Special-Purpose Acquisition Companies, or SPAC’s, are the hottest thing on Wall Street. In 2020 alone, the year of Covid, SPAC IPO’s have raised over $57 Billion with two months to go, dwarfing the previous high of $13.6 Billion, raised in 2019. By investing in a SPAC IPO, investors are giving a “blank check” to a management team to go out and purchase a business and operate it as a publicly-traded company. The acquisition target is likely not identified at the time of the IPO. Does this sound like a good investment opportunity to you? It may be, but unless you really do your homework, you are setting yourself up for failure.

SPAC’s

SPAC’s are sort of a way for average investors to invest in private equity-type deals. Only institutions or accredited investors are eligible to invest in traditional private equity, and they do so because returns can be high, but so can corresponding risk. Often, in private equity deals, a business is targeted followed by a search to find a team to manage the business, but it can also happen the other way around.

Anyone Can Invest

Anyone can invest in a SPAC – you don’t need to be an accredited investor. In a SPAC, as opposed to traditional private equity, the management team comes first, followed by the business acquisition after the IPO money has been raised. That’s why SPAC’s are referred to as “blank checks” – investors are giving money to a team and it’s up to the team to spend it how they want. The valuation and the fundamentals of the acquisition target are not known to the SPAC investors at the time of the SPAC IPO. SPAC investors are therefore giving over the right to analyze and negotiate a good deal to the SPAC management team. Of course, the SEC has guidelines for how SPAC’s are to spend their IPO money, but, still, an investor has to take a leap of faith to entrust their investment just in a team of people and let them go for it without your pre-approval.

Is It Really That Far-Fetched?

Though investing your good money with a management team in search of a business sounds different, it really isn’t. Think about mutual funds, which most investors own in some capacity. An actively-managed mutual fund operates somewhat in the same way: investors give money to the mutual fund managers, who in turn take the money pool and invest it typically in publicly-traded companies that they believe to be undervalued or that they believe have potential to appreciate such that their returns will outperform market returns. Investors trust that the mutual fund manager is superior at doing their investment analysis better than they can working on their own. Though mutual funds diversify by investing in many public companies, SPAC’s typically are less diversified, investing in only one or a couple of businesses. That said, the concept of delegating the acquisition and investment decision to someone who is more able is not that strange, and is a common element between actively-managed mutual funds and SPAC’s.

Should You SPAC?

Should you invest in a SPAC? In my opinion, if you do so, you better have a very strong knowledge, belief, and experience with the management team in charge of the SPAC. Since you can’t do your homework on whatever company they plan to acquire, you had better be darn sure that the team are comprise of people with integrity (so that they won’t just make off with your money) and acumen. Beyond that, there are other things to consider. For instance, typically a management team has experience in a certain type of business or industry. You as a possible investor should consider whether there are good opportunities in that industry for acquisitions. If it is a “hot” industry, perhaps there are a lot of other money pools out there trolling for potential acquisitions, in which case the price of those acquisitions could be bid up. On the flip side, perhaps this team’s experience is in a market that is petering out. If so, is there a catalyst within that market that could cause it to either stabilize or turn back in the right direction? These are the type of questions that you should consider before you invest.

IMO

Caveat Emptor – buyer beware – is very appropriate for investors who are looking to invest in a SPAC because they think they can earn private equity-type returns. While there are other types of investments out there that fit a similar profile, SPAC investors have to be extremely comfortable with whoever is in charge of the SPAC. While the investor may not be able to do their homework on the target company, there are elements they can bone up on, and so there are ways they can and should get more comfortable before they open their checkbooks.

Question: Is insider trading illegal? No, it is not always illegal, and that answer may surprise some people. Insider trading, meaning the buying and selling of shares and the exercise of options among corporate “insiders” is perfectly legal as long as the insider follows the requirements set by the Securities and Exchange Commission and most likely trades during an open “window” established by the company. Illegal inside trading occurs when the SEC rules aren’t followed – usually because the trading occurs by someone who is not an insider and who is in possession of “inside information” that only insiders should know and who likely trades outside of the corporate window.

