about how tax cuts create jobs and boost the economy. All you need to do in order to see that's a lie is to compare the 1990s versus the 2000s. Taxes were lower in the 2000s, but there's no question that the 1990s were better economically.

That stupidity is highlighted even more by the return on investment on unemployment versus tax cuts. Take a look at the chart from Moody's Economy.com. There is absolutely no question that extending unemployment benefits provides far more bang for the buck than extending the Bush tax cuts.

We realize that math may be difficult for people like Senator Kyl, but even he should be able to figure out that a return on investment of $0.29 per dollar spent is a hell of a lot worse return on investment than $1.64 per dollar spent. Let's put it this way. The tax cuts that people like Senator Kyl are pushing for will COST the government and the tax payers $0.71 for every dollar provided to the population. On the other hand, extending unemployment benefits will provide the government and tax payers a gain of $0.64 for every dollar spent.

The return on investment from the $678 billion Senator Kyl wants to saddle the country with will be $197 billion. On the other hand, the return on investment from the $35 billion that he says is too expensive will be $57 billion. In other words, unemployment benefits will cost around five percent of what the Bush tax cuts will and they'll provide the economy with 29 percent of what the tax cuts will.

If you were a CEO of a company, and one of your managers came to you and said that he wanted to spend money on something with an ROI of $0.29 per dollar over something that provides an ROI of $1.64 per dollar, you'd fire him. And if he told you that he wanted to spend 20 times more on that low ROI project, you'd call security and have him escorted out on the spot so that he couldn't do more damage to your company.

But in Congress, that kind of mindset is just fine. The debate over the unemployment benefits highlights it and show just how idiotic Congress can be.

For more articles like this, please visit Buy and Hold Plus.

Options Expiration on Friday Means Trading on Monday

2010-07-19T19:18:13Z

As you know, last Friday was the third Friday of the month. That meant it was options expiration date. It's a day we watch cautiously as we determine whether our positions will get called away or if we were right and the income we collected for selling our calls became the closest thing you can get to a free lunch in investing.

This month, thanks in large part to the swoon the markets took over the past several weeks, that was the case. We didn't have any of our core holdings of General Electric, Johnson & Johnson, or Intel called away. Nor did we have positions in our ride them until they get called away holdings of ABB, Qualcomm, Sprint, or Ford get called away. That meant it was a winning month for our options trades. Even though we took some losses in our positions, the income generated made up for it. And the core holdings are something we want to hold for a long time, so we don't mind the short term loss.

We took the opportunity, however, to close our position in Sprint. We've generated enough income from the calls to have made our two month trade in that position worthwhile, and we think the company is going to hover for the next few months. We thought about selling another call against it, but decided to just let it go.

Our next step was to turn around and sell calls again that expire in August. That's what we did with ABB, Ford, General Electric, Intel, Johnson & Johnson, and Qualcomm. By doing this, we generated about $160 in income net of commissions. Multiply that by 12 and you come up with $1,920 in a year. That's nearly $2,000 in gains from just selling calls.

For our trading portfolio, that works out to a little more than four percent. That's a hell of a lot better than the return we'd get on a money market fund. It's also a good way to boost our returns.

Consider this. If we were to just take the average return on the S&P 500, in 20 years, every $10,000 in our portfolio would be worth $67,275. That's working with an average annual return of 10 percent, which is what the S&P 500 has averaged since the Depression. If we factor in the income from selling covered calls, that boosts our return to 14 percent. That means that in 20 years, every $10,000 will be worth $137,435.

That's why we sell calls and why we believe that options trading should be a part of any investors toolbox.

For more articles like this, please visit Buy and Hold Plus.

Why Cramer is Good for Entertainment, Not Advice

2010-07-15T13:23:58Z

Image by Getty Images via @daylife

So, Jim Cramer is telling people not to wait for a recovery in the American economy before buying stocks. Cramer's logic? The United States is the caboose of worldwide economic recovery. But hey, he says. The rest of the world will drag the United States along.

Now, the United States is still relevant, he says. "I am not saying we are irrelevant. We still matter," Cramer said. "I am saying that now we are the world's drag ... the caboose."

