What is the Stock Market

An anatomy of the Stock Market - Bull & Bear Market Cycles

In financial markets, the “majority is always wrong.” When the investing majority or the crowd is overly bearish, this is the best time to be buying stocks. When the crowd is overly exuberant, this is the time to be selling stocks. The financial markets work in this ironic way because not everyone can win in the market.

The Start of a Bull Market

The bottom of the market starts at a time when the stock market is weak and the general population is pessimistic. At this point most investors sell after having endured a long and torturous bear market. This extreme pessimism found at a bottom is always irrational and undeserved. Now the market is undervalued and is a bargain. Savvy investors, the “smart money”, buy bargain stocks knowing that they will be able to sell them higher in the near future. Smart money buying, called accumulation, causes stocks to rise. These people have access to information that the general public does not.

Rising stocks eventually gain the respect of institutional investors, as billions of dollars of capital is introduced into the market place. Mutual fund investment causes the stock market to advance in a powerful manner. Much of the steady large trends are powered by institutional investors. After the stock market has gained, stocks are now fairly valued and are no longer considered bargains. The smart money is now sitting on a large profit, as well. The average investor is still skeptical, however.

As bull market events unfold, retail investors begin to take interest in stocks. Retail investors, or the unsophisticated little guy, make up the vast majority of investors. This group does not invest for a living. Retail investors often make investment decisions based on what they read in financial magazines, from their brokers and from tips from friends. As the flood of retail capital is invested, the market soars, causing great euphoria. The market generate even more optimism as unsophisticated investors buy into the fallacious thoughts of instant riches. Now is the time when many small investors become wealthy. In this phase, stocks are doubling and tripling as the media cheers on the advancing bull market.

At this point, the smart money sells, or distributes, the now overvalued stocks to overconfident retail investors. The smart money knows that overvalued stocks are no longer worthy investments, and will soon drop in value. Widespread greed always occurs, in some form, at stock market tops. Sometimes this greed takes form as stock market scams and fraud. These immoral activities can take place because irrational retail investors will buy a stock simply because it is glamorous. To compound the problems, investors will now start to use margin, or leverage, to further accelerate gains. All caution is thrown to the wind as investors think “the old rules don’t apply”.

The Start of a Bear Market

After mutual funds and retail investors are fully invested, the market is overbought. This means that there is no more cash to fuel the rally. The market can only go in one direction - DOWN. All it takes is just a hint of negative news and the market collapses under its own weight. Investors quickly realize the market is made of smoke and mirrors, as frauds or other scams come to light.

When panic selling starts, a market will always fall quicker than it had risen. Oftentimes, as everyone heads for the exit at the same time, there isn’t anyone willing to buy the stock. This can be especially disastrous for margin users as they grow deeply indebted to their brokers. Bankruptcy is the usual result for these foolish gamblers. The majority of retail investors don’t sell even as the market is plummeting. This crowd keeps holding on to stocks in hopes that the market will recover. As the market plummets 25%, then 50% the average retail investor foolishly holds on, in complete denial that the bull market is over. Finally retail investors sell every stock they own plummeting the market even further. This mass exodus is called capitulation.

The Cycle Starts Again

It is at this point that stocks are undervalued once again. The smart money is accumulating and stocks rise. The majority of retail investors bought at the top and sold at the very bottom. This is the very essence of the "dumb money". They are perpetually late into the game. This cycle continues over and over. Only the smart money actually "buys low and sells high". After trading in this manner, the "dumb money" which is the majority of the public will say, 'the stock market is risky'. In reality, however, the stock market is only risky because they trade like the mindless majority. As traders, we follow the "smart money" and against the "dumb money". Our valuable tool is only charts and our natural "trader instincts". We don't follow tips and we do our own homework.

Gold and Crude Oil rebounds

Gold rebounds on Iran missile test, off two-week low

Gold regained ground on Wednesday as speculators resurfaced on news that Iran had test-fired nine long- and medium-range missiles, lifting the metal's safe-haven appeal in times of uncertainty.

State media said Iran had test fired missiles, including one which it had previously said could travel as far as Israel and US bases in the region, at a time of increased tension between Iran and Israel over Tehran's disputed nuclear programme.

Gold hit a low of $915,60 an ounce before bouncing to $921,15/922,15 an ounce on the Iranian news, steady from 921,35/922,55 an ounce late in New York.

Gold fell as low as $912,50 an ounce on Tuesday, its lowest level since June 27, on weaker oil and a rebounding US dollar. Gold was well below a record high of $1 030,80 hit in March.

"It's not surprising that the market has taken the news as positive for gold. I think $910 to $912 are going to be support, on the top side we are looking at $925 as resistance," said Darren Heathcote of Investec Australia in Sydney.

"We still have an awful lot of uncertainty out there, which should help to underpin it for the time being," he said.

Tension is also high between Iran and the United States over Iran's nuclear programme, which Washington says is aimed at making an atomic bomb but Tehran says is for generating energy.

There has been media speculation of a possible US or Israeli military strike against Iran's nuclear facilities.

Gold has hit a lifetime high on record-high oil prices which raise the metal's appeal as a hedge against inflation and expectations of more interest rate cuts in the United States, which lift its appeal as an alternative investment.

The euro rose to $1,5713 the Iran news, which also pushed up oil prices by more than $1 a barrel.

While jewellery makers were on the sidelines, dealers said gains in bullion held by SPDR Gold Trust, the world's largest gold-backed exchange-traded fund, to 658.99 tonnes, within sight of a record in March, showed investors' confidence in gold.

"From an investment perspective, there's still demand there," said Heatchote of Investec Australia.

Spot platinum firmed to $1 945,00 s/1 965,00 an ounce from $1 940,50/1 960,00 late in New York. It hit a two-month low of $1 936,50 on Tuesday on fears a slowing US economy could weaken demand from car makers.

Platinum was well below a record high of $2 290 hit in March on supply fears in main producer South Africa. Arbitrage buying from speculators in Tokyo futures pushed up cash prices but platinum struggled to sustain gains.

"After platinum fell below the $1 950 region, I think it could move lower, from a technical perspective. Gold and silver are definitely much better off," said a dealer in Singapore, who pegged support at $1 920 for platinum.

The most active platinum contract for June 2009 delivery on the Tokyo Commodity Exchange fell as low as 6 635 yen per gram, its lowest level since early June.

