The Morning of Chernobyl

One of my favorite memories in the investment business was the Morning of Chernobyl. I got into the office early and reviewed my senior citizen clients who had purchased some utility trusts. I wondered what would happen at the open. I then wandered over to my guru broker's office, Bruce, of whom I have written earlier. He never came into the office that early so I figured something was wrong.

"What are you going to do this morn," I asked. "Well," he responded, while everybody is pretty scared about the Chernobyl deal, I will probably buy some utilities that I like if they correct at the open. "

Then he went on, " This is just life, in that we have to figure out the meaning of it all, only in this business, we have to do it by 8:30am. There is an urgency here so just get used to it. "

One of the things that I do miss about the investment business is that if you had an idea, there was always one of your competitive peers that would think you were nuts and disagree with you. That was very helpful. Believe me, there are some crazy things I have done, but there are a whole bunch that I avoided cause I listened to someone argue with me that the idea was crazy....so.

In many ways, in the morning, I am still doing what I did back in the 80's. I am going over what is in the news, trying to see what it means and COUNTING ON the readers to pick out the ideas that are just crazy so I avoid them. The farmers always had the morning coffee in town to chat---I always wondered what they talked about. It was really whether October beans were too high at 1.55. They argued over the issue. Is it best to close the position or hold? Out of the talk they avoided some solo crazy ideas.

In many ways, this is what the Observer is all about. And it is ok to talk and argue about ideas before action. In fact, it is far preferable to acting and then dimly realizing several years later that the plan of action was very, very, very wrong.

P/E Matters

About twenty years ago, one of the hallmark technical indicators that folks looked at was the P/E ratio, or the price/earnings ratio. It was one of the key things folks talked about. Then, as has happened in every boom since the 1920's, it became inconvenient to look at the number. People were in the frenzy. They needed a new thing to concentrate on. So---they looked at future PE ratio and made up dreams of future earnings to justify buying higher and higher, and higher.

One of the stocks that comes to mind in this regard is QCOM, or Qualcomm. They were manufacturing, or in the process of developing the technology for the current cell phones that could transmit video and pictures. The P/E as I recall was 85 times earnings. The pundits always said that that was no longer important.

When the tech stocks imploded, everyone learned the rest of the story. P/E does matter. In every mania, the tendency is for folks to deny what has always been accepted valuation, and in time, those very folks become shocked when they discover that the old rules do matter.

The Covered Call---the grandmother's option

Ed.note: The following is just a reflection and not a recommendation or advice in any way.)

Option trading is for the few. I say that even though in today's media pronouncements on options, mostly hyped by the options exchanges themselves, one would think that anyone who could lift a beer glass could also trade options. From my experience, options are for the young, the wealthy, and those with steel cold nerves.

As a person who was licensed in options, I quickly realized my background of midwest conservatism did not qualify me as an extreme risk taker. Yes. There was the thing about steel nerves, and even yes...age. Anyway. I wanted a way to learn about options and the way to do that was "The grandmother's option, or formally, "The covered call."

One trainer explained it me this way: On the opposite of every trade is a different risk. On the other side of the gambler is either the banker or the "grandmother." In the covered call, you are the grandmother. It is a calculated conservative risk. Yet it can be played aggressively and one can get the sense of the fast paced world of options.

The first part of the investment is the stock. You own the stock. Hopefully, you own it bought at a lower price. And it is a high quality stock. That is key. If it is a stock with three letters----it is a New York stock and that always meant higher liquidity for me. Another part of the game is that is is fun if the stock is one where there is some mystery about the future--maybe a buyout or such. And maybe there have been recurrent rumors over the past years, and the stock has spiked up and then down. When the stock has gone down, you buy the stock. And when it spikes up, you sell the covered call and get some money for the call. Then you buy the call back when the stock comes down and pocket the difference, or just let the call expire. For every call option there is a strike price and a month and year. Time and price interact daily on each call value.