Bad Reputation

Insider trading gets a bad reputation because of those who don’t follow the rules and ended up in prison, but it is an important part of corporate governance. Without the ability to buy or sell their corporate stock, corporate officers and directors would not have a way to raise money and diversify their holdings. Instead, they would be stuck owning their stock until such time they are no longer corporate insiders. Not being able to sell stock would be demotivational for management and thus bad for business.

Public Information

Any corporate insider who wants to buy or sell their own company’s stock must file a Form 4 with the SEC. By doing so, their filing becomes public information that is tracked by any number of services. The tracking website that I look at is through Finviz.com, but there are many others that you can use Google to discover. Tracking is done on a daily or even real-time basis so this is public information that you can use to do your own trading.

What Does It Mean?

You might think at first that an insider who is buying is bullish for the future of that company and hence that stock and an insider selling is bearish. In my experience, that is not entirely the case. Insider buying is more bullish than insider selling is bearish. Corporate officers and directors sell their stock for all sorts of reasons: desire to buy something else like a house; needing to pay taxes; the stock has hit a pre-determined target in a 10b5-1 plan, which is a pre-approved plan for orderly stock sales; or just plain portfolio diversification. These sellers need money for some reason and they sell stock to raise it.

Insider Buying

On the other hand, an insider filing to buy additional stock or to exercise existing stock options can be viewed as a re-commitment or a “doubling down” on the company and could be a bullish signal in the broadest sense about the future of the company. Insiders of companies whose stock has been beaten down may stake their future on buying the stock at a low point so as to steady the stock’s fall and try to get the ship pointed in a different direction. In my opinion, if you as an investor spot this type of corporate insider buying at a low point, you may want to consider buying into that company as well. It may be an opportunity for a deep value play that will make you big money – or maybe it won’t. In any event, you need to have a keen eye for this type of play, and perhaps you want to “paper trade” or pretend to invest a few times before you actually put any real money into it, just to see if your instincts were correct.

IMO

Insider trading is perfectly legal as long as the rules are followed. If you are so inclined and if you are diligent in tracking these transactions, it might be a way to pick out a plum value play if you are astute enough. Also, don’t sell your stock if you see that an insider is selling, because they may have good reasons unrelated to the future of the company to be selling.

This point is directly from the latest Insight Memo from Howard Marks, the legendary investor and head of Oaktree Capital Management. Mr. Marks says he believes (and I agree) the major stock indexes have risen so dramatically since March because interest rates have been reduced to near zero. The Fed reduced the Fed Funds rate by 150 basis points to near zero in one fell swoop in March, and longer-term rates soon followed suit. This decline in rates reset return expectations across the gamut of asset classes. If bond investors are willing to accept 150 – 200 basis point lower returns on their investments, then stock investors will accept lower returns on their investments, which means that stock prices increase, as long as returns (i.e., earnings) remain constant.

The following two charts (created by me using my admittedly wanting level of technical skill but taken directly from Howard Marks’ memo) illustrate what I mean. The blue line on the first chart shows the returns that investors expect with different investments with increasing levels of risk. Riskier investments require higher rates of return, from “risk-free” US Treasuries up to private equity capital. Before Covid, investors were looking at a return of perhaps 2% or thereabouts on Treasuries and upward from there – that’s what this chart attempts to portray:

This next chart adds an orange line that shows how investors’ expected returns have shifted during this Covid era. Notice that expected returns during the Covid era are lower across the board from the pre-Covid era:

The Fed

It is the Fed that took the first step when it dropped the rate on the Fed Funds Rate to near 0%. That step took down the yields on all Treasuries across the entire yield curve. With “risk-free” Treasury returns at near zero, investors searching for return quickly began to invest farther out on the risk spectrum, particularly in “quality” and “aggressive” stocks, thereby bidding their prices up and expected returns down. Without the Fed Funds and US Treasury rates as low as they are, we would not have had the stock market rebound to the extent that it has.