Spot palladium rose to $439,00/447,00 an ounce from $437,50/445,50 an ounce late in New York. Silver edged down to $17,79/17,84 an ounce from $17,82/17,88 late in New York.

Gold futures for August delivery on the COMEX division of the New York Mercantile Exchange fell $0,5 an ounce to $922,8.

Iran test fires longer range missiles

Iran has test-fired a missile whose range puts Israel within reach, angering the United States amid growing fears that the stand-off over the contested Iranian nuclear drive could lead to war.

The Shahab-3 was among a broadside of nine missiles fired off early Wednesday from an undisclosed location in the Iranian desert, state-run Arabic channel Al-Alam and its English counterpart Press-TV reported.

Al-Alam said the missiles test-fired by the elite Revolutionary Guards included a "Shahab-3 with a conventional warhead weighing one tonne and a 2,000km range."

The firing comes at a time of growing tension over Tehran's nuclear drive, which Iran has insisted is peaceful but the West fears could be aimed at making an atomic bomb.

"The aim of these war games is to show we are ready to defend the integrity of the Iranian nation," Al-Alam quoted Revolutionary Guards air force commander Hossein Salami as saying.

"Our missiles are ready for shooting at any place and any time, quickly and with accuracy. The enemy must not repeat its mistakes. The enemy targets are under surveillance," he added.

The United States, which has never ruled out military action against Iranian atomic facilities, immediately condemned the missile tests.

"Iran's development of ballistic missiles is a violation of United Nations Security Council resolutions and completely inconsistent with Iran's obligations to the world," White House spokesman Gordon Johndroe said.

Nine missiles were tested in all, state-run Press-TV reported.

Along with the Shahab-3, also test-fired were the Zelzal, with a range of up to 400km, and the Fateh which has a range of around 170km.

Press-TV showed footage of the Shahab-3 and other missiles being launched, apparently successfully, leaving huge clouds of smoke around the launch site.

The Islamic republic test-fired the Shahab-3 for the first time in an exercise in November 2006, but launching its longest-range weapon amid the current tension is sure to concern Iran's Western foes.

The semi-official Fars news agency said the warhead on the Shahab-3 would fragment just before impact, maximising damage to the enemy.

There has been concern that an attack against Iran could be imminent after it emerged Israel had carried out manoeuvres in Greece that were effectively practice runs for a potential strike against Iranian nuclear facilities.

Israel is Iran's arch regional enemy and has expressed alarm over the rhetoric of President Mahmoud Ahmadinejad, who has repeatedly predicted that the Jewish state is doomed to disappear.

The missile launch comes a day after an aide to supreme leader Ayatollah Ali Khamenei warned that Iran would "set fire" to Israel and the US navy in the Gulf as its first response to any American attack over its nuclear program.

"Tel Aviv and the US fleet in the Persian Gulf would be the targets that would be set on fire in Iran's crushing response," said mid-ranking cleric Ali Shirazi, Khamenei's representative to Revolutionary Guards naval forces.

Wednesday's launch was part of The Great Prophet III war games by the missile and naval sections of the Revolutionary Guards which are aimed at improving combat readiness.

But diplomatic efforts are also continuing. Iran has responded to an offer from world powers to end the nuclear crisis and diplomats are analysing what is said to be a complex answer from Tehran.

The offer from world powers proposes that Iran suspend uranium enrichment - the key sticking point in the crisis and the process which they fear could be used to make a nuclear weapon - in exchange for technological incentives.

However the French foreign ministry has confirmed that Iran does not say in its response it is prepared to suspend uranium enrichment. Iranian leaders have repeatedly vowed never to suspend sensitive nuclear activities.

Iran rejects Western accusations and insists its nuclear program is aimed solely at generating energy for a growing population whose fossil fuel reserves will eventually run out.

History Crude Oil Futures

A recent low point was reached in January 1999 of $16 (all prices are in US$ per barrel), after increased oil production from Iraq coincided with the Asian financial crisis, which reduced demand. Prices then increased rapidly, more than doubling by September 2000 to $35, then fell until the end of 2001 before steadily increasing, reaching $40-50 by September 2004. [2] In October 2004 light crude futures contracts on the NYMEX for November delivery exceeded $53 and for December delivery exceeded $55. Crude oil prices surged to a record high above $60 in June 2005, sustaining a rally built on strong demand for gasoline and diesel and on concerns about refiners' ability to keep up. This trend continued into early August 2005, as NYMEX crude oil futures contracts surged past $65 as consumers kept up the demand for gasoline despite its high price. Crude oil futures peaked at a close of over $77 in July 2006, and in December 2006 at about $63. That is just about where they began the year 2006.[3] In September 2007, US crude (WTI) crossed $80. Multiple factors caused this high price. OPEC announced an output increase lesser than expected.[4] US stocks fall lower than experts predicted[5] and six pipelines were attacked by a leftist group in Mexico. [6]

In October 2007 US light crude rose above $90 for the first time, due to a combination of tensions in eastern Turkey and the reducing strength of the US dollar.[7]

On January 2, 2008, a single trade was made at $100[8], but the price did not stay above $100 until late February.

Oil broke through $110 on March 12, 2008[9], $125 on May 9, 2008[10], $130 on May 21, 2008 [11] and $140 on June 26, 2008.

Prices on June 27, 2008 touched $142.26 for August in the New York Mercantile Exchange, the highest price ever, amid Libya's threat to cut output, and OPEC's president predicted prices may reach $170 by the summer.[12][13] Oil prices on June 28 hit a record of $142.99 at 1:58 p.m., the highest since 1983, and to $142.97, the highest intraday price since 1988, owing to a weak dollar, geopolitical unrest and global equities slump.[14][15][16] Oil rose on July 1 to a NYME record $143.67 and a London ICE Futures Europe exchange record $143.91.[17][18] On July 3 prices hit $145 for the first time.[19] London Brent crude reached a record of $145.75 a barrel, and Brent crude for August delivery peaked to a record $145.11 a barrel on London's ICE Futures Europe exchange, and to $145.85 a barrel on the NYMExchange.[20][21] By midday in Europe, light, sweet crude for August rose to a record $ 145.85 a barrel on the NYME while Brent crude futures rose to a trading record of $ 146.69 a barrel on the ICE Futures exchange.[22][23]