The effect of playing with covered calls is kind of like riding a surf board. One has to judge the waves and time the transactions. You are never betting the farm on any transaction.

So. If you are conservative. And if you are not a wild gambler. You may have the temperment for the covered call. Any options exchange booklet can explain the details. Enjoy.

An Introduction to Power

It was a hot Saturday night in New York in 1985. The young brokers in training were in second week of three, and mostly their money had run out---the suite of rooms at the swank mid town Manhatten hotel were paid for, but the real test of toughness was surviving on the small allowance. The very first day had been the eye opener. Flush at surviving the subway system returning from Battery Park, the brokers had ventured to have a quick cocktail at the Hyatt on the way home. After getting the bill, we realized.....at $10 a glass, the living allowance was going to last a week at that pace. So....beginning the third week, we were cooking spagetti in our room.

Hours afterward, as the brokers were getting ready for bed, the lone broker who had gone to the Broadway theatre came in----we all knew that somehow he had managed to pay the ticket price and now as he walked through the door, we noticed a stunning blond on his arm. He introduced her quickly as one of the actresses in the play he had seen. Then a quick hushed conversation with one of the brokers, and the two headed to the corner suite.

The broker was all smiles as he explained that this guy had given him $200 to sleep on the couch. Wow. What a windfall.

Just when I was about to ask who this guy thought he was, one of the guys told me.....he was the son of the owner of the World Trade Center. Over the years, the scene has made more and more sense to me.

The 5% Rule for Options; A distant memory? Enron as the Model for the Global Economy

Twenty years ago, folks when they opened a stock market account, chose a cash account, called a type1 account, or a margin account, a type2 account. As the name suggests, the securities in the cash account were paid for, and the ones in the margin account were "Margined" or they may or may not have some of the equity in the account be borrowed funds. The rules of the stock exchange were quite specific on the opening margin amount, and the maintanance amount, respectively 50% and 20%. To use a simple example, if one had $3000 one could buy $6000 worth of stock. Then if the stock declined, the minimum amount of equity one would have to have on a daily basis was 20%.

The other element was that on the very top of each account opened was a PURPOSE. The purpose had to mirror the type of account. Normally, retired folks had cash accounts. They did not trade on options, or use margin. It was the duty of the manager of the office to supervise each broker to see that the details of each account matched the purpose on top.

If a person who had been quite conservative and was 60 for example, would want to simply dabble in options, a separate account would have to be opened, and there was a 5% Rule. If the investor was to lose everything in the option account----this "TOTAL" loss could not exceed 5% of the total liquid net worth of the investor, and this may have been 5% of the liquid net worth that the firm could verify or had under management.

Here is a story to illustrate the point. One day one of my old school chums called up and asked whether I could go for coffee. He was a very successful lawyer. I was a stockbroker at the time. After ordering a coffee, as usual in the Minnesota Viking mug with the extra sugar and whipped cream, I asked how things were going.

He said, "Not too well. One of my major clients just lost a million dollars." It seems that during a market swing, he had been invested in options and had simply lost his entire account at a major brokerage house in St. Paul.

I replied, "That simply cannot be so."

Then I explained the 5% Rule. After explaining that when each account on Wall Street is opened, the client is given a booklet with the rules in it, by law, and the 5% rule was in it. The broker in this firm had broken the rule and the investor should get his money back and be made whole for the excess over 5%.

After the coffee, he smiled. "I'll be happy to pick up the check", he said.

Later I passed him in the street and he laughed and said that the client had been made whole.

Over the past 20 plus years, with the blurring of cash and margin accounts, and with the relaxation of the barrier between banks and brokers, and with the global marketplace and the absence of supervision over both products and the brokers that sell them, not only the individual investor is at risk by complicated products that the banks and the investors and the regulators do not understand...entire nations are at risk. That is the lesson of the recent trader losing 7 Billion in the French Bank.