The Future

The Fed has been explicit that rates will remain low for the next several years. The long end of the yield curve has seen higher rates in recent days, meaning the yield curve is less flat and more upward sloping, which is probably a good thing. Investors therefore don’t need to guess which way the Fed is leaning, which eliminates an element of uncertainty from the forecast of where stock prices are headed. The point is that interest rates that are this low and will remain this low for the next several years are bullish for stocks. This is not to say the stock market will head straight up because there are a lot of other uncertainties out there related to Covid, geopolitics, US elections and ensuing governance, as well as fiscal policy. There will also continue to be technological disruptions through which some companies will win and others will lose. Yet we have seldom had a situation wherein rates are this low and we have been told that they will remain this low for a period of time. Understand that the Fed has given us investors this knowledge and this investing environment. We ought to take advantage of it.

Most social media-savvy people know that “going viral” means something that gains rapid popularity due to acknowledgements, re-postings and re-tweets in social media. Things or people that were unheard of yesterday suddenly become the talk of the town today. The thing or person has achieved that currently much sought-after attribute: popularity. Also, don’t forget that it is the CoronaVirus that has the world economy in peril, and so it seems Virus is trending in all sorts of ways these days.

Remaining Viral

It is one thing to go viral, but it is another thing to remain viral. People have short memories, especially in social media, so it seems the trick to remain viral is constantly to reinvent one’s self and go viral over and over again. No small feat to do so. Perhaps this is who “celebrities” who become and remain viral are so handsomely paid – it is a difficult trick to pull off. Kudos to those who understand this world and capitalize on it.

Stocks Are Viral

As I write this, it appears that stocks and investing in the stock market are becoming viral. A big chunk of the US work force is still working from home, and some of them have financial media such as CNBC and Fox Business News on their TV’s while they Zoom in to work. This is feeding a boost in interest in stock investing, options trading, and the amassing of one’s own capital. These have been abetted by easy-to-use trading platforms such as Robinhood.com, as well as by free commissions for some trades. Those companies that are doing well in this stay-at-home economy have benefitted, and this has driven the tech-heavy Nasdaq 100 index up about 26% this year and about 73% since it hit a Covid-influenced low of about 7000 this past March. Investing in one particular stock, Tesla, and its options, has caused its price per share to increase almost 3 1/2 times this year. That is as viral as it gets in the stock market.

Is Viral Good?

A virus itself is not a good thing; see: Coronavirus. But it seems that going viral is a good thing in the short term. For stocks, going viral means everyone is jumping on the bandwagon and investing, perhaps regardless of the underlying company fundamentals. As with one-hit wonder social media stars who become viral but flop back to earth when they can’t maintain their popularity, so to can “viral” stocks return to earth quickly without any substance. One example: Eastman Kodak, which went from the $2-range up to a high of $60 (!!) in the course of a couple of days in late July due to its apparent involvement in a government program to help with the manufacture of Coronavirus medications. When that deal didn’t pan out as hoped, Kodak fell back to the $8/range – still higher than $2 but nowhere near $60. So, for every Tesla, which so far has maintained its viral nature, there are many Kodaks.

IMO

Don’t fill your investment portfolio with viral stocks. Make diversified funds the bulk of your portfolio. If you must, designate a small portion of your wealth as “fun money” to play the viral game. The ability now to buy fractional shares in some companies make it easier to get involved, especially for lower net-worth investors. Or, buy call options on what you think may hit it big soon, keeping in mind that call options expire at some point. If you load up too much on viral stocks, you run the risk of infecting your entire portfolio with losses, and losses are hard to overcome.

A fly that alit on Vice President Pence’s head and stayed there for a long time became the talk of Wednesday’s Vice Presidential Debate between Pence and Senator Kamala Harris. What does that say about the state of our political dialogue, that a fly can become the star of the show? But I digress. The dark-colored fly became prominent against the contrasting background of Vice President Pence’s light gray hair. Light gray hair – black fly: You will see the fly. Had the fly alit in Senator Harris’ dark hair, we viewers may not have seen it. As a result of the contrast of Pence’s head, it is a “viral” news item.