The Future

Fatih Birol, chief economist of the International Energy Agency said in October 2007 that oil prices will remain high for the foreseeable future due to rapid increases in demand from the rapidly growing economies of India and China.[24] The ministers of OPEC, meeting in early December 2007, appeared to reach a consensus for high, but stable prices. This price point would deliver consistently high income to the oil producing states, but avoid prices so high that they would depress the economies of the oil consuming nations. A range of $70-80 was suggested by some analysts to be OPEC's goal.[25] This would be in step with the price of shale oil, which, though more expensive to drill, will not likely go above $100. [26] The ministers of OPEC Major oil-exporting countries are rapidly developing and are using more oil domestically. Particularly significant are Indonesia, which no longer exports oil, Mexico and Iran, where projected demand will exceed production in about five years, and Russia, which is growing rapidly.[27]

Due to rapidly changing valuations of the United States dollar, it is unclear when these price points will break. While it is not expected to reach as high as $200 anytime soon, backsliding but still leveling at the previously unheard of $70 could become the norm.

Russian energy giant Gazprom meanwhile forecast that soaring oil prices would "very soon" hit 250 dollars a barrel.

A difficult factor to isolate is the total volume of the futures markets themselves. As there are many indirect owners of futures (401k plans, mutual funds, and even simple savings accounts are routinely invested in such things without the account holder being explicitly aware,) the knock-on effect of a downwardly spiraling economy could itself further devalue oil. Similar factors corrected the run away that gold and silver experienced in the early 1980s, for example.

As with any speculation market, it is well within investors' ability to drive up the price of futures well out of proportion with the supplies and demands involved. But there are two dangers that can quickly effect such transient spikes. Demand can drop off, and supply can increase. This was the case in 1998/1999 when the Asian market collapsed, reducing demand, and Iraq increased production by over 12%, increasing supply. This caused the all-time low of $8. As it pertains to recent events, the demand side is slowing, though not appreciably enough. The US Congress opened to panels to investigate the potential speculation fraud on Tuesday June 17. On the same day, Saudi Arabian oil production increased by 200,000 barrels a day, the largest in its history was announced as a potential option. This and other factors caused oil to drop for fourth day in a row, closing at $133.53.[28]

How to Predict Stock Market Crash

One of the greatest myths of all time is that market crashes are random, unpredictable events. The lead up to a market crash is often years in the making. Certain warning signs exist, which characterize the end of a bull market and the start of a bear market. By learning these common warning signs, you can liquidate your investments and prosper by shorting the market.

The stock market is a study in human psychology as it is human emotion that drives all market action. A healthy human mindset is cautious and skeptical, but also realistically optimistic. Throughout the early stages of a bull market, investors tend to be cautious and skeptical, as well. This caution always signifies the health of a bull market.

Nearing the end of a bull market, the market psychology becomes manic, or excessively euphoric. Being manic is a form of mental illness in humans, as well. This is characterized by euphoria that isn’t rational. For example, a manic person may feel so wonderful that they may not sleep for days or give away their life savings. Later on, the mentally ill person is no longer manic, they are depressed. The stock market follows same exact manic-depressive pattern. This realization of the market being manic-depressive was by the brilliant Benjamin Graham. Benjamin Graham was the mentor of the greatest investor of all time and second richest man in the world, Warren Buffett.

At the top of a bull market, words can’t describe how euphoric investors are. It is very common for investors of very modest means to now have portfolios valued in the hundreds of thousands of dollars. In the Dot Com Bubble, many secretaries had multimillion dollar stock option portfolios! This type of instant wealth isn’t reality, unfortunately. It is one of the prime characteristics of a coming stock market crash. In every stock bubble, people of average means become fantastically wealthy, all while barely trying.

Another major sign of a coming stock market crash is overly euphoric news media. The news media has an extremely poor track record at forecasting markets. Their record is so horrible, that doing the direct opposite is highly profitable! If financial newspapers have headlines that are exalting the recent stock market performance, SELL- as fast as you can!

The most deadly phrase in the market is “this time is different”! Another costly adage is “we are in a New Economy”! Both these phrases and their variations have been around since the dawn of markets. The markets never change, because human psychology never changes. When phrases like these are used, it’s because the user is in denial of reality. In these cases, it is the “dumb money” investors who want to keep riding the bull market in the same lazy fashion. The professional “smart money” realize that bull markets are always temporary. The smart money will profit in both a bull market and a stock market crash.

At the precipice of financial disaster, inflation becomes rampant. Inflation is the rising cost of living, which decreases the buying power of a dollar. The rising cost of living can be observed by much higher gasoline prices, housing prices and food prices. Ironically, it is the strong economy that causes inflation. In simple terms, the strong economy causes more demand for goods and transportation. When salaries go up, people take more vacations, which require gasoline, etc. Small inflation is a good sign, but when it really heats up, look out below!

Once high inflation sets in, the Federal Reserve tries to cool down the economy. The Fed tries to engineer a “soft landing” by raising interest rates. If inflation and stock speculation is out of hand, rates will have to climb fairly high to have an effect. Pretty soon, the stock market crashes as speculators head for the exits. The overvalued stocks quickly become a fraction of their previous values. The market will often crash for several years to come.

Stock market crashes are not difficult to forecast, as they all have the same tell-tale signs. If you are astute enough to recognize these signs, prospering from a crash is a realistic proposition.

How to Profit from Stock Market

It’s quite common to hear someone grumbling about how much money they lost on a stock, but did you ever stop to think where that money went?

In contrary to popular opinion, that money is far from lost. In fact, that money was won by a professional trader who profited from the stock’s decline! Sophisticated traders such as these are called the “smart money” because they profit regardless if the market is crashing or booming. The smart money wins most of the money lost by the “dumb money”, or the “average joe” amateur investor. By learning how to trade like the smart money, you can profit tremendously in any type of market. Let’s learn the differences between the two types of traders:

According to the National American Securities Administrators Association, more than 70% of traders will lose nearly all their money! This is solid proof that the majority of traders and investors are dumb money.

What is the Dumb Money Doing Wrong?

First and foremost, the dumb money act as a herd or mob. This group exhibits very little individual decision making. This is exemplified by how the herd follows the financial news so religiously. The financial news is a severe lagging indicator. This is because reporters only report after the fact. It is so silly that people actually think they will gain knowledge that will allow them to have “the edge” in the markets. This isn’t possible because millions of other competing investors are watching the same news! The news is notoriously bullish right before a bear market and bearish right before the market starts soaring.

