Ask Your Financial Advisor - What Insider Information Do Others Get?

Here is something important you should be aware of, especially when making your own market or portfolio management decisions, or when relying on the advice of your financial adviser. Do you know whether or not you have open and complete access to all the pertinent information you might need to make those investing or share trading decisions? In a perfect world, as an independent investor in stocks, you should be able to access and analyze the same information available to takeover experts and corporate acquirers, such as investment bankers, private equity investors, public accountants, and so on. This, regrettably, is not the case. Investors and traders in public market securities and securities analysts have access only to publicly available information. As a result, they have less than complete information available to them when they invest, trade, or in the case of securities analysts, prepare their reports and recommendations.

The information they don’t have is often just as important in the development of comprehensive, meaningful valuation determinations. This is not a criticism of public market participants (the financial advisers and analysts), who do not have access to this vital and relevant information. This is a result of securities laws that are outside their control. These investment professionals need to do much the same analysis as do those corporate acquirers, seeking to purchase 100% of a company. As opposed to public market participants, corporate acquirers and their advisers, (pursuant to the appropriate legal documents), have direct access to the directors and executives of the target company. These persons provide detailed responses to all requests for information made by the corporate acquirer, hence providing information that is both in the public domain and not in the public domain. Furthermore, they get access to all documentation in the target company’s possession related to its assets, liabilities and historic/prospective operating revenues, expenses and cash flows. But imagine if you did have much more information…almost the very same as the corporate acquirers.

I know of one independent investor who decided to do something about this. He conducted extensive investor and market research, and then used that knowledge – and his own industry experience – to assist those who want to manage their own portfolios, the financial advisors who assist them; and others who need unbiased, independent help. He used innovative thinking and the web. In the investment world, the Internet is helping to change things and level the playing field. Every week someone comes up with a great idea to harness the capabilities and distribution power the Internet provides.

© Roy MacNaughton, 2007

To learn what the research mentioned in the story above revealed, go to: : http://www.stockresearchddblog.com Roy MacNaughton is a business writer and “niche” marketing adviser. He’s a seasoned marketer, with more than 25 years of international experience, including eight years online. Visit his blog at: http://www.UmarketingU.com

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Time Decay

Time decay, also known as theta, is defined as the rate by which an option’s value erodes into expiration. The value of the option over parity to the stock is called extrinsic value.

Since an option is a depreciating asset, meaning it has a limited life, the extrinsic value in the option will wither away daily until expiration. This “decay” is not a linear function meaning it is not equally distributed between all of the days to expiration.

As the option gets closer to expiration, the daily rate of decay increases and continues to increase daily until expiration of the option. At expiration, all options in the expiration month, calls and puts, in-the-money and out-of-the-money must be completely devoid of extrinsic value as noted in the time value decay charts below.

As more time goes by, the options extrinsic value decreases. Again, it is important to note that the rate of this decrease is not linear, meaning not smooth and even throughout the life of the option contract. An option contract starts feeling the decay curve increasing when the option has about 45 days to expiration. It increases rapidly again at about 30 days out and really starts losing its value in the last two weeks before expiration.

This is like a boulder rolling down a hill. The further it goes down the hill, the more steam it picks up until the hill ends.

By selling the option and owning the stock, the covered call seller captures the extrinsic value in the option by holding the short call until expiration.

As mentioned earlier, an option’s loss of extrinsic value over its life is called time decay. In the covered call strategy the option’s time decay works to the seller’s advantage in that the more that time goes by, the more the extrinsic value decreases.

Key Point – The covered call strategy provides the investor with another opportunity to gain income from a long stock position. The strategy not only produces gains when the stock trades up, but also provides above average gains in a stagnant period, while offsetting losses when the stock declines in price.

We have now seen how a covered call strategy is constructed and how it is supposed to work. Keep in mind that the trade can be entered into in two ways. You can either sell calls against stock you already own (Covered Call) or you can buy stock and sell calls against them at the same time (Buy Write).

Example 1

You own 1000 shares of Oracle at $9.50.

The stock has been stuck around this level for a long time now and you have grown impatient. You finally give in and sell the front month (November for example) at-the-money calls. The at-the-money calls would have a strike price of $10 if the stock was trading at $9.50.

You sell the calls at a $.50 premium per contract which creates a $10.50 breakeven point. Remember, in a buy-write, the breakeven point is the strike price plus the option premium. Let’s look at what our returns will be in each of the three scenarios.

About author:
Ron Ianieri is a professional options trader, former floor trader, and market maker on the PHLx options exchange. As co-founder of the Options University, Ron teaches hundreds of aspiring options traders from all over the world how to trade options ‘the right way’. Click here to learn more: optionsuniversity.com

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