"Buy Put" Stock Option Investment Strategy"

A stock option is a contract that gives investors the right, but not the obligation, to buy or sell 100 shares of stock at a strike price by a set expiration date. A "call option" enables investors to "lock-in" a price for a particular stock (the strike price) for a premium. If the stock price goes above the strike price by enough to cover the premium paid for the "call option" and any commission fees, the investor will make a profit. Should the stock price never reach that strike amount, the investor only loses the premium, and any commissions paid. In other words, "call options" have unlimited potential profit with minimal risk, which make them good investments during bull markets, where returns continue to outperform historical norms.

A "put option", however, is a better investment option during bear markets, when returns are below historical averages. A "put option" gives the holder the right (but not the obligation) to sell 100 shares of stock at the strike price to the writer of the option. In other words, the writer of the option is betting that the stock price will rise above the strike price. Using the "buy put" stock option investment strategy means that you are betting that stock prices will go down---and the lower the better!

The more "bearish" you feel about the market, the better the "buy put" stock option strategy becomes. Thus, for the price of the premium, the investor locks in the right to sell the 100 shares of stock reserved by the option to the writer at strike price.The lower the stock price goes, the more profitable the option becomes. The investor would be acquiring the 100 shares of stock at a cheaper price (if he/she does not already own it), but is guaranteed to sell the option to the writer for the (higher) strike amount. The larger the gap between the actual stock price and the strike amount (at time of expiration or when option is exercised), the greater the profit.

The maximum loss for an investor using the "buy put" stock option investment approach is the premium paid plus commission fees. If the expiration date arrives and the stock price remains above the strike price, then the loss is total, and the option is worthless. The break even point for a "buy put" option is the exercise amount of the stock, minus the premium and commissions.

"Buy put" options are also susceptible to decay, as their value continues to decrease as the expiration date grows nearer. The only variable that affects decay is the overall volatility of stock prices. When the market is more volatile, the rate of decay will slow. However, when prices are steady and consistent, the rate of decay will actually increase, since predictable prices mean that the time decay is also predictable. For investors who believe that they are in a bearish market, however, the "buy put" stock option investment strategy may be a good one with limited downside.

12 Essential Trading Tips

This isn’t some self-help rubbish list that’s meant to inspire. This is a down and dirty, harsh and truthful list.

1. Learn the Basics 

Yes this is a simple one but it has to be said. A man in my position has the pleasure of talking to scores of newbie traders on a daily basis. If there is one thing I have learned it’s that most newbies forego the basic training and jump straight into the warzone. This is of course a fatal error, on their part, so if you’re a newbie LEARN THE DAMN BASICS!


2. You Won’t Get Rich Quick, Experience Makes You Rich
If you’re here to get rich quick you’re just a clueless tourist. Don’t be naive. Trading is all about experience. As is the case with any career, the longer you do it the more efficient you become. I am often asked “Nick, how did you make 90 pips when I only made 70 pips on the same trade?” It is all about experience. I have been trading for 5 years so I am an efficient trader. I see things that newbie’s don’t because I have the experience. The journey to becoming a trader is a long one so be prepared to stick it out for 1-3 years before you’re consistently profitable.

3. Experts Are a Joke 

Listening to expert opinions is great right? Of course it is!
The problem with financial markets is that every newbie who’s had a good week thinks they are an expert. The other, more pathetic, type of expert is the 30-60 year old guy/girl, in a suit, who claims to be a professional trader yet begs you to buy their book. These people are usually failed traders who make money teaching other traders how to fail. Self-proclaimed experts tend to:

1. Regurgitate generic old information that just doesn’t work.
2. Say they’re rich full time traders yet try to sell you books.
3. Make outrageous claims like they turned $1k into $1mil in a month or some such rubbish.
4. Try to prove they are profitable traders by posting pics of photoshopped account statements.
5. Cleverly use maths to make themselves appear more successful than they are e.g. double counting wins and single counting losses.

So most ‘trading experts’ are a joke. Take what they say with a pinch of salt.

4. Do Your Own Analysis 

Continuing from the last tip, blindly following others will make you blind. Your goal should be to become a successful trader, not a pigeon following others around for scraps of information.
As a trader you need to pick a method and learn to analyse the market. Being able to do your own analysis will bring you closer to being a pro trader. Doing your own analysis allows you to:

1. Be self reliant.
2. Actually learn to trade.

If you choose to blindly follow some self-proclaimed guru all you are is a pigeon. How will you make the money when the guru stops giving tips or the tips stop working? Will you even understand why they worked in the first place and why they no longer work?

