$10 Oil Will Never Happen

Recently I read an opinion article posted on Bloomberg View where a guy named Gary Shilling predicted that the oil price could fall as low as $10. The title of the article read “Get Ready for $10 Oil”.

Of course this is a sensationalist title, and the author probably doesn’t really believe that oil will fall that low, but it ranked #1 on Google News results. The link is here.

Before people go buy new Hummers, let it be known that the lowest production cost in the world is $10-$20 per barrel in Saudi Arabia – and Saudi Arabia only produces around 13% of the world’s crude. The US imports most of it’s oil from Canada, and produces shale oil at a cost between $25 and $95 per barrel. It would be more economical to simply stop pumping oil rather than producing it for free – and that’s what’s happening. Around 100 shale oil rigs were closed in the US in late January, and more are probably being closed as we speak. Countries with small bankrolls will not be able to afford running their oil industry with oil at $10, and will most likely end up in economic chaos. Russian oil production costs are between $10 to $16 but the transportation costs are high to get the oil to suitable refineries and around the world. World demand for oil is not decreasing, but increasing at a slower pace (until the effects of people all bathing in oil and taking joyrides in 18 wheelers starts to kick in).

As of today Crude WTI oil trades at $52.78 and Brent trades at $57.39. Brent is the price used for global oil producers and WTI stands for Western Texas Intermediate. This is up from the low of around $45 in late January.

With all the volatility in oil prices you can bet people are making money off of the price changes. You can too – just read my article “How To Capitalize on Low Oil Prices“.

Cheers

 

How To Get Out

The bull market that has basically defined the past six years seems to have stalled. After recording no gains for December or January it remains to be seen whether or not the market is experiencing a temporary lull or has reached a summit. With the Federal Reserve expected to raise interest rates in June, one can only expect that the market will push down further in the medium-term.

What should you do if you’re currently holding stocks but want to get out? First of all, don’t panic – you should assess your situation and deal with it accordingly. This article is catered for strategies of liquidating stock holdings so if that is not your plan then please read one of my other articles!

Scenario 1: Holding lots of short term stocks

Answer 1: If you’re holding a lot of short term stocks and want to get out, you should first determine if you have any capital gains on those stocks. If you are selling at a loss, then go ahead and sell these stocks now and make sure to record your losses in order to benefit from capital loss carry-overs in the future. If you’ve made a lot of money off of these stocks and are in a high tax bracket you can sell with the knowledge that you will be paying high tax on these gains or buy put options for these stocks that expire when you can sell these stocks as long term gains.This really only works when that date is in the near future, since put options’ price is largely influenced by a factor of time. If you have to wait six more months before selling it usually does not make sense to buy put options since the cost of those options may trade at around 20% of the stock’s price. In the case of Apple, which has gone up 20% in the past six months – it’s $115 put options trade at around $11 dollars per share, which upon purchase would cut a 20% profit into only a 10% profit, which would only benefit those who are paying more than 50% short term capital gains tax (I’d hate to live in an area where my combined federal/state/local tax is that high!).

Scenario 2: Holding lots of long term stocks

Answer 2: Sell them! You’re going to have the pay the long term capital gains someday anyway and might as well sell when you think they’re most profitable!

Scenario 3: Have no brokerage accounts, but instead have lots of money in a 401k primarily invested in stocks

Answer 3: You should be able to reallocate your money into bonds or fixed income assets. Bonds have higher returns but more risk than fixed income. Unfortunately most 401ks do not allow individual choosing of bonds, instead offer a choice of bond funds. Bond funds will fare differently dependant on the length these bonds are held for. Long term bonds will fare poorly if the Federal Reserve increases the prime interest rates since the bonds themselves are locked into a lower interest rate.

 

How To Capitalize on Low Oil Prices

With crude oil trading the lowest it’s been since 2009 there are a few things you can do today to capitalize:

As Jerry Reed says in his song “Lord, Mr. Ford“:

Well, if you’re one of the millions who own one of them
Gas drinking, piston clinking, air polluting, smoke belching
Four wheeled buggies from Detroit City, then pay attention:

Now is a perfect time to load up the family and take a road trip. A penny saved on gas is worth more than a penny earned (considering taxes).

If the price of oil remains low, many sectors stand to benefit from the cost savings to their business. Obvious candidates include shipping, airlines, and retail. Oil revenue dependent companies should be avoided if low prices persist, such as drilling support and manufacturing companies.

If you think the oil price is bound to jump up sometime in the near future then you can buy oil futures, or if you have a regular stock brokerage account you can trade in exchange traded funds (known as ETFs) which base their performance on the performance of the oil price.

