February 18, 1999

(Q) What's the difference between a call and a put? The question was in reference to Pride International an oil service sector stock.

(A) Call options are to a long position in a stock, you think the stock is going to go up. Put options are to a short postition in a shock, you think the stock is going to go down.

A call option is the right to buy at a specific price. So if you think PDE will be $7.50 by July and you buy one July $5 contract. You will have the right to buy 100 shares of PDE for $5 at the time you buy the contract up to the third Friday in July (US stock options, European options are different). If your analysis is correct and PDE is $7.50 in July, you could buy the 100 shares for $5.00 and turn around and sell them for $7.50 in the secondary market, exercising the option contract.

Please, Please, Please, there is much more to it than just this, so don't think that the above paragragh explains it all. Options are complexed and there are many different possibilities.

For example, many options are not exercised, meaning, in the above example you would not of exercised the option and bought the 100 shares at $5 and then turned around and sold the 100 shares. You would have simple sold the option contract itself.

A more realistic look: You buy a July $5 call on PDE for $300 (I don't have a clue if this is accurate and I'm not going to look up the exact price, I'm totally, guessing.). You are paying $300 which includes no intrinsic value because the current stock price of $5 (I'm assuming the current stock price is $5.) = the strike price of $5, the $300 is basically the cost for the time you are given for the stock to do what you think it will do, and that time is Feb, Mar, Apr, May, June, and July or 6 months. Note: the volatility of the stock plays into pricing also, but is very complexed, if a stock is more volatile the better chance it will move quickly, and the quicker it moves, assuming it is moving in the direction you want it to, the more money you can make (higher volatily means more cost for the option contract). However, for my purposes I'm going to just use the intrinsic and time value of the option.

If PDE would move to $7.50 the day after you bought the option, I realize that is not likely, but if it did, you now have $250 in intrinsic value $7.50 - $5.00 = $2.50 X 100 (one contract gives you the right to buy or it gives you control of 100 shares) = $250 and you still have your $300 of time value because you still have almost the full 6 months (- one day), so now you could sell the option for $550, close to a 100% gain for a 50% price movement in the stock. Also, there are transactions costs to the broker and market maker.

Another scenario is that it takes PDE the full 6 months to hit $7.50, this time you have no time value and only intrinsic value of $250, so you lost $50.

Another scenario, PDE never gets past $5 even in July. No intrinsic value and no time value, loss of $300 or 100% of investment.

Another scenario, PDE goes bankrupt in July, no intrinsic value and no time value, loss of $300 or 100% of investment.

This is one good thing about options after the leverage advantage and that being you limit your risk, you were wrong and the stock didn't get past $5, and you lost your $300, but if you had really missed the call and the company actually went bankrupt, you still only lost the $300, you limited your risk with options.

Please, Please, Please, the value that I put on the options were a guess, a 50% movement in a stock price in one day after you bought the contract may produce much more than just a 100% gain, and if the stock moved by 50% and it took the whole 6 months you might not really of lost $50 and may have actually made money. My numbers for the above examples are for illustrative purposes only.

MarketInsider

February 17, 1999

(Q) How much do fundamentals play in determining a stock's market price. The question was in reference to Pride International an oil service sector stock. At the time the oil service sector was out of favor with Wall Street.

(A) When I started investing I was a pure fundamentalist and it worked well for awhile (1984-1996). However, when the institutions, led by the mutual fund companies, started marketing their services like cars and soda, the stock market changed. There was now a high demand for stocks, created by the marketing machine of the institutions, stock prices and their valuations would now be higher than ever. The institutions knew stock valuations were high, but their businesses depend on the stock market going up, not down, so they continued to try and justify the lofty valuations, their favorite being low interest rates.

When this was all going on from about 1996 to the present there was a clear change going on as far as what would affect an individual stock's price. Instead of fundamentals being number one it would be momentum and liquidity, with fundamentals being a distant third.