5. The Demo Myth
If I wanted to be a professional boxer then I would go out and buy a boxing game for my PlayStation 3 and start my boxing training. Would that make any sense?? Well it makes just as much sense as trading demos in the hopes of becoming a successful trader.
Demo trading for 3 months does not work for 2 reasons:-

1. Demos give new traders false confidence and cause them to learn bad habits.
2. Demo account performance is often superior to a brokers live account performance. This includes execution speed, stop hunting, and several other factors.

The best solution is to use a demo to learn the basics and test out, or find, a trading method. When it comes to actually trading you should only trade a live account. These days you can open an account with pocket change ($10) so there are no reasons not to trade live.
Oh and if you cannot afford to lose $10 you should not be trading anyway….

6. Kill Losing Streaks Early
This is by far the most important rule I have ever put to action in my own trading. Had I not stringently stuck to this rule I truly believe I would not be a successful trader today.
If you lose 3 trades in a row STEP AWAY from your charts. Take a few days off trading and come back with a clear head. Losing streaks are very dangerous and falling into one can lead to very big losses.
I cannot stress this tip enough.

7. Following the Pack
Have you heard that 90% of new traders fail? Like most statistics that one is probably bull. However it is fair to say that the majority of newbie’s coming into this market fail.
I believe the secret is to break away from the pack and do your own thing. That doesn’t mean you should segregate yourself from the trading community. It just means you should rely on yourself. Get enough knowledge/experience to be independent and not simply a follower.
Think about this one logically:-

1. The vast majority of new traders fail.
2. If I follow the majority I become part of the majority.
3. If I am part of the majority I am likely to fail with them.

Become independent DO NOT remain a follower.

8. Stick to Your Method
Every trading method has its ups and downs. No trading system, method or style will be 100% profitable, all year round. My method, for example, has on average an 80% success rate. Some periods of the year I will win only 6 in 10 trades (60%). Other periods in the year I win 100% of trades for a month or two.
I know each year, I will have some bad periods in which case I lose more trades than normal. I do not lose faith though. I stick it out and keep on trading. The problem with most newbie’s is they will give up on a method after its first bad week.
Don’t abandon your method when times are tough.

9. Keep It Simple
This is an easy one. Keep it simple!
There is no reason to complicate trading. For example, my trading method is extremely simple yet extremely effective. I spend 2-5 hours per week trading and the rest of the week enjoying life.
Your method does not have to be incredibly complex to work. Keeping it simple will allows you to:

1. Work much more efficiently
2. Work less
3. Speed up your learning (KISS)

If you remember nothing else from this article, remember this…..
Keep it simple, stupid!

10. Trade Only One Pair
The key to making that transition from newbie to pro is keeping your trading simple.
One of the easiest ways to keep trading simple is to trade only a single currency pair at a time. This is so damn obvious I am surprised more people do not do it. Trading one pair helps because it allows you to concentrate all your efforts on learning that pair, therefore allowing you to understand how it moves.
If you try and trade 5 pairs at the same time, learning to trade becomes much harder. You will have to learn the unique characteristics of all those different pairs and each pair is unique. Each currency pair:

1. Reacts differently to news.
2. Moves at different rates, some fast some slow.
3. Moves more rapidly at different times of the day.
4. Has to be managed differently when holding an open position.

As a newbie, jumping into the deep end with multiple pairs adds a lot more stress and slows the learning process.
So start off with a single pair. Once you’re profitable you can add as many pairs as you think you can handle.

11. Trade Only One Time frame
As above, picking a single time frame keeps things simple.
Looking at a single time frame has several benefits:

1. Allows you to concentrate on learning one time frame, therefore removing a lot of the confusion that comes with learning multiple time frames.
2. Gives you less charts to look at and allows you to concentrate more energy on analysing a single chart, therefore improving efficiency and the quality of your analysis.
3. Stops you from overanalysing your pair. Looking at too many time frames can give you conflicting signals.
4. It just makes your life easier.

Remember it’s all about keeping it simple. If you have a single timeframe and a single pair it means you’re looking at a single chart. As a newbie you do not want to juggle multiple charts. Stick with one chart, until you become consistently profitable.

12. Clean Charts
Most newbies pile as many indicators as possible onto a chart, when they first start trading. Indicators help with your trading (apparently) so the more the better, right? Wrong!
As traders gain more experience they start figuring out that less is more. The more indicators you have on your chart the more confusion you will have. Every extra indicator:-

1. Adds to the clutter making your charts harder to read.
2. Gives you more to think about therefore clouding your judgment.
3. Increases the possibility of giving you conflicting signals.
4. Looks pretty damn ugly…

Indicators are not essential. I personally trade with no indicators and have an 80% success rate. I am not saying you need to remove all indicators but limit it to a max of 2 at a time on your chart.
I trade with no indicators, simply a few support and resistance lines and candlestick patterns.