Two of the most popular of such funds are ‘UCO‘ and ‘SCO‘. UCO aims to emulate 2x the positive price change of oil, while SCO aims to emulate 2x the negative price change of oil. Take a look at the performance of these two funds over the past six months.

UCO ultra oil fund performance for past six months

UCO ultra oil fund performance for past six months

SCO ultra oil fund performance for past six months

SCO ultra oil fund performance for past six months

As you can see, UCO has been hammered by the fall in oil price over the past six months while SCO has climbed over 250%. If oil stages a large rally then UCO has a lot of upside potential – while SCO has a lot to lose. Four potential strategies that would benefit from a oil price increase include the following:

  1. Buy call options for UCO
  2. Buy put options for SCO
  3. Buy long UCO
  4. Sell short SCO

Outside of purely playing the oil price movements with these ETFs, you can also consider buying companies that have been hammered by the lower prices. This strategy involves more risk because companies have the possibility of going bankrupt and bringing their share price to zero, while the oil price will never reach zero until a revolutionary technology make it obsolete (and that transition time would be formidable).

Oil behemoths are more likely to survive a sustained weak oil price than smaller more leveraged companies. Some of these giants include:

  • Exxon Mobil Corporation (XOM)
  • Chevron Corporation (CVX)
  • Royal Dutch Shell (RDS.A / RDS.B)
  • BP (BP)

Smaller players that may return a better yield if a oil rally occurs include:

  • ENSCO (ESV)
  • Transocean LTD (RIG)
  • Seadrill Ltd (SDRL)
  • Northern Oil & Gas, Inc (NOG)

 

Whether or not the oil price remains cheap, recovers, or falls even further there are always ways to profit from it if you take a certain degree of risk. Given the deflated state of oil, it’s large but limited supply, and the motives behind the price bullying of American oil operators by OPEC I think oil will stage a moderate comeback in the next few months (make sure to read my disclaimer below).

Low Dollar Stocks Not Necessarily Cheap

The statement “cheap does not mean cheap” has never been more meaningful. The first “cheap” means price relative to fixed amount say $100, and the second cheap means how much the stock costs relative to the value of the underlying company. A $1 stock might seem cheap to the inexperienced investor but a $100 stock might have a lot more value and be cheaper in relation to how much of a return you will be getting based on a company’s earnings.

Case in point – Advantage Oil & Gas Ltd is trading at just $4.59 , but it’s last reported earnings per share was just three cents! For those who know what P/E ratio is that would be a whopping 134.72. On the other hand, you might have a company like Chevron with a price of $108.21 but earning $10.86 per share while paying dividends of over a dollar per quarter! I would much rather choose Chevron over Advantage simply because the first is more of a gamble!

I think the biggest problem people have is that they think that a single or a few shares of an “expensive” stock is more risky, when in fact the opposite is true! See how investors in China are piling money into penny stocks, which might sustain itself if enough people keep joining in but most likely will result in a huge bust.

I’m not saying that high or no P/E ratio stocks should be ignored completely, however these types of securities are more risky than others. If you think there’s an upper bound on a share price you are wrong, as the $224,000 price for Berkshire Hathaway proves.

Using a stock filter, I have randomly chosen a few stocks that are ‘cheap’ under the layperson definition and ‘cheap’ under the investor definition. I will post their five and ten year performance below.

Cheap (dollar wise)

Of course, one of the reasons you might stumble across a cheap stock is because it's price has already stumbled so much!

Of course, one of the reasons you might stumble across a cheap stock is because it’s price has already stumbled so much!

Helios and Matheson Analytics Inc – Perhaps the only good random pick, pays a 5% dividend but the price change has been disappointing in the past 5 years considering the rest of the market

Vaporin Inc – looks like this stock got vaporized

 

Cheap (P/E ratio)

ACE Limited - Looks like a steady price increase, yielding almost 140% in the past 5 years on top of regular dividend payments.

ACE Limited – Looks like a steady price increase, yielding almost 140% in the past 5 years on top of regular dividend payments.

Allstate Corp - 125% return on past 5 years along with regular dividends. Another winner in my book.

Allstate Corp – 125% return on past 5 years along with regular dividends. Another winner in my book.

Andersons Inc - 186% return in past 5 years with a small dividend. Not too shabby.

Andersons Inc – 186% return in past 5 years with a small dividend. Not too shabby.

While there are thousands of more examples to go through, just a random selection of a few showed that the first version of cheap should have just been thrown in the trash and the second, intelligent, version is what you should be looking out for.

Good hunting!

Is The Bear Here?

Is the bear here? Have six years of solid yields in the stock market going to be wiped away by a massive correction? Should you be worried?