Another dumb money tactic is to take investment advice from their broker or advisor. Brokers make money from commissions, not from investment performance. They just want their clients to trade frequently to generate more commissions. Additionally, these brokers tell all of their clients the same information, which means you have absolutely no edge over the competition.

The dumb money make investment decisions based on their emotions, rather than solid information. This group will buy stocks based on glamour. For example, in the dot com boom, investors would buy any stock that was a “dot com”, regardless if it had earning or a business plan. The crowd tends to gain a gambling mentality when “playing the market”. They act upon “hunches” and tips, which never work.

This same group consistently buys stocks late into a bull market. The smart money accumulated tech stocks in the early 1990’s, when many investors didn’t even own a computer! By the late 1990’s every investor was buying tech stocks, and this is when the market crashed. Sadly, the markets are set up so that the second the dumb money gets the gist of the game, the rules are changed. This is because the markets are zero-sum, where for every winner there must be a loser.

What is the Smart Money Doing Right?

If the majority of traders and investors lose, then doing the opposite is a winning strategy. This is precisely is how the smart money trade. The smart money wait for a time when the dumb money is most vulnerable to losing. In most cases, this would at the top of a bull market when the dumb money is foolishly raving about how “stocks will never drop” and how “we are in a new economy”. Whenever the majority of investors are euphoric about the market, it is guaranteed to drop! At this point, the smart money liquidates their stock positions and shorts the market, anticipating the coming bear market.

Shorting the market is a process which allows a trader to profit as the market crashes. It is exactly the opposite of buying a stock. As most investors are entering the poorhouse, the people that short in a market crash become extravagantly wealthy. Jesse Livermore shorted stocks and made $100 million in the stock market crash of 1929!

The smart money rarely pay attention to the financial news media because they know that they can’t gain valuable information from something that everyone is watching. Hypothetically speaking, if profitable news media was available, investors would quickly trade upon it, immediately eradicating any competitive advantage. The smart money have their own top secret forecasting systems, however. These systems have rare information that allows the smart money to have an edge over the masses.

The smart money never act upon their emotions for trading decisions. The smart money buy and sell based on what the market and their trading systems are dictating. For example, when the markets have been crashing for a while, stocks become undervalued. This is the best time to buy, as the market will start to rally in the near future. The dumb money is always most fearful at this perfect buying point. This is exactly when the smart money accumulate stocks. If they relied on their emotions, however, it certainly wouldn’t seem like the best time to be buying stocks.

By learning to do the opposite of the crowd, you can become highly prosperous in the financial markets. So next time you hear of someone who lost their shirt in the market, think of the person that profited handsomely!

Intrinsic Value and Time Value

Intrinsic value and time value are two of the primary determinants of an option's price. Intrinsic value can be defined as the amount by which the strike price of an option is in-the-money. It is actually the portion of an option's price that is not lost due to the passage of time. The following equations will allow you to calculate the intrinsic value of call and put options:

Call Options: Intrinsic value = Underlying Stock's Current Price - Call Strike Price Time Value = Call Premium - Intrinsic Value
Put Options: Intrinsic value = Put Strike Price - Underlying Stock's Current Price Time Value = Put Premium - Intrinsic Value

ATM and OTM options don't have any intrinsic value because they do not have any real value. You are simply buying time value, which decreases as an option approaches expiration. The intrinsic value of an option is not dependent on the time left until expiration. It is simply an option's minimum value; it tells you the minimum amount an option is worth. Time value is the amount by which the price of an option exceeds its intrinsic value. Also referred to as extrinsic value, time value decays over time. In other words, the time value of an option is directly related to how much time an option has until expiration. The more time an option has until expiration, the greater the option's chance of ending up in-the-money. Time value has a snowball effect. If you have ever bought options, you may have noticed that at a certain point close to expiration, the market seems to stop moving anywhere. That's because option prices are exponential-the closer you get to expiration, the more money you're going to lose i f the market doesn't move. On the expiration day, all an option is worth is its intrinsic value. It's either in-the-money, or it isn't.

Put Options

Put options give the buyer the right, but not the obligation, to sell an underlying asset at the strike price until market close on the 3rd Friday of the expiration month. Just like call options, put options come in various strike prices depending on the current market price of the underlying instrument with a variety of expiration dates. Expiration dates can vary from one month out to more than a year (LEAPS options). However, unlike call options, you might consider going long a put option if you expect market prices to fall (bearish). In contrast, if you are bullish (expect the market to rise), you might consider selling a put option.
If you choose to buy or go long a put option, you are purchasing the right to sell the underlying instrument at whatever strike price you choose until the expiration date. The premium of the long put option will show up as a debit in your trading account. The cost of the premium is the maximum loss you risk by purchasing a put option. The maximum profit is limited to the downside as the underlying stock falls to zero. A profit can be made in one of two ways if the underlying market declines. By exercising a put option, you are short 100 shares of the underlying stock. If and when the underlying stock falls below the put strike price, you can exercise the put to short the shares at a higher price and then buy the underlying stock at a cheaper price to cover the short and exit the trade (strike price - current price = profit). The second technique for profiting on a put comes from offsetting it. If the price of the underlying stock falls, the corresponding put premium increases and can then be sold at a profit. If you go long a put option and the underlying security (index or stock) increases in price, the value of the put will fall. Then you can either sell the put at a loss or let it expire worthless.

If you choose to sell or go short a put option, you are selling the right to sell the underlying stock at a particular strike price to an option holder. The premium of the short put will show up as a credit in your trading account. In most cases, you are anticipating that the short put option will simply expire worthless on the expiration date so that you can keep the premium received. The premium amount is the maximum profit you can receive by selling a put option. If the underlying stock falls below the put strike price, the put will most likely be assigned to an option holder who may choose to exercise the option. The option seller then has an obligation to buy 100 shares (per option) of the underlying stock at the put strike price from the option holder. You will then be long 100 shares of the underlying stock and your loss depends on how low the price of the underlying stock falls as you try to sell the shares to exit the position. Experienced traders who choose to go short put options do so in a stable or bull market because the put will not be exercised unless the market falls.