Financial analysis with the DuPont ratio: A useful compass

Financial Analysis and the Changing Role of Credit Professionals

In today's dynamic business environment, it is important for credit professionals to be prepared to apply their skills both within and outside the specific credit management function. Credit executives may be called upon to provide insights regarding issues such as strategic financial planning, measuring the success of a business strategy or determining the viability of an acquisition candidate. Even so, the normal duties involved in credit assessment and management call for the credit manager to be equipped to conduct financial analysis in a rapid and meaningful way.


Financial statement analysis is employed for a variety of reasons. Outside investors are seeking information as to the long run viability of a business and its prospects for providing an adequate return in consideration of the risks being taken. Creditors desire to know whether a potential borrower or customer can service loans being made. Internal analysts and management utilize financial statement analysis as a means to monitor the outcome of policy decisions, predict future performance targets, develop investment strategies, and assess capital needs. As the role of the credit manager is expanded cross-functionally, he or she may be required to answer the call to conduct financial statement analysis under any of these circumstances. The DuPont ratio is a useful tool in providing both an overview and a focus for such analysis.

A comprehensive financial statement analysis will provide insights as to a firm's performance and/or standing in the areas of liquidity, leverage, operating efficiency and profitability. A complete analysis will involve both time series and cross-sectional perspectives. Time series analysis will examine trends using the firm's own performance as a benchmark. Cross sectional analysis will augment the process by using external performance benchmarks for comparison purposes. Every meaningful analysis will begin with a qualitative inquiry as to the strategy and policies of the subject company, creating a context for the investigation. Next, goals and objectives of the analysis will be established, providing a basis for interpreting the results. The DuPont ratio can be used as a compass in this process by directing the analyst toward significant areas of strength and weakness evident in the financial statements.

ROE = (Net Income/Sales) X (Sales/Average Assets) X (Average Assets/Average Equity) (1)

The ratio provides measures in three of the four key areas of analysis, each representing a compass bearing, pointing the way to the next stage of the investigation.

The DuPont Ratio Decomposition

The DuPont ratio is a good place to begin a financial statement analysis because it measures the return on equity (ROE). A for-profit business exists to create wealth for its owner(s). ROE is, therefore, arguably the most important of the key ratios, since it indicates the rate at which owner wealth is increasing. While the DuPont analysis is not an adequate replacement for detailed financial analysis, it provides an excellent snapshot and starting point, as will be seen below.

The three components of the DuPont ratio, as represented in equation (1), cover the areas of profitability, operating efficiency and leverage (liquidity analysis needs to be conducted separately). In the following paragraphs, we examine the meaning of each of these components by calculating and comparing the DuPont ratio using the financial statements and industry standards for Atlantic Aquatic Equipment, Inc. (Exhibits 1, 2, and 3), a retailer of water sporting goods.

Profitability: Net Profit Margin (NPM: Net Income/Sales)

Profitability ratios measure the rate at which either sales or capital is converted into profits at different levels of the operation. The most common are gross, operating and net profitability, which describe performance at different activity levels. Of the three, net profitability is the most comprehensive since it uses the bottom line net income in its measure.

The net profitability for Atlantic Aquatic Equipment in 1996 is:

Net Profit Margin = Net Income/Sales = $70,530/$5,782,000 = 1.22%. (2)

A proper analysis of this ratio would include at least three to five years of trend and cross-sectional comparison data. The cross sectional comparison can be drawn from a variety of sources. Most common are the Dun & Bradstreet Index of Key Flnancial Ratios and the Robert Morris Associates (RMA) Annual Statement Studies. Each of these volumes provide key ratios estimated for business establishments grouped according to industry (i.e., SIC codes). More will be discussed in regard to comparisons as our example is continued below.

Operating Ficiency or Asset U tion: Total Asset Turnover (TAT: Sales/Average Assets)

Turnover or efficiency ratios are important because they indicate how well the assets of a firm are used to generate sales and/or cash. While profitability is important, it doesn't always provide the complete picture of how well a company provides a product or service. A company can be very profitable, but not too efficient. Profitability is based upon accounting measures of sales revenue and costs. Such measures are generated using the matching principle of accounting, which records revenue when earned and expenses when incurred. Hence, the gross profit margin measures the difference between sales revenue and the cost of goods actually sold during the accounting period. The goods sold may be entirely different from the goods produced during that same period. Goods produced but not sold will show up as inventory assets at the end of the year. A firm with abnormally large inventory balances is not performing effectively, and the purpose of efficiency ratios is to reveal that fact.

The total asset turnover (TAI) ratio measures the degree to which a firm generates sales with its total asset base. As in the case of net profitability, the most comprehensive measure of performance in this particular area is being employed in the DuPont ratio (other measures being fixed asset turnover, working capital turnover, inventory and receivables turnover). It is important to use average assets in the denominator to eliminate bias in the ratio calculation.