I have no idea, but I’m prepared to a certain extent whether or not a bear yields its ugly face. You can do the same, as long as you are approved for options trading.

 

Strategy #1: Make sure you have put options covering or exceeding the amount of shares you have in companies – for example if you are holding 100 shares of Apple which is worth around $106.25 after falling almost 7% in the past five days, you should hold at least one put option of Apple. The strike price for the put option is where a lot of the magic comes into play, as if you buy a put option with a strike price above Apple’s current market value you are making a very conservative play that will be handsomely rewarded if Apple stock price falls but costs a moderate amount more than an option with a strike price around $100 for example.

In my real-price example I will use the March 20th, 2015 expiration date. The Put option with strike price of $110 (above the market price of AAPL which is $106.25) costs $850. The put option for $100 costs $370. The difference is $480, which is less than the difference in share price for a given options “basket” which is $625. That means that It makes more sense to buy the more expensive put option if the stock falls, because even if it falls past the lower strike price you will be making more money.

Let’s say Apple falls to $90 per share by March 20th – with the more expensive put option you make $20 per share in your basket minus the commission which comes out to a profit of $1150. If you had purchased the cheaper lower strike price option you would make $630. Of course you stand to lose more if Apple goes up by March with the first option, which is why options being supported by a long ownership of Apple makes sense.

Strategy #2: Short the stock market. Sell  shares of a company you don’t own with the intent of buying them back later at a lower price. This is a highly risky strategy as shorting a stock makes you liable to pay any dividends they issue from your account and without a call option to secure the short position the loss potential is astronomical. One company that is heavily shorted is Herbalife Ltd., which some hedge fund managers consider to be a pyramid scheme soon to be busted by the government. If you short the stock market you will make money in a bear market.

Strategy #3: Sell all of your stocks and invest in corporate bonds or bank CDs. This is sort of like giving up on high yield investing, find a bond that suits your risk level or go with a municipal bond that may offer tax savings at the state level. Even more risk averse you can put money into T-Bills, which is what countries like China have done to protect the value of their huge cash surplus.

Locking In Gains with Put Options

Are you too scared to sell the stocks that have made over 50% in the past year or two? Is it because you want to hold off on cashing in and paying a heft amount of capital gains tax? How about doing what the big banks do, buy put options! Put options go up and make money if the price of a stock goes below a certain amount by a certain time. That means if you buy put options for your most profitable stocks you will be essentially locking in profits while not having to sell these stocks which might be paying dividends.

The downside with put options is you must pay a price to buy the put option from an available seller and put options expire based on what their expiration date is. The longer the expiration on a put the more expensive it will be. Let’s say you were lucky enough to be able to purchase Alibaba at IPO pricing – $68 per share. Currently BABA trades at $106, so you’ve made $38 per share, not too shabby. However, you foresee or have fear that BABA may fall below $100 and want to make sure you lock in those profits while not making a short term sell. What you can do is buy put options to cover your stocks until October 2015. Or if you want to save some money you could also buy put options now to cover you until March and then re-evaluate your “options”.

Options are cheaper than their underlying security because they are worthless if they aren’t “in the money” when they expire – to understand these options concepts if your a newbie please read this, this, or this.

What’s a Bull Spread?

A bull spread is a type of call option that aims to profit off of a underlying security that has a specified percent increase. Most of the time investors aim for moderate or low price increase.

An example of a bull spread is to buy a call option for Apple for a expiring three months from now for a strike price of $130 per share. Apple trades at $113.99 as of right now (premarket 12/29/2014). The call option costs $1.37 market price, so for a single option you will be paying $137 (options come in stacks of 100). If you wanted to lower that cost all you’d have to do is sell another call option for Apple for say $140. You’ll get 50 cents for this, so you’ll lower your total cost for this “play” to 87 cents. So pay $87 rather than $137 to make at MOST $10 per share, or $1,000.

I personally am not a fan of the bull spread because of the fact that you’re limiting your winnings, it’s like buying insurance on your winnings. I must prefer having unlimited UPSIDE potential with a put option in place as INSURANCE. Even so, when you’re hedging your investments you are limiting your profit potential.

You can also do what I call a “bear spread” by buying a put option and then selling a put option for a even lower strike price. This would be in anticipation for a moderate downfall in the price of an underlying security. I would personally never do this, it would almost take a wizard or oracle to predict such a price fall to such a degree. You’re better off shorting a stock then paying such hefty premiums for these options.