Looking at PDE this explains why it's at $5. The oil services sector has no momentum, nor does PDE, and PDE with a market cap of around $300 million has no liquidity as far as institutions are concerned (I'm not saying institutions won't own the stock, but that there won't be strong demand for the stock as far as the institutions go because of the stock's lack of liquidity.). The third issue regarding PDE's stock price is fundamentals and yes they are strong, but unfortunately the market doesn't care about them at this time.

One thing I would point out here about PDE's fundamentals is its PE ratio. Vice looking at the trailing PE of 3 or 4 (because this is based on the past and the stock market doesn't care about the past), I would look at the forward PE. Estimates are for a low of 40 cents to $1.25 a share for 1999. This means that the forward PE is anywhere between 4 and 12. If the analysts are correct, you have to answer that for yourself, this stock is a great buy. And you can't argue with the book value.

One note about book value and I think it's going to bring out the most important question about PDE's stock. If management are a bunch of clowns, they can wipe out book value in a few months. This is why I think that management is the most important question you have to ask yourself if you are a PDE stock holder long. The fundamentals are great and if management can "responsibly" get though this period of low oil prices, then in time, the momentum will return to the oil service sector and PDE. Granted, PDE will still have less liquidity than the larger caps like HAL, etc., but because of the low float of this stock it doesn't take much momentum to move it up a lot.

Since my time horizon is 1 to 2 years and I am conservative when it comes to valuation (when the S&P 500 has a PE of over 30), I am a buyer of PDE. As far as shorting the stock and 10% of the float is short, it's one hell of a gamble. I say that because the best you can do is to make 100% and that's if the company goes bankrupt, but the worse you can do is lose 100%, 200%, or God forbid 300%, and etc. (buying puts is a different story). I want to point out I'm not talking about the past, no doubt, many have made money shorting this stock in the past, but you have to admit it's quite a risk at this point with the stock at $5.

MarketInsider

February 9, 1999

(Q) Can you please define 'float'?

(A) The number of shares that are outstanding and are available for trading by the public. Does not include those shares held by insiders.

Now if you want to find the float of a stock go to Yahoo quotes, enter the stock symbol, when the quote comes up, click on the symbol and select profile. At the bottom of the report on the left you will see how many shares are outstanding and what the float is.

A couple of other tidbits about float. If the float is small the stock is more volatile. The stock price goes up faster on less buying, but goes down faster with less selling.

Also, look at the relationship of float to outstanding. If the ratio is high, that is, outstanding is 10 million and float is 2 million, the stock most likely will be volatile simply because the float is low at 2 million, but note too, that insiders are holding 8 million and if the stock goes up, they will be just itching to let their shares go. If at that time, the company has good earnings and other fundamentals the stock may stay up there, but if the stock has been pushed up by the small float, day trading, and etc., it might not.

MarketInsider

February 3, 1999

(Q) Not only internet stocks have high PEs right now. Even my favorite big companies (like WalMart) are carrying high PE ratios. Does anyone even use this number in their buying decision anymore. My low PE stocks are not faring well. A little confusing.

(A) When it comes to PEs with me, I look at them this way. First a PE of the market or of an index is different than a PE of an individual company. I realize that you were talking about individual companies, but I think investors should also look at PEs of the market.

High PE markets always fail, unlike some high PE stocks such as Microsoft that just keep going and going. In the early 90s, Japan's stock market was in the 40K to 50K range and had an overall PE approaching 60 (like the NASDAQ 100 now). What has that high PE market in Japan returned for investor since the early 90s? A loss of its value of about 65%.

The NASDAQ 100 with a PE approaching 60 and the S&P 500 in the mid 30s are clearly pushing the PE to the limit. Never in history have PEs this high lasted. However, when you really think about it, this time it is different.

Back in the 60s my father watched a Giants game and read the newspaper. When he did this he was not being told through the newspaper articles that Social Security wasn't going to be there for him, nor was he told at commercial breaks of the game to go out and by Fidelity mutual funds. What's this got to do with PEs of the stock market?