Financial ratio bias is commonly present when combining items from both the balance sheet and income statement. For example, TAT uses income statement sales in its numerator and balance sheet assets in the denominator. Income statement items are flow variables measured over a time interval, while balance sheet items are measured at a fixed point in time. In cases where the firm has been involved in major change, such as an expansion project, balance sheet measures taken at the end of the year may misrepresent the amount of assets available and/or in use over the course of the year. Taking a simple average for balance sheet items (i.e., ((beginning ending)/2)) will control for at least some of this bias and provide a more accurate and meaningful ratio. The limiting assumption is that the change in the balance sheet occurred evenly over the course of the year, which may not always be the case.

The measure of total asset turnover for Atlantic Aquatic Equipment is:

TAT = Sales/Average Assets= $5,782,000/(($2,203,200 $2,476,200)/2)= 2.47. (3)

In this case, total assets did not substantially change over the course of the year, and therefore, potential bias caused by using the ending asset amount would not be substantial. Regardless, it is a good idea to get into the habit of using averages for all balance sheet items when conducting this type of analysis.

Leverage: The Leverage Multiplier (Average Assets/Average Equity)

Leverage ratios measure the extent to which a company relies on debt financing in its capital structure. Debt is both beneficial and costly to a firm. The cost of debt is lower than the cost of equity, an effect which is enhanced by the tax deductibility of interest payments in contrast to taxable dividend payments and stock repurchases. If debt proceeds are invested in projects which return more than the cost of debt, owners keep the residual, and hence, the return on equity is "leveraged up." The debt sword, however, cuts both ways. Adding debt creates a fixed payment required of the firm whether or not it is earning an operating profit, and therefore, payments may cut into the equity base. Further, the risk of the equity position is increased by the presence of debt holders having a superior claim to the assets of the firm.

The leverage multiplier employed in the DuPont ratio is directly related to the proportion of debt in the firm's capital structure. The measure, which divides average assets by average equity, can be restated in two ways, as follows:

Average Assets/Average Equity = 1/(1 -(Average Debt/Average Assets)), or
Average Assets/Average Equity = 1 (Average Debt/Average Equity =1 (Average DebtlAvernge Equity). (S)

Equation (4) employs a simple debt/asset ratio, while equation (5) uses the well known debt/equity ratio. Once again, averages are used to control for potential bias caused by the end-of-year values. The leverage multiplier for Atlantic Aquatic Equipment is:

Average Assets/Average Equity = $2,339,700/(($995,652 $1,025,982)/2) = 2.31.(6)

Combination and Analysis of the Results

Once the three components have been calculated, they can be combined to form the ROE, as follows:

(Net Income/Sales)X(Sales/Average Assets)X(Average Assets)X(Average Assets/Average Equity) = ROE

1.22% X 2.47 X 2.31 = 6.96%. (7)

While additional measures for prior years would provide the basis for a necessary trend analysis, this result is not meaningful until it is compared to an industry or best practices benchmark. The DuPont ratio for the industry (Exhibit 4) is:

3.60% X 2.60 X 2.00 = 18.72% (8)

As can be seen, problems in Atlantic Aquatic Equipment are immediately evident in the comparison of equations (7) and (8). The company appears to have a significant weaknesses in profitability, while total asset turnover and leverage seem to be roughly in line with the industry. The analyst can now focus on the company's profitability. A quick analysis of profitability yields the following result:

As can be seen, the inventory turnover is significantly lower than the industry average, which means that the problem is more likely due to poor location or inventory quality rather than the inventory management processes. The next step in the analysis would most likely be a qualitative study of the composition of the inventory as well as the retail facility itself.

Concluding Remarks

Sound financial statement analysis is an integral part of the management process for any organization. The DuPont ratio, while not the end in itself, is an excellent way to get a quick snapshot view of the overall performance of a firm in three of the four critical areas of ratio analysis, profitability, operating efficiency and leverage. By identifying strengths and/or weaknesses in any of the three areas, the DuPont analysis enables the analyst to quickly focus his or her detailed study on a particular spot, making the subsequent inquiry both easier and more meaningful. Some caveats, however, are to be noted.

The DuPont ratio consists of very general measures, drawing from the broadest values on the balance sheets and income statements (e.g., total assets is the most broad of asset measures). A DuPont study is not a replacement for detailed, comprehensive analysis. Further, there may be problems that the DuPont decomposition does not readily identify. For example, an average outcome for net profitability may mask the existence of a low gross margin combined with an abnormally high operating margin. Without looking at the two detailed measures, understanding of the true performance of the firm would be lost.

The DuPont ratio can also be broken into more components, depending upon the needs of the analyst. In any case, the DuPont can add value, even "on the fly," to understand and solving a broad variety of business problems.