If you’re interested in seeing what a bull spread looks like on a profit-loss graph here it is below:

Call option March 20 leg 1 buy $130, leg 2 sell $140

Call option March 20 leg 1 buy $130, leg 2 sell $140

Cybersecurity And You

Cybersecurity means protection for data. It means protecting machines involved in storing data and methods of communication to keep data from being intercepted and decrypted. With the recent revelation of a massive hack of Sony Entertainment and the resulting cancellation of a multi-million dollar movie release it is more important than ever that you as an individual also keep your data secure as to avoid any theft of information or funds from your accounts. While many banks and credit card companies provide fraud protection, and will reimburse losses, some will not do so if it is determined that gross negligence has occurred. Gross negligence is extreme carelessness – read below to keep yourself from getting yourself in trouble.

1. Protect your passwords – make sure to never share your password with anyone who might be careless with it. It’s better not to write down your password. Also, try to keep your password 10 digits or more if allowed, including upper-case, lower-case, numbers, and special characters. Ensure your password is not in a dictionary! Avoid using credit cards overseas in shady areas, as some ATMs or card readers may have been hijacked and installed with secondary card readers which will read your number and security code. Do not use the same password for multiple things, for example if your registering for some reward card the website may not encrypt your password so if there is internal fraud or a data breach for that company hackers will surely try to use those credentials in more important areas such as banking.

2. Do not access unprotected wireless access points – whenever you connect to the internet through wifi make sure you know that you are connecting to a genuine hotspot. Hackers can easily set up hotspots where all data is routed through their “packet sniffing” software and they will have access to all unencrypted communications and with the right tools may be able to hack some of your encrypted data.

3. Never let someone else use your machine – if you log into a laptop and let someone else use it, they may be able to install keylogging software in less than a minute which can report keys typed to themselves without you ever seeing this program. Even if you are logging into a secure site the hackers will be able to know which website you are on along with which keys you pressed – from there it’s easy to get your password.

4. Use two factor authentication – two factor authentication usually means a password and some phrase that is generated over time semi-randomly based on a time based key. The code might be accessible through a device you keep on your keychain or sometimes emailed to you. This means just knowing the password will not allow a hacker to get into your information.

5. Set up country specific blocks – if you know you’ll never log into your computer or access your data from Nigeria or Brazil (For example), some websites allow for country specific blocking. This will not keep sophisticated hackers from using proxy servers to try to hack into your account, but should keep a few unwanteds out. You can also call your credit card company and should be able to disable all transactions from outside your home country.

With these five steps in your pocket I’m sure you will feel a bit more secure while letting your nest-egg grow.

When Politics Influences the Stock Market

Politics ALWAYS influence the stock market. Higher taxes usually means lower returns for companies and a falling stock market. Low interest rates means cheaper capital for companies as well as lower return alternatives for investors which drives stocks up. Why put money in a 0.1% interest account when you can be investing in a stock that pays 3% in dividends every quarter? Below is an example if you’re doubtful:

3% Dividends four times a year

3% Dividends four times a year

Higher regulations on the coal industry during the Obama administration have virtually killed coal stocks such as ABX which fell from over $73 in 2008 to its current price of $1.93. I’m not here to state a value judgement, but a pure stock price judgement – so make sure you pay close attention to campaign promises of politicians. Here’s a video of Obama basically promising to bankrupt coal companies. Whether you like it or not, industries change and the President or other politicians can help spur this change.

From $73 to $1.93 in the past six years

From $73 to $1.93 in the past six years

Keep a close eye on what the media and politicians say about regulation on the soft drink or tobacco industry, as well as the budget set aside for defense and even our space agency NASA. Oil prices are largely affected by conflicts in the Middle East, and trade protectionism also is something to watch out for.

Is DCA Right For You?

Dollar cost averaging is sometimes boasted as the best way to invest your money – over time in order to avoid investing a lump sum at a time of over-inflated prices. If you contribute to a 401k plan every pay check you are involved in this investment strategy, however the benefits of such a strategy are largely focused on investor’s emotions rather than being the statistically right choice.

If you want to eliminate the seasonal trends of the stock market, then a DCA over a period of one year might be right for you – for example investing $100,000 into the stock market by adding $8,333.33 to your portfolio each month. Some folks take a different stance and invest around November and sell their investments in April – based on a historical trend of stocks rising in these months more than the others. This is called the “Best 6 Months” strategy.

However, the best 6 months strategy when applied to taxable investments will always result in short term capital gains which are taxed more heavily than long term capital gains (See Stocks for more information). Also keep in mind that you are losing out on dividends when you don’t hold shares. If you are planning a six month strategy I suggest doing so in a tax-free account such as a Roth IRA using a mutual fund to capture a large portion of the market.

Most folks engage in DCA through regular 401k contributions, many companies match a portion of this contribution. It would be foolish to not contribute up to the employer match.