Put options give you the right to sell something at a specific price for a fixed amount of time. A put option is in-the-money (ITM) when the strike price is higher than the market price of the underlying asset. A put option is at-the-money (ATM) when the price of the underlying is equal (or close) to its strike price. A put option is out-of-the-money (OTM) when the price of the underlying security is greater than the strike price.


Example:
Jane opens a small travel business that specializes in island vacations. The manager of a a local business agrees to purchase 100 trips to Hawaii in January for $300 round-trip as perks for his employees. Jane's computed total cost of each trip is $200-a $100 profit on each trip which locks in a guaranteed profit of $10,000 for her initial period of operation. In effect, the guaranteed order is a put option.

Scenario 1: As luck would have it, just as November rolls around, a competitor offers the same trip for only $250. If Jane didn't have a put option agreement, she would have to drop her price to meet the competition's price, and thereby lose a significant amount of profit. Luckily, she exercises her right to sell the trips to Hawaii for $300 each and enjoys a healthy profit in the new year. Jane's put option was in-the-money in comparison to the price of her competitor.

Scenario 2: Jane gets a call from another client who needs to set up 100 trips in January to fulfill obligations to his management team and is willing to pay up to $400 per trip. Since Jane is under no obligation to sell the trips to her first customer, she agrees to sell them for the higher market price and makes a total profit of $20,000 on the deal.

Put Option Review



1. Put options give traders the right, but not the obligation, to sell the underlying stock at the strike price until market close on the 3rd Friday of the expiration month. A put option is in-the-money (ITM) if its strike price is above the current price of the underlying stock. A put option is out-of-the-money (OTM) if its strike price is below the current price of the underlying stock. A put option is at-the-money (ATM) if its strike price is the same as (or close to) the current price of the underlying stock.

2. Buying Puts - If the options trader is bearish -- i.e. believes the underlying stock or index will fall in price -- the trader can buy (go long) puts. When the put is purchased, it is called an opening transaction. Now, the buyer has rights. A put buyer has the right, but not the obligation, to sell the underlying stock at the strike price of the option until the expiration date. Furthermore, if a trader buys a put option, the risk of the trade equals the money paid for the option, or the debit. The profit is equal to the fall in the price of the underlying asset. The profit will result if the underlying security moves lower. The profit is limited because the underlying asset will not fall below zero. Finally, to offset a long put, the trader will sell a put with the same terms (strike price and expiration) to "close" out the position. On the other hand, if the trader exercises a long put, then he or she is selling, or short, the underlying stock or index at the strike price of the put option.

3. Selling Puts - If the options trader is bullish -- believes the market will rise -- the trade can sell (go short) puts. Sellers have obligations. A put seller has the obligation to buy 100 shares (per option) of the underlying stock at the put strike price. In other words, the option seller must be ready to have the stock "put" to him or her. The put seller's risk is the drop in the stock price, which is limited to the stock falling to zero. The profit equals the credit received from the sale of the put. Put sellers often prefer options with little time left until expiration because they want a put to expire worthless. In that way, the seller keeps the entire premium. A short put is offset by purchasing a put with the same strike price and expiration to close out the position.

Call Options

Call options give the buyer the right, but not the obligation, to purchase an underlying asset. They are available in various strike prices depending on the current market price of the underlying instrument. Expiration dates can vary from one month out to more than a year (LEAPS options). Depending on the mood of the market, you may choose to buy (go long) or sell (go short) a call option.
If you choose to buy or go long a call option, you are purchasing the right to buy the underlying instrument at whatever strike price you choose until the expiration date. The premium of a long call option shows up as a debit in your trading account. The premium amount represents the maximum risk a long call strategy can incur. Profit is made on a long call when the price of the underlying asset rises above the strike price of the call. You can then either exercise the call or offset it by selling a call with the same strike price and expiration date. By exercising a long call, you end up with 100 shares per option of the underlying stock at the call strike price. You can then turn around and sell the underlying asset at the current (higher) price to garner a profit on the difference between two (current price - strike price = profit). If you choose to offset the call option, the maximum profit is unlimited. The call's premium will increase in value depending on how high the underlying instrument rises in price beyond the strike price of the call. As the price of the underlying asset rises, the long call becomes more valuable because it gives you (or the person you sell it to) the right to buy the underlying stock at the lower strike price of the call. That's why you want to go long a call option in a rising or bull market.

If you choose to sell or go short a call option, you are selling the right to buy the underlying instrument at a particular strike price to an option holder. Selling a call option prompts the deposit of a credit in your trading account in the amount of the call's premium-a limited profit. You get to keep this credit if the option expires worthless. Thus, to make money on a short call, the price of the underlying asset must stay below the call's strike price. If the price of the underlying asset rises above the short call strike price, it will be assigned to an option holder who may choose to exercise it. This gives the option holder the right to buy 100 shares (per option) of the underlying stock from the assigned option buyer at the strike price of the short call. This means that the option seller must buy the underlying asset at the current price and sell it at the call's lower strike price to the assigned option holder, thereby incurring a loss on the trade (current price - strike price = loss). The maximum loss is therefore unlimited to the upside, which is why selling "naked" or unprotected call options comes with such a high risk. However, experienced traders who do choose to short call options would be wise to do so in a stable or bear market.

Call options give you the right to buy something at a specific price for a specific time period. However, if the current market price is more than the strike price, the call option is in-the-money (ITM). If the current market price is less than the strike price, the call option is out-of-the-money (OTM). If the current market price is the same as (or close to) the strike price, the call option is at-the-money (ATM).

Example:
A local newspaper advertises a sale on VCRs for only $129.95. The next day Jane goes down to the electronics store intending to purchase a VCR at the advertised price. Unfortunately, by the time she arrives, the VCR is already out of stock. The manager apologizes and gives her a rain check entitling Jane to buy the same VCR for the advertised price of $129.95 anytime within the next two months. Jane has just received a long call option which gives her the right, but not the ob ligation, to purchase the VCR at the guaranteed strike price of $129.95 until the expiration date two months away.

Scenario 1: A few weeks later, Jane return's to the store to exercise her rain check. The same VCR is now in stock, priced at $179.95. Jane approaches the store manager who agrees to honor the rain-check and sell her a VCR for the advertised p rice of $129.95. Jane has just saved $50. Her long call option was in-the-money.

