Friday, January 21, 2011

Provide Insurance to Other Investors: Generate Income Selling Put Options.

In a stock market environment with inflated prices, the intelligent investor must look for more innovative ways to generate income and increase their wealth.

One method often overlooked is the selling of what are called "put-options." Quite simply, a put option gives the buyer the right to sell a stock at a fixed price and at a fixed date in the future. For example, if John Smith owns shares of CIBC and the current price of his shares are $50, he can buy an option to sell those shares to someone else at $48 six months from now. Why would John do this? Perhaps John owns too much CIBC and wants to just have a little insurance in case the price declines too much. If the shares decline to $30 in six months, John will be very happy that he bought the insurance as he can now sell them to someone at $48. If, however, six months go by and CIBC is still selling at more than $48, John will simply keep his shares and not want to "exercise" his right to sell the shares at $48. His insurance will simply expire.

Of course, John must buy his insurance from someone, and this insurance costs money. Personally, I like to provide this type of insurance on stocks that I would like to own anyway. You could think of it like buying stocks on and getting paid to do it. For instance. If I want to buy CIBC at $48, but it is currently selling at $50, I have two options. I could simply wait until it falls to $48 and then buy it... or I could agree to buy them from John in six months at $48 should he choose to want to sell them, and for this agreement I collect a fee, called an "options premium." The size of this fee changes. The more the owner and myself are worried that the price of the stock might fall in the future, the larger this premium would be.

Now, if agreements like this had to be made on an individualized basis, it would be quite difficult. Thankfully, our modern market economy has what is called an "options market." In Canada, the market is in Montreal at the Montreal Options Exchange. In the United States it is in Chicago at the Chicago Board Options Exchange. The more well known global names will be listed in Chicago, with the domestic Canadian names listed in Montreal.

Now, the "caveat" to this is that you must actually have enough money in your investment account to buy the shares on the date agreed to should the buyer of the put option choose to "exercise," or sell them to you, at the agreed upon price. This seems obvious, but it is important to remember that you cannot simply take your insurance premium that you collected and forget about the contract. You must then provide the insurance that was paid for if it is needed.

This may sound complicated, but the strategy is really fairly simple once you get more comfortable with puts and "options" in general. In the future, I will discuss how money can be made utilizing "call" options. Or the right to buy something at a future date and at a fixed price.

As always, just e-mail me with any questions or concerns : )

Monday, January 17, 2011

Mortgage Rules Getting Tougher: Canadian's Piling on More and More Debt.

Mortgage rules in Canada will be getting tighter this year. With Canadian families piling on more and more debt, due partially to historically low interest rates, the Canadian Finance Minister announced that there will be a few changes to make it more difficult for Canadians to accumulate higher debt levels.

Firstly, the maximum amortization period, or the length of time that it will take to pay off your mortgage, will be reduced from 35 years to 30 years. This will have the effect of increasing a $1300 per month mortgage to about $1400, or by about $100. But it saves big money on interest payments if you consider that a family would now own their home a full five years sooner.

Secondly, the refinancing limit will be lowered to 85% of the home's value from 90%. This is a great idea as it helps decrease the common practice of people using their homes as a massive ATM machine for frivolous discretionary purchases like furniture, electronics, and aesthetic renovations. Also, considering it is always possible for house prices to fall, owing 90% of the property's value does not leave much room for failure... and that is what primarily lead to the U.S. housing crisis, during which the bank's repossessed home's that were not even worth the amount of debt owed on them.

These changes will come into force on March 18th, so there is still some time for Canadians to satisfy their appetite for higher debts and grab that 35 year mortgage. But after that, Canadians will be just a little more protected from their own stupidity. Statistics Canada now reports that the average household now has a debt load 148% of their income!! And amazingly, that number is now higher than it is in the United States, which is traditionally seen as a basket case when it comes to household finances.

To be sure, in addition to their mortgage, the average Canadian now has over $25,000 in consumer debts, or debts accumulated for consumer and not investment purposes. Sadly, the trend toward higher debts is increasing, but thankfully the Canadian government is carefully watching this trend before it leads us into an economic crisis. The positive side of this news, however, is that it should prevent the Canadian government from being forced to raise interest rates in the near-term, which was definitely becoming a possibility... and could lead to disaster for anyone on a variable rate mortgage.

Sunday, January 16, 2011

Zellers Sold to Target for $1.8 Billion: The U.S. solidifies its strangle-hold on retail in Canada.

The Hudson's Bay Company has recently sold Zellers to U.S. retailer Target (NYSE:TGT) for $1.8 Billion. Target plans to convert about 150 stores and sell the remaining 70 Zellers locations to another buyer.