Contrasting Background

Something that is visually different will likely stand out from the crowd. What about you and your personal finances? Would you like to be the one with a black bug on your white hair and thereby stand out from the crowd and attract attention? Or would you prefer to blend in to the background? Here are some examples to think about:

• College: Your high school senior is a good student and would likely be admitted to any number of elite private colleges, but they would have to borrow a lot of money to do so. Your child’s closest high school friends will also likely go to private college, so your child would better blend in if they also did so. However, the better financial decision is to go to State U., or even your local CC for a couple of years. Should you contrast with your neighbors just to save some money?
• Investing: The stock market has been bullish and the TV “experts” think the bull run will continue. However, you think things are about to take a turn. Do you stick with the experts (blend in) and hold your positions, or do you liquidate now (contrast) and stick to your own intuition – or maybe it’s more than just intuition?
• Retirement: Your childhood friends are all taking early retirement and seem to be having the time of their lives. They are all urging you to retire and join in with their fun. However, you figure you need to work a few more years (God willing) to complete your financial goals. Do you blend in with your friends and retire early (it does sound like a lot of fun!)? Or do you contrast with your friends and work until you feel you can retire more comfortably?

Not Easy

Although my examples seem so, the “contrast” option is not always the correct decision. Sometimes everyone else is right and you are wrong. It is difficult to make a decision when you right in the middle of a situation and you are perhaps not objective in your reasoning.

IMO

The point that I am making is that you should not be afraid to go with the crowd and blend in with your financial decisions, nor should you be afraid to be the fly on Pence’s head and contrast with the crowd. You are not always right and the background crowd is not always wrong, and vice-versa. The trick is to recognize which way to go when you have a fork in the road. That said, if you are concerned about saving for the future, decisions that boil down to “spend less money today” are usually good decisions that perhaps result in some sacrifice in the current for good stuff in the future. Rather than focusing on the background color – i.e., what other people will think or say – focus instead on how this decision will help you achieve your own financial goals. That’s the better way to make a tough decision.

We all know that interest rates are low, which means that your rates on bonds, bank CD’s, or any other fixed-income investment are also low. Investors are reaching for anything that might improve their current return. One such “reach” that is being heavily promoted by the insurance companies that issue them is an Indexed Variable Annuity. If you have seen any of these promotions and are considering a purchase of an Indexed Variable Annuity, my advice is: Beware!

Annuity

I say Beware because you at least have to understand all of the vocabulary of this part of the investment world and how each word relates to your money and your investment. An Annuity is a steady stream of income over a period of time. Typically the income stream is fixed, and therein lies one issue with an indexed variable annuity: Its income stream is not fixed.

Variable

Having dealt with the noun in this type of investment, let’s move to the adjectives. Variable means just that – not fixed. The owner of a variable annuity doesn’t know for sure what the income stream will be, at least for a period of time, based on the type of variable annuity it is. This isn’t necessarily a bad thing; just different than traditional fixed annuities. If you can deal with the uncertainty of the variable payout rate, then the investment could work for you. The current return of variable annuities depends on the performance of a portfolio of securities (usually mutual funds) that the issuer (typically an insurance company) invests in. A variable annuity will often have a “floor” return that provides the annuity holder some safety, but your principal can be at risk when you invest in a variable annuity. Current returns of such investments are difficult to search and find on the internet – a lot different than traditional bond rates or dividend rates of stocks.

Indexed

The second adjective means that the annuity’s return is tied to a major stock index, such as the S&P 500 index. Often there is a provision such as your return will be no lower than 0% (i.e., you don’t lose money) and will be up to 70% of the performance of the S&P 500 index. That may sound like not such a bad deal, but the return is variable, not fixed; your money will be tied up in the investment for the long term and it may be difficult to get your money out if you need it; and there are high fees.

Other Vocabulary

Other terms you need to be comfortable with if you consider an indexed variable annuity:

• Term Cap: The most you can earn during a given term, usually a number of years, and usually expressed as a percentage (such as 70% in my example above) of the underlying index.
• Participation Rate: The percentage rate of return that you earn, up to the expressed Cap.
• Trigger: If the underlying index has a positive return for the year, that “triggers” participation in that return for the annuity holder.
• Floor and Protection Level: If the underlying index goes down, the insurer will “eat” the loss up to a certain floor amount. Sometimes the floor is 0%, but other times it may be a negative number, meaning you as the annuity holder could lose money.