Scenario 2: A few weeks later, Jane returns to the store and finds the VCR on sale for $119.95? Her rain check is now worthless because she can simply purchase the VCR at the reduced price. In this case, Jane's call option expired worthless b ecause it was out-of-the-money. Just because you own a long call option doesn't mean you are under any obligation to use it.

Scenario 3: Jane's friend Jeff phones and mentions that his VCR has just broken. She tells him about her rain-check and agrees to sell it to Jeff for $5 (the option premium). The strike price is still $129.95 and the expiration date is 2 month s out. However, Jeff is taking a risk. The VCR might be priced lower than the $129.95 strike price in which case the rain-check is worthless and Jeff loses $5.


Call Option Review


1. Call options give traders the right to buy the underlying stock at the strike price until market close on the 3rd Friday of the expiration month. A call option is in-the-money (ITM) if its strike price is below the current price of the underlying stock. A call option is out-of-the-money (OTM) if its strike price is above the current price of the underlying stock. A call option is at-the-money (ATM) if its strike price is the same as (or close to) the current price of the underlying stock.

2. Buying Calls - If bullish - believe the market will rise - buy (go long) calls. Buyers have rights. A call buyer has the right, but not the obligation, to buy the underlying stock at the strike price until the expiration date. If you buy a call option, your maximum risk is the money paid for the option, the debit. The maximum profit is unlimited depending on the rise in the price of the underlying asset. To offset a long call, you have to sell a call with the same strike price to close out the position. By exercising a long call, you are choosing to purchase 100 shares of the underlying stock at the strike price of the call option.

3. Selling Calls - If bearish - believe the market will fall - sell (go short) calls. Sellers have obligations. A call seller has the obligation to sell 100 shares of the underlying stock at the strike price to the person to whom the option was sold, if that person chooses to exercise the call option. Sellers have obligations. If you sell a call option, your risk is unlimited to the upside. The profit is limited to the credit received from the sale of the call. When selling calls, make sure to choose options with little time left until expiration. Call sellers want the call to expire worthless so that they can keep the whole premium. To offset a short call, you have to buy a call with the same strike price to close out the position.

Learning to Trade Options

Learning to Trade Options

Options are the most versatile trading instrument ever invented. Since options cost less than stock, they provide a high leverage approach to trading that can significantly limit the overall risk of a trade or provide additional income. Simply put, op tion buyers have rights and option sellers have obligations. Option buyers have the right, but not the obligation, to buy (call) or sell (put) the underlying stock (or futures contract) at a specified price until the 3rd Friday of their expiration month. There are two kinds of options: calls and puts. Call options give you the right to buy the underlying asset. Put options give you the right to sell the underlying asset. It is essential to become familiar with the inner workings of both. Every strategy you learn from this point on depends on your thorough understanding of these two kinds of options.
There are no margin requirements if you want to purchase an option because your risk is limited to the price of the option. In contrast, option sellers receive a credit in their account for selling an option and get to keep this amount if the option expires worthless. However, option sellers also have an obligation to buy (put) or sell (call) the underlying instrument if their option is exercised by an assigned option holder. Therefore, selling an option requires a healthy margin.

To trade options, you must be acquainted with the select terminology of the option market. The price at which an underlying stock can be purchased or sold if the option is exercised is called the strike price. Options are available in several strike prices above and below the current price of the underlying asset. Stocks priced below $25 per share usually have strike prices at 2 ½ dollar intervals. Stocks priced over $25 usually have strike prices at $5 dollar intervals.


The date the option expires is referred to as the expiration date. A stock option expires by close of business on the 3rd Friday of the expiration month. All listed options have options available for the current month and the next month as well as specific future months. Each stock has a corresponding cycle of months that they offer options in. There are three fixed expiration cycles available. Each cycle has a four-month interval:


A. January, April, July and October

B. February, May, August and November

C. March, June, September and December

The price of an option is called the premium. An option's premium is determined by a number of factors including the current price of the underlying asset, the strike price of the option, the time remaining until expiration, and volatility. An option premium is priced on a per share basis. Each option on a stock corresponds to 100 shares. Therefore, if the premium of an option is priced at 2, the total premium for that option would be $200 (2 x 100 = $200). Buying an option creates a debit in the amount of the premium to the buyer's trading account. Selling an option creates a credit in the amount of the premium to the seller's trading account:

Example:
Jane wants to buy a house. After a few weeks of searching, she discovers one she really likes. Unfortunately, she won't have enough money for a substantial down payment for another six months. So, she approaches the owner of the house and negotiates an option to buy the house within 6 months for $100,000. The owner agrees to sell her the option for $2,000.

Scenario 1: During this 6-month period, Jane discovers an oil field underneath the property. The value of the house shoots up to $1,000,000. However, the writer of the option (the owner) is obligated to sell the house to Jane for $100,000. Jan e buys the house for a total cost of $102,000-$100,000 for the house plus the $2,000 premium paid for the option. She promptly turns around and sells it for a million dollars for huge profit of $898,000 and lives happily ever after.

Scenario 2: Jane discovers a toxic waste dump on the property. Now the value of the house drops to zero and she obviously decides not to exercise the option to buy the house. In this case, Jane loses the $2,000 premium paid for the option to the owner of the property.


How Options Work Review



1. Options give you the right to buy or sell an underlying instrument.

2. If you buy an option, you are not obligated to buy or sell the underlying instrument; you simply have the right to.

3. If you sell an option and the option is exercised, you are obligated to deliver the underlying asset (call) or take delivery of the underlying asset (put) at the strike price of the option regardless of the current price of the underlying asset.

4. Options are good for a specified period of time, after which they expire and you lose your right to buy or sell the underlying instrument at the specified price.

5. Options when bought are done so at a debit to the buyer.

6. Options when sold are done so by giving a credit to the seller.

7. Options are available in several strike prices representing the price of the underlying instrument.

8. The cost of an option is referred to as the option premium. The price reflects a variety of factors including the current price of the underlying asset, the strike price of the option, the time remaining until expiration, and volatility.

9. Options are not available on every stock. There are approximately 2,200 stocks with tradable options. Each stock option represents 100 shares of a company's stock.

The Nasdaq Internet Bubble

After the 1987 stock market crash, the global markets resumed their previous bull market trend. This powerful trend was driven by computer technology. Many of the technology stocks were listed on the Nasdaq exchange, which is an electronic marketplace.