Even if you agree with Cramer's premise, which is that the United States is not the driver of growth anymore -- a position we think is ridiculous, seeing how the United States is the world's largest economy -- his claim is just plain wrong.

The recovery in the United States economy is underway, and it's been going on since 2009. GDP growth -- yes, growth, Cramer, which indicates a recovery -- was three percent for the first quarter of 2010 and it was 5.6 percent in the fourth quarter of 2009. We had a five month run of job growth this year, interrupted only by the drop we saw last month due to the end of temporary Census worker positions. Even there, we saw job gains in the private sector. Stocks have rallied by about 50 percent since their lows in 2009.

So the recovery is underway in the United States. No, it is not a strong one. Consumers still have too much debt and way too many homeowners are underwater. Unemployment remains high. But a recovery has begun.

But the pundits like Cramer act as if we're still shedding nearly 800,000 jobs in a month and GDP is dropping like a rock. That's just not the case.

This is a perfect example of why you've got to take anything the pundits say with a grain of salt. Economists are predicting growth of two to three percent in GDP this year. It's not something that will remind people of the dot com bubble days, but it's growth.

So for Cramer -- or any pundit -- to say that you need to buy stocks BEFORE the recovery in the American economy takes hold is ridiculous. The recovery is here. In order to buy stocks before the recovery begins, you'd have to go back in time. If you can do that, please go back to March 2009 and buy some S&P 500 1000 calls for January 2010 for me.

For more articles like this, please visit Buy and Hold Plus.

Definitely No Double Dip In the Works for Intel

2010-07-13T21:05:35Z

Image by Getty Images via @daylife

VH1 ran a show for about five years called Best Week Ever. Intel could steal their title, change it up slightly, and that sums up the second quarter for Intel.

Best Quarter Ever.

In fact, that is what they said in the press release accompanying their quarterly results, which they titled "Intel Reports Best Quarter Ever."

So what constitutes the best quarter ever for Intel? We'll start with earnings of $0.51 a share, or $2.9 billion. Revenues for the quarter came in at $10.8 billion. And the gross margins for the company came in at 67 percent. Think about that for a minute. More than two thirds of the revenue generated by Intel flows to the bottom line before you factor in expenses such as interest, depreciation, and other costs. Previously, the company had projected margins to be between 62 and 66 percent. Furthermore, the company's projecting margins to hold at their current level. The company's CFO said that in the third quarter, margins are expected to range between 64 to 68 percent.

Analysts had expected that Intel would deliver $0.43 a share in earnings and revenues of $10.3 billion, so the actual results destroyed expectations. Of particular interest to investors were the written comments made by Intel's CEO in the earnings release, where he noted "strong demand from corporate customers for our most advanced microprocessors." Furthermore, the company is optimistic about the future. "The PC and server segments are healthy and the demand for leading-edge technology will continue to increase for the foreseeable future," he added.

Still, incredibly, there are some who think there are storm clouds for Intel. According to an analyst from Wedbush Securities, traders are concerned that computer makers may accumulate too much inventory, thus curbing future demand. That's not something Intel sees, with the company projecting that computer sales may increase by as much as 16 percent annually.

One of the issues that some analysts take with Intel is their past history in penetrating markets outside of their core PC business, which is what the company is counting on in order to boost sales. An analyst from FBR Capital Markets warns "Intel has a long track record of poor performance in penetrating new markets outside of the PC market."

Even if the company does have problems with penetration of non-PC markets, we believe that Intel will continue to increase sales of its chips. Many companies are running with old computers, and with lots of cash on hand, it's likely some of that will be invested in technology. It's a lot cheaper for a company to spend money on upgrading its computer systems than to hire new employees, thus boosting productivity and getting more from their current workforce.

Regular readers of this column know that Intel is one of our core holders. We dumped a loser, Kraft Foods, in order to buy this company. We intend to hold this stock until it is no longer the dominant player in its field. Our views on Intel are similar to those of an analyst at Global Equities Research. Of the second quarter results, he said "they beat on the top line, they beat on the bottom line, the gross margin is through the roof. It couldn't be better." And he also called the stock "very underpriced."

We concur, and that's why we'll continue to hold Intel. And Intel's monster results bode well for the tech sector as a whole.

For more articles like this, please visit Buy and Hold Plus.