Considering that the Zellers chain was on it's last breath following HBC's sale to U.S.-owned NRDC Equity Partners in 2008, the news is not surprising. Rumours have been circling about a sale of the chain to Target for years now, and steep competition from Wal-Mart (NYSE:WMT) left the chain struggling to find customers.

Though the retail market in Canada is thriving, the recent sale of the chain reminds us of the terrible truth that American corporations have a strangle-hold on the Canadian marketplace. Wal-Mart, Costco (NASDAQ:COST), Best-Buy (NYSE:BBY), and a slieu of other global behemoths have largely gobbled up their Canadian competitors. With the exception of Canadian Tire (TSE:CTC.A), Loblaws (TSE:L), and a few others, there are very few Canadian owned retail locations.

Sadly, expansion southwards has not gone as well for Canadian companies. Only Tim Horton's (TSE:THI) and Couche-Tard (TSE-ATD.B) have really been able to crack the U.S. market. There are a number of reasons for this, but much of it is attributable to lacking economies of scale for companies in Canada as compared to the U.S., where there is a ready market 10 times the size as in Canada. U.S. retailers can utilize their large networks at home to leverage their expansion north, whereas Canadian retailers have to leverage a much smaller network to expand into the highly competitive American market.

Interestingly, both Tim's and Couche-Tard are great investments for Canadians, especially considering the prospect for extensive expansion plans and continued growth. Both stocks should be on your watch-list awaiting a dip in their share prices. As for Target, the shares are reasonably priced, but in the retail sector both Wal-Mart and Costco have more potential for continued success.

Tuesday, January 11, 2011

The Dinar and the Opportunities for Investment in Iraq.

Below is a link to a CNBC video with Jim Cramer discussing the possibilities for investing in Iraq and the new Iraqi Dinar. Inevitably, this new currency will turn into what is commonly referred to as a "petro-dollar," or a currency that goes up and down with fluctuations in oil prices. The reason for this is due to the fact that the nation's primary export is oil, and thus that will be the primary reason why foreigners will buy the Dinar.

The new Iraqi Dinar.

As a way to invest in the future growth and prosperity of Iraq, the Dinar is a perfectly logical strategy. The wild-card in this scenario, however, is any instability in the region, and in the United States' willingness to maintain the defence and governance of this overseas dependency. If it becomes clear that the United States will not maintain Iraq as a protectorate or dependancy, then the currency will surely be under serious pressure because the investing public will lose confidence in the country's ability to maintain its own security, and thus the security of its medium of exchange.

For the more cautious investors, looking for a company that operates successfully in Iraq may be a better way to explore this investment opportunity. One interesting company is Heritage Oil, which is listed on the Toronto Stock Exchange under the symbol HOC. It operates in the Kurdistan region of Iraq.

Iraq location shot
Above is an image of the region where Heritage Oil operates.

Friday, January 7, 2011

U.S. Dollar Parity Means More Opportunity South of the Border and Overseas.

The recent appreciation of the Canadian dollar versus the U.S. dollar and the Euro means that goods and services have become cheaper for Canadians who shop abroad. This holds true for people who cross the border to do some shopping, or for those who wish to make some cross-border investments.

Above is a chart of the Canadian dollar versus the U.S. dollar over recent years. Canadians can now use their high priced dollars to invest abroad and buy great international companies at reduced prices. Some examples of great international companies to buy during this period of exchange rate parity are:

Pepsi: (PEP) This is a company with a great franchise (both Frito Lay and Pepsi are great businesses with lots of customer loyalty) and a nice dividend of 2.90 percent. They increase the dividend regularly and appear to be largely immune to most fluctuations in the economy. This means that in good times and bad... they make money!

Above is Pepsi's 5 year revenue and income levels. Healthy and steady with stable profit margins.

Johnson & Johnson: (JNJ) This is a business that I recently added to my portfolio. They make drugs, medical devices, and many household products you buy in the pharmacy or grocery store. Financially, they are in great shape with little debt, and they have a dividend of 3.50 percent. They have raised this dividend every year for almost 50 years!!!! Proving that they are loyal to their shareholders and that management knows how to operate this business in tough times.

Above is JNJ's debt levels... very low for the industry.
Kimberley-Clark: (KMB) They manufacture and market various health care products worldwide. The international nature of their business is great because it helps alleviate fluctuations in any one currency or country. The company operates in four segments: Personal Care, Consumer Tissue, K-C Professional & Other, and Health Care. The stock pays 4.30 percent each year, which has increased every year for almost 40 years!! Also, this business is very defensive. This means that when the economy declines, their business tends to stay relatively positive.

So be sure to keep international opportunities in mind, especially with the Canadian dollar at historically high levels. Buy not only consumer goods in the U.S., but perhaps some stocks as well : )