IMO

Indexed Variable Annuities are complicated, and it is said they are “sold” rather than “bought.” Go ahead and Google “Rates on Indexed Variable Annuities”, and you will not see a percentage rate that is easily explainable or comparable among different issuers. The current returns on traditional fixed income investments are low, and you may be looking out there for alternatives. Unfortunately, I don’t see the upside of owning an indexed variable annuities as commensurate with the downside of owning such an investment. That said, it may work for you, but at least make sure you understand what you are getting yourself into. Contact me if you think I might help.

I have noticed recently that the daily performance of the S&P 500 Index and the Nasdaq 100 Index have not always been consistent with one another. This is probably due to the evolution of the Covid economy in the US. Since the onset of Covid, the Nasdaq 100 has outperformed the S&P 500 because more of the “stay at home” or “work at home” stocks are in the Nasdaq 100. During the past month, however, the S&P 500 has outperformed on some days on the hope that some industrial, financial and retail sectors are about to reawaken as Covid restrictions are loosened. To test my hypothesis, I went to a site I have used in the past: etfscreen.com. I found that the correlation coefficient between the two etf’s that represent the respective indexes – SPY for the S&P 500 and QQQ for the Nasdaq 100 – is 0.90. This is high, meaning that my hypothesis that the two etf’s could represent hedges against one another is not valid.

Correlation

Correlation is a calculation that determines the returns of securities over time relative to the returns of different securities over the same time. To do the calculation involves calculus – go ahead and Google “Correlation Coefficient” if you want to see the equation. A correlation coefficient of 1.0 means the returns of the two securities that you are testing are perfectly correlated, and a coefficient of 0.0 means the two’s returns are not correlated at all. Correlation coefficient sounds a lot like Beta, perhaps because the values are typically between 0 and 1. However, whereas correlation is about how two different securities perform relative only to one another, beta is about how one security’s volatility relative to the entire rest of the market, so correlation and beta represent different concepts.

A Handy Tool

The purpose of my post today, however, is to encourage you to use the same tool that I used to calculate how well your portfolio of etf’s are correlated. The website etfscreen.com can do the calculation for you. Once on the website, click Tools, and then Correlation Data. You will see a chart with the correlation data of some of the most actively-traded etf’s, including SPY and QQQ. There is an entry field right below the chart. In the entry field, you can customize the chart by entering the ticker symbols for etf’s that you want to explore. Hit Enter, and it will calculate the correlation coefficients for your portfolio of etf’s. Unfortunately, this will not work for individual stocks or mutual funds; only for etf’s. However, if you are curious how one sector of the economy is performing relative to another sector, use the etfscreen.com website to find sector index etf’s that represent the sectors that you are curious about (unless you already know those ticker symbols), plug them into this Correlation calculator tool, and it will calculate the coefficients. For instance, are you curious how the financial sector performs relative to the consumer discretionary sector? Plug the Vanguard Financial Sector ETF (VFH) and the Vanguard Consumer Discretionary ETF (VCR) into the chart and it calculates their correlation coefficient to be 0.79 – pretty high, but not perfectly correlated.

Why Is This Important?

Knowing the correlation coefficients of various investments within your portfolio is important because of diversity. Not “diversity” in the current sense of gender, race, or identity. Rather, diversity of returns. If one sector of the economy surges ahead, will another sector likely follow, and to what extent? You should seek a portfolio that is diverse from the standpoint of asset class as well as diversity of returns. Different asset classes should have different return prospects, but not always and not entirely. Similarly, you may have different assets within the same class of assets (i.e., stocks or etf’s), but because they may have low correlation coefficients, you may have a portfolio that is relatively diverse. A rising tide doesn’t necessarily lift all boats at the same time, to twist an old saying.

IMO

ETFScreen.com’s correlation data tool is very helpful and one you should use if you want to see how diverse your portfolio really is, even if you are invested in a limited number of distinct asset classes. Though this particular site is only helpful with respect to etf’s, because there are so many etf’s available, it can give you a good idea of what returns to expect across the spectrum of sectors out there.

No, I am not advocating that you go and take pictures of yourself in flirty or provocative poses and post them on Instagram in an effort to draw social media attention to yourself. However, I am advocating that you adopt an “Influencer” state of mind with respect to your investing and personal finances. Pick someone or a group of people that you love and/or respect in the field of finance and conduct your own finances such that you want to influence their own such conduct in a good way.

What Is An Influencer?