The main reason why PEs are at all time highs is not because the stocks are fundamentally worth it, it is because Wall Street is marketing stocks, selling them to the public. Right now, due to the baby boomers heavy buying of stock, stock prices are high and may continue to go even higher, until the boomers want their money back, who knows.

Why are the boomers buying so much stock, one reason is they don't think Social Security will be there for them because that's what the government and financial news media are indirectly telling them. The boomers are saving for retirement and they are using stock mutual funds because most boomers don't know how to invest themselves and the mutual fund companies are advertising that all you have to do is buy their mutual funds and you will have a nice retirement nest egg (even though in small print they always tell you that past performance is not gaurantee of future performance).

To make a long story short demand for stocks is very high right now, that demand causes prices and therefore PEs to be very high. Just to give you an example, last month something like $20 billion game into the market and CNBC made a big deal about it. But just think about what that $20 billion added in market cap to NASDAQ alone, NASDAQ's market cap was just over $2 trillion at the beginning of January and at the end of January it added over $300 billion. So that $20 billion in demand for stocks added $300 billion to the market caps or increase the PE of NASDAQ by over 10% in just one month.

When it comes to PEs of individual stocks you first have to look at forward and trailing PEs. The trailing PE is great because it's an exact value, in the last four quarters XYZ made $1 and with a stock price of $10 it has a trailing PE of 10. Unfortunately, the trailing PE may be exact, but it's also the past and the past does not necessarily mean the future. So let's look at the forward PE, that's great because it's going to tell you what the PE is of the stock in the future and that's what matters. True enough, however, the forward PE is only an estimate because it's based on an estimate of the next four quarters and as we all know these estimates that are calculated by Wall Street Analysts are anything but accurate.

With all this I still think investors need to know there is a difference between the trailing PE and that it doesn't really mean anything because it's the past. A better use of PE is to use the forward, but again it doesn't mean a whole hell of lot because it's only a guess.

Lastly, look at the internet stocks. Of course PE doesn't mean anything when it comes to the internet stocks. The buyers of internet stock are not buying the stocks for fundamental reasons so it only makes sense that you can't look at them in the context of PE or book values, or price to revenues. Internet stocks are being bought on momentum and for gambling purposes, I'm not saying there is anything wrong with this. I'm only saying that since the stocks are not being bought for fundamental reasons, don't expect to be able to analyze them that way.

One final point for every "high" PE stock that has maintained that high PE, the Microsofts and Ciscos, there has been 10 "high" PE stocks that didn't the Iomegas and Netscapes. There is no doubt that I wished I had consistently held those high PE stocks that made it, unfortunately, knowing which ones in the future will maintain isn't very easy to do. Yes, I could claim that back in 1990 I knew that the high PE stocks that were going to make it were Microsoft and Cisco, but that would be bull shit wouldn't it.

MarketInsider

December 16, 1998

(Q) What's the difference between a limit order and "breaking the spread?"

(A) A limit order is not the same as "breaking the spread." Breaking the spread means getting a better market price, a price better right now, a better price than the quoted bid and ask rather you are buying or selling a stock.

Back in 1994 some college did research and found out that spreads on NASDAQ listed stocks were very high compared to the AMEX and NYSE. When an individual complained about this high spread problem the SEC and NASD could care less, however, when the college did their research and got media attention, the SEC and NASD finally started to listen and do something about the high spreads.

Institutions had always been able to break the spread, but now the little guys were suppose to be able to do it too. The SOES (small order execution system) was part of the plan, that is, to give small investors the chance of breaking the spread. (You can confirm that someone is breaking the spread simply by looking at the bid, the ask, and the last trade, numerous times you will see the last trade between the bid and ask, the reason why, is because someone broke the spread.)

For the most part, even today, for whatever reason, the small guy is still not able to break the spread (on NASDAQ) and I don't know why because we are constantly told by the SEC, NASD and our brokers that we can.