In the early 1990’s, the personal computer was rapidly gaining acceptance for business and personal use. The computer was at last becoming more reasonably priced and more user-friendly. Computers were no longer the fodder of geeky hobbyists. They were veritable business tools, which were vital in gaining a competitive edge. Business applications were invented to aid the user in accounting, calculating taxes and word processing. Computers also began to compete with televisions as a form of entertainment, as PC video games flooded the marketplace. Corporations such as Microsoft prospered enormously as almost every computer system contained their operating system software.

During this time, the US computer industry focused more upon computer software versus hardware. This is because software was an extremely high margin product, due to it not being a physical product, like chips. Software companies produced a markup from selling licensed information, which costs very little to reproduce. Computer hardware became a commodity product, i.e. virtually indistinguishable from the product of any other competitor. Commodity products produce very little profits as each competitor constantly undercuts each other’s prices. Asian companies, with small manufacturing costs, produced virtually all of the hardware components at this point. Software, however, was protected as intellectual property with patents. Therefore, a product such as Microsoft Windows is a one of a kind product. This creates a strong barrier to entry, a benefit which is highly sought after in business.

The stock prices of software companies were marching ahead rapidly. Many small software companies were started by college students in garages, paying their employees with as much pizza and soda they desired. Every startup wanted to become “the Next Microsoft”.

Eventually, several of these start-up companies took the notice of serious venture capitalists, who were looking to finance these operations, take them public and reap massive profits. Soon the fledgling startups began to pay their hopeful employees with company shares. The premise was that when the company went public, the early shareholders would become instantly wealthy. The majority of the software companies were started in Silicon Valley, near San Francisco, which was a technology Mecca. The Nasdaq index of technology stocks was rising extremely fast, creating many millionaires.

Computers became further popularized in the mid 1990’s, as blockbuster PC games were created, such as Sim City and Duke Nukem. This fueled an increase in tech savvy youth, as computers went from “geek to chic”.

The Internet Age

Around 1994, a new frontier called the internet, was first being made available to the general public. In actuality, a primitive form of the internet had been around since 1969. This early internet was called DARPANet and was created by government agencies as an efficient way to exchange scientific and military information to computers in different locations. By the 1990’s the internet had evolved as a way to communicate using email, use chat rooms and view informational websites.

Almost immediately, businesses saw the internet as a profit opportunity. America Online made the internet available for the masses. The Yahoo search engine was started in 1994 as a directory for the universe of websites. Amazon became the first online bookstore in 1994. EBay was started in 1995 as an online auction site. As the internet moved from the hobbyist domain to a commercialized marketplace, online business owners became fantastically wealthy. Many technology companies were now selling stock in IPO’s. Most initial shareholders, including employees, became millionaires overnight. Companies continued to pay their employees in stock options, which profited greatly if the stock went up even slightly. By the late 1990’s, even secretaries had option portfolios valued in the millions! Many companies had BMW sign on bonuses! This is surely an example of irrational exuberance.

Tech Stock Mania

Several economists even postulated that we were in a “New Economy”, where inflation was virtually nonexistent and the stock market crashes were obsolete! Even worse, it was said that earnings were not relevant in picking stocks either! The “Old Economy” referred to industrial stocks, such as those in the Dow Jones Average. Another buzzword was “Paradigm Shift”, which is a synonym of “New Economy”. Investors were enamored by these buzzwords, as they deceptively described something that was sleek, sexy, and exciting.

From 1996 to 2000, the Nasdaq went from 600 to 5,000! Dot-com companies run by people who were barely in their 30's, were going public and raising hundreds of millions of dollars of capital. These companies didn’t even have much of a business plan, and certainly didn’t have any earnings, either! For example, Pets.com had no earnings yet came public and raised billions of dollars. Dot-coms wasted millions of dollars per night on frivolous parties. Hard work was never part of the picture for dot-commers. There are many stories of dot-com employees walking around barefoot in the office and playing foosball all day. At one point, a new millionaire was created every 60 seconds! Many of these instant millionaires thought that they were so brilliant, that all they had to do was play to make money. Never mistake a bull market for brains.

The Bubble Pops

By early 2000, reality started to sink in. Investors soon realized that the dot-com dream was really a bubble. Within months, the Nasdaq crashed from 5,000 to 2,000. Hundreds of stocks such as Pet.com, which were each worth billions, were off the map as quickly as they appeared. Panic selling ensued as investors lost trillions of dollars. The stock market kept crashing down to 800 in 2002. One high flier, Microstrategy, slid from $3500 per share to $4! Numerous accounting scandals came to light, showing how many companies artificially inflated earnings. Shareholders were crippled. In 2001, the economy entered a recession as the Fed repeatedly cut rates, trying to stop the bleeding. Millions of workers were now jobless and had lost their life savings.

Needless to say, the New Economy was a farce, and traditional economic principles still hold. What is sadly interesting is how bubbles will continue to occur in the future. When they do occur, foolish investors will say, “This time is different!”

Truth on Why People Lost Money

I found something very interesting, I'm just requoting someone who speaks the truth from the Star article.

W’e re 50 years old and Bursa Malaysia is 35 years old, and yet we are not doing it right. We refuse to learn from our neighbours or peers and we refuse to change.
In every stock market, there is always a bull and a bear. Both of them are fighting daily on the trading board, and sometimes the bull wins and sometimes the bear.

Whatever the market condition, investors must have the option to choose whether the bear or the bull will win. So, for trading in the structured warrant, if you think the bull will win, you trade the Call Warrant and if you think the bear will win, you trade the Put Warrant. But this is not the case in Bursa Malaysia.

There’s only the Call Warrant and no Put Warrant. So during the bear market and you still continue to trade on the Call Warrant, you are actually swimming against the flow of the river. This is also against the normal logic of trading.

Look at some of the strike prices of the Call Warrants, which are ridiculously high compared with the shares’ underlying price. By the time they expire, the Call Warrants could be worthless. The last person holding the Call Warrant is the loser. Maybe Bursa is the only stock exchange in the world that has the Call Warrant but not the Put Warrant on the trading board.

The bear started to appear in late November 2007, when the problem with the US economy surfaced. Till today, we can still see that investment bankers are issuing chunks of Call Warrants with high premium in the range of 35% - 50% low issue price. Most people, especially those who do not know much about the Call Warrant, are trading in this Call Warrant.