Pop culture influencers can get a bad reputation because they can seem self-centered, trendy, and/or not too deep. Yet, while there are bad influencers, there are also good influencers. Someone out there who is advocating a universal good such as being kind and respectful to other people is a good influencer. At their core, and influencer is someone who wants to use the example of their own life experience to attempt to sway other people to act in a similar fashion to their own.

Financial Influencer

Most people have an idea of what good financial advice consists of and who may have given them some good financial advice in the past. It may be someone in the media, a personal financial advisor or planner, or maybe an older relative such as a parent. Why might you have taken a financial influencer’s advice to heart? Probably because their words or actions over the years have earned your respect. If that is the case, maybe you should try to earn the respect of other people in your own lives, perhaps your own children, and conduct your finances in a way such that they will respect you and that you might influence them to do the right thing when the time comes and a decision has to be made.

Less Self-Centered

In a way, by thinking about how others might look to you as an example when you make financial decisions, as long as you hope that people think of you in a good way, is a less self-centered approach. Rather than thinking just about yourself and what benefit you might accrue by making a new, big purchase, for example, perhaps you should think about what others may think, or even how you want to be a good example to your own kids when you make that purchase. Being more outward-thinking might help to temper your own rashness and make a better decision, which in turn might influence others to think and act more like you.

Example: A New Car

Let’s say you and your spouse need a new vehicle, but you also have multiple children who also have needs. You have ogled at the fancy new German crossover and you try to convince yourself that it would be practical for your family’s transportation. However, the kids are getting more expensive and you know you don’t really need the expensive crossover when a minivan will do the job just fine, maybe even better, at a fraction of the cost. At this point, consider what your own kids might learn if you do go for the German crossover. The kids might take it as a sign that there are no limits or other issues to consider when making spending decisions. The result might be that your family is headed for financial hardship for years to come. On the other hand, if you opt for the minivan, perhaps you might influence your own kids to make practical decisions within their own budgets when they grow up.

IMO

A number of social media addicts today see the Influencers that they follow on their platforms and think maybe they take a few of their own selfies that maybe some clothing or makeup company might sign them to a contract to peddle their wares. This isn’t inherently a bad type of influence, but it is not quite what I have in mind when I advocate that you become an Influencer yourself. Instead, I say that you should consider the people you most respect or love and act or make decisions such that you will gain their respect and perhaps be able to influence them now or in the future. Don’t make decisions or take actions in a vacuum. Instead, consider your decisions and actions as to what others will think about them. Such a mindset might cause you to make a better decision for yourself.

“Disruptive” is another common buzzword, albeit one that has been around for a while. In business, “disruptive” mostly relates to new processes or technologies that emerge and are either superior, less expensive, or superior and less expensive than existing processes or technologies. The late, great Harvard Business School professor Clayton Christensen made “disruptive” a buzzword when he wrote about the process of disruption in his 1997 book “The Innovator’s Dilemma.” In today’s economy, hydraulic fracturing in the oil industry is an example of a disruptive process, and the Tesla is example of a disruptive product.

Are You Disruptive?

Are you a disruptive person by nature? Do you like to cause trouble, or stir the pot? Whether you are or not may be a function of your stage in life. Younger people tend to like to be more disruptive, whereas older people tend to conform just to make it easy on their lives. It is neither good nor bad to be disruptive as long as you follow the rules and don’t hurt other people unfairly.

Do You Invest in Disruptive Companies?

However, even if you don’t view yourself as a disruptive person, as an investor, you need to understand the nature of disruption, which companies are the disruptors and which are being disruptive, and invest somehow in those disruptive companies. Why is that so? Because disruptive companies are leaving “old technology” companies in the dust. According to this article from The Street, the top 10 companies in the S&P 500 Index account for all of its growth this year, and the remaining 490 companies’ stocks are cumulatively underwater. All of the top 10 are disruptive companies such as Apple, Microsoft, Facebook, and Alphabet/Google. On the other hand, ExxonMobil, though still part of the S&P 500, was dropped from the Dow Jones Industrial Index of 30 stocks because XOM has not kept up with the pace of the disruption in the energy sector. An investor these days has to invest in disruptive companies just to keep up and not fall behind in meeting their financial goals.