A limit order is an order to execute at a certain price, if you want to buy a stock and the bid is $10 and ask is $10.50 and you place a limit order to buy at $10.25 this is not "breaking the spread, but is simply waiting for the market price to fall and for the quoted bid and ask to change to $9.75/$10.25. If the market price does change to $9.75 and $10.25 and your order is filled the SEC, the NASD, and your broker wants you to believe that you broke the spread, but you didn't. All you did was to wait until the market price fell which is kind of ironic because you are buying the stock because you think it's going to go up not down.

In the example where you state that someone "chiseled for 1/16 and lost the trade and therefore it's your own fault is not necessarly true (One investor had placed a limit order to buy at 1/16 below the curent ask and since the stock never fell, the order was never filled. In my explaination that follows I'm suggesting that the investor could have placed a market order and still gotten the 1/16 less than ask and still have filled the order immediately if their broker was what they claimed, that is, someone who gets the best price for their customers.). If an investor places a market order to buy and the broker does what they are suppose to do which is to get you the "best price" there is no reason why you can't pay $10 and 7/16 for a stock that has a current ask of $10 and 1/2 and get that $10 and 7/16 price right now. Institutions have been doing this for years and individuals are suppose to be able to do it now too. However, like I said, this usually doesn't happen, the broker gets the market order and you get the order filled, not at the best price which is what you are told, but at the current ask which again, is not breaking the spread.

If you complain and ask the SEC, the NASD, or your broker, "how come I never break the spread when I place a market order?" Most likely they will use the excuse that if you wanted $10 and 7/16 you should have placed a limit order. But again, this is just a con, placing the limit order meant you had to wait for the market price to change, you were at risk of not making the trade if the stock went up. However, if your broker whould have done what he was suppose to do, you could have placed a market order, right now, the broker could go out and check all market makers, not just the ones that he gets paid for "order flow," and most likely find the $10 and 7/16 and fill your order right now without having to place a limit order.

MarketInsider

December 1, 1998

(Q) What's a margin account?

(A) Basically, when it comes to margin, I'm mostly concerned with "equity percent." If I open a margin account I can borrow an equal amount to buy more stock (Note: my broker requires that the stocks I buy have a share price of $10 or more or they are not considered fully marginable, brokers vary regarding this issue.). So using the amounts from your example, I start with $4000 and am able to buy an addition $4000 worth of stock.

The broker is now holding $8000 worth of my stock and I have $4000 in equity or $4000/$8000 which is 50% margin which is what the SEC requires (margin requirement is another thing that is set by the Fed). Another way of looking at it is I'm leveraged at 2 to 1. If my portfolio ($8000) doubles I make $8000 and I did that with $4000 in cash (2:1). I still owe the broker $4000 plus any margin interest. I don't have to pay the broker back at any specific time, I can just continue on if I choose. Now my equity percent is $12000/16000 which is 75% which is great and I can relax a little bit (even though this may be an over statement since the market, even as a whole, is becomming very volatile).

However, always remember that just the opposite could have occurred. That is, I put in the $4000 and buy $8000 worth of stock, my equity percent is 50%. Instead of my portfolio doubling it drops by 25%. After dropping 25% my margin equity is $2000/$6000 or an equity percent of 33% (My account equity is only $2000 now not the original $4000 because my portfolio just lost me $2000 of my money, $8000 worth of stock minus 25% or $2000, then take the $2000 from my original $4000 and you get my equity of $2000.). Brokers vary on when they send out a "maintenance call" which is a requiring to come up with additional cash or to sell stock to bring up your "equity percent" to an acceptable level.

Like I said, brokers vary, mine is 35%, and when my equity percent fell below which it did at 33%, I would get a "maintenance call" and be required to bring my equity percent back up to 35%. If I don't send in cash or sell stock immediately, my broker will sell stock in my account to do it, that is, bring up my equity percent. In this example, my portfolio only had to fall by 25% for me to get a "maintenance call" when I initally margined to the maximum allowed which was an equity percent of 50% (or 2:1 leverage).

MarketInsider

Date

Text

Date

Text