So with the bear storming in recently, there’s not a single cave for them to hide in. These Call Warrants will be just worthless information in their CDS account when they expire. Some 'hope' it will recover, but really? For example, HSI-C2 Call Warrant is based on the Hang Seng Index and the exercise level is 30,870 points. The index is now at about 22.000. This Call Warrant will expire on May 28. Can the index reach this level by May 2008? I doubt it.

It is time that Bursa fixes this problem fast. Introduce a legislation whereby for every issue of a Call Warrant on a particular underlying share, there should be an equivalent issue of a Put Warrant on it. Let the people decide whether the bull or the bear wins.

http://thestar.com.my/news/story.asp?file=/2008/1/23/focus/20087713&sec=focus
Interesting article isn't it? This article is posted on The Star, Wednesday January 23, 2008 which is the start of the severe bear trend. If Bursa Malaysia and the investment banks have not been so stubborn and listened to ideas from bloggers or people out there, they would have saved a lot of investors money. The investors could hedge on the 'put warrants' when they purchase the KLCI index-linked mother shares. Of course most of all, it would have saved retailers money too. At the time of the article was written, KLCI is at 1383. But where are we today? at 1177. That is -206 points drop and billions of investor's capital were wiped out clean, not to mention retailers money were stuck in 'out-of-the-money' call warrants. Look at the BURSA-CF recently, from a high of 0.635 to completely worthless now at 0.01. If we don't employ a 'trader's mindset' to cut-loss, our capital would have been wiped out clean if we stick to the old 'investor's mindset' to average down. If there is ever a such thing as BURSA-PW (put warrant), that is sure to cheer up investors/retailers as they could hedge against the mother share BURSA which peaked at 16.3 in January to 8.4 today.

So now I guess you guys must realize that you have been 'indirectly' conned by the investment bank seminars on "How to Trade Structured Warrants Successfully", simply because they never reveal the 'TRUTH' to you people. THE TRUTH IS MARKETS ALWAYS WORK BOTH WAYS, we need bulls & bears. By only issuing call warrants as bull market instrument and ignoring the put warrants as bear market instrument, they are only telling you 50% of the truth while hiding the other 50%.

Compound Interest

When we were born, we have no assets and our greatest assets in life is our TIME and our MIND. When you're young, you have an asset money can't buy: TIME. Start saving now and turn pocket change into riches.

Compound interest is a concept that anyone who wants to understand investing and accumulating wealth must grasp. Compound interest has been called the eighth wonder of the world. And with good reason. It magically turns a little bit of money, invested wisely, into a whole lot of cash. Even Albert Einstein -- a bit of a smarty pants -- is said to have called it one of the greatest mathematical concepts of our time.

But you don't need to be a genius to harness the power of compounding. Even the most average of Joes can use it to make money. Trust me. This is so much easier than the theory of relativity. Here's the gist: When you save or invest, your money earns interest or appreciates. The next year, you earn interest on your original money and the interest from the first year. In the third year, you earn interest on your original money and the interest from the first two years. And so on. It's like a snowball -- roll it down a snowy hill and it'll build on itself to get bigger and bigger. Before you know it ... you're rich!

1. Start young. When you're in your twenties and thirties, your best friend is TIME. Start rolling your snowball at the top of the hill and you'll have a much bigger mass at the bottom than someone who started halfway down.

Consider this: Amy, a 22-year-old college graduate, saves $300 per month into an account earning 10% per year for six years. (That's the average annual return of the stock market over time.) Then at age 28, she starts a family and decides to stay home with the children full time. By then, Amy had kicked in $21,600 of her own money. But even if she doesn't contribute another cent ever, her money would grow to a million bucks by the time she turned 65.

Compare that to Jason, who put off saving until he was 31. He's still young enough that becoming a millionaire is within reach, but it will be tougher. Jason would have to contribute the same $300 a month for the next 34 years to earn $1 million by age 65. Although Amy invested less money out-of-pocket -- $21,600 over six years vs. Jason's $126,000 over 34 years -- her money had more time to grow, or compound.
Bottom line: Getting rich is easier and more painless the earlier you start.

2. Remember that a little goes a long way. Don't think you have enough money to start investing? You can get into a good mutual fund for as little as $50 a month.

Let's say a 20-year-old stashes $50 a month into a fund earning 10% annually. He'd have $528,000 by age 65. Not bad for practically starting with pocket change! See 20 Small Ways to Save Big to find room in your budget to get started.

A little bit can make a difference elsewhere in compounding, too. For example, if our 20-year-old earned 9% annually instead of 10%, he would amass only $373,000 in the same period of time. That seemingly small 1% difference in performance resulted in 29% less money over the long haul.

That's why, when you're young, you need to invest fairly aggressively. You should invest nearly all your money in stocks or stock mutual funds (as opposed to bonds and other conservative investments) in hopes of netting a bigger return. You'll certainly have ups and downs, but over the long-term, TIME (again, your best friend) will smooth them out for your benefit. Crunch your own numbers with our savings calculator.


3. Leave it alone. The prospect of making a lot of money without doing anything sounds good on paper. But, admittedly, in practice, it can be maddening. Every time you receive your account statement, you watch your balance s-l-o-w-l-y inch up -- or even drop. How on earth are you ever going to get rich at this pace?

Investing is a lot like Heinz ketchup: Good things come to those who wait. You must be patient for compounding to work its awesome power. Remember that as your money earns more, it'll earn even more. You certainly won't get rich overnight this way. But you will get rich if you start young, invest wisely and leave it alone.

A final note
If you invest or save in a regular, taxable account, Uncle Sam will want his share. So make sure you factor that into your saving goal. However, you can invest in tax-sheltered accounts and keep more of the money to yourself. My favorite is the Roth IRA because all your money is tax-free in retirement. See Why You Need a Roth IRA to learn more.

And what about inflation? True, $1 million won't have the same purchasing power in 40 years as it has today, but that's all the more reason to start saving now! The examples above use flat contributions -- $50 per month, for example. But over the years, your income will rise, too. If you increase your savings with each increase in your pay, you'll give your money more fuel to compound, and you'll certainly boost your spending power down the road.

Besides, having a million bucks in 40 years is better than not having a million bucks at all. Start as soon as you can and save what you can to let compounding work its magic.