The Good News

The good news is that there is a relatively easy way to invest in disruptive companies, and that is just by investing in index funds, especially the tech-heavy Nasdaq 100 Index. You don’t have to be an electrical engineer working at a venture capital company and be a seed investor in start-up companies in order to invest in disruptive companies. Disruption has now gone mainstream. Even the traditionally anti-tech, stick-in-the-mud Warren Buffett’s Berkshire Hathaway invested an estimated $730 million in the Snowflake IPO earlier this week. So, even if you just own the S&P 500 Index through your IRA or 401k account at work, you own Berkshire Hathaway through your ownership of that index, and you in turn own a part of the new hot IPO Snowflake.

Covid-19

Currently we are in the middle of the pandemic which is an agent for even more disruption. Consider that companies are trying to make do with their employees working from home and how that disrupts many aspects of our economy such as the future need for traditional office space as well as the need for the technical infrastructure to make the work-at-home economy happen. Companies whose processes or products enable the Covid economy to transact are doing well but companies that depend on the pre-Covid world are in great difficulty.

IMO

“Disruptive” is a buzzword for a good reason, and that is because disruption is the driving force behind all of the growth in today’s economy. Because of Covid, the pace of disruption will likely accelerate even more. If you want to grow or even just maintain your portfolio to meet your financial goals, then you need to be investing in disruptive companies, even if it is through index funds.

Options trading is booming. People are bored sitting at home during quarantine and are turning their attention to the stock market and specifically options trading. Easy to use platforms such as Robinhood have helped to facilitate significant growth in options volume. It has emerged that Japanese giant SoftBank bought $4 Billion of options during recent weeks and that helped fuel the approximately 75% rise in the Nasdaq 100 index since the depths of March 2020.

Options Prices

If the volume of options trading is up, what do you think that means for the price of the options being traded? As with any other product, if the demand rises, then the price rises, all other things being equal. If the number of bidders for a particular call option at a particular strike price and expiration goes up, then the price to buy that call option will go up. The opposite is true as well. Quants will point you to the Black-Scholes Option Pricing Model to figure out what a call option is really worth, but in reality an option is worth what someone else will pay for it on the open market, and that goes back to simple supply and demand. If you believe that the stock or index that underlies the option stands a good chance of going up, then it may make sense to buy the call option. But, at present, you will pay a premium to do so.

Buy or Sell?

Consider this, however: If the sales price of a product is inflated, as option prices currently are, does it make sense to be a buyer in an inflated market or to be a seller? What I am saying here is that now is a great time to be a covered call seller, or writer, because option premiums are inflated. “Covered” calls involve owning the underlying stock or index and then selling calls at inflated prices and pocketing the premiums that you get from the sale. Typically a call seller will sell calls with strike prices at or above the current price of the underlying stock. For instance, you may want to sell a call with a strike price that is 1% higher than the current price of the underlying security. You pocket the premium that you sold the call option for no matter what happens next. At the expiration of the option, if the price of the underlying is below the strike price of the option, then you keep your stock as well as the option premium. If the price of the underlying at expiration is higher than the strike price, then you still keep your option premium but you have to “put” the underlying stock to the call option owner at the strike price, not at the actual price of the underlying. That’s your risk: you give up some potential upside in return for current cash in the form of the option premium. With option premium prices inflated presently, selling sounds like a good deal to me.

Don’t Be Naked

Don’t be naked, by which I mean don’t sell option premiums, either calls or puts, without owning the underlying security. Naked selling is very risky. If you like to be naked, then go ahead and buy options – don’t sell them naked.

IMO

Right now, options are like the new, hot restaurant that just opened. All of the beautiful people are there hanging out and it is tough to get a seat. Since the restaurant is in high demand, it boosts its prices up. Do you believe it is a good investment to try to “buy” a seat at this hot new place called the options market? Or might a be a good idea to avoid it for now and wait until the hype dies down a bit so that you can partake at a more reasonable price? My restaurant analogy falls short with respect to my covered call strategy (you can’t “short” future seats at the restaurant, at least not yet). However, I hope you get the picture: Be fearful when others are greedy. Be careful if you decide to trade options if you are new to the game, and please don’t jump in naked.