In the second part of this article piece, I laid the foundation required for basic understanding of options. In this third part, I will be talking specifically about Calls. Options are a zero-sum game, meaning that what one person wins is what is lost by another. So, I will be looking at it from the point of view of a Call buyer and Call writer or seller.
Recall that a Call option gives the buyer the option to buy the underlying asset at a given price (Strike) on or before the expiration or maturity of the option. Also, recall the explanation of the moneyness of a call option and that of intrinsic and time value. It is only options that are in the money that are advantageous to the buyer.
Exercising an Option
What does it mean to exercise an option? When one talks about exercising an option, it simply means that the buyer of the option, in this case, a Call option, goes to the seller to buy the underlying at the agreed price, no matter the market price.
When to Exercise
Now back to our Access Bank case. Let us say that the price of Access Bank shares increases to N7.25 per share. This means that the intrinsic value of the call option is N7.25 minus N6.75, that is N0.5, but you were required to pay N0.5 as option premium. In this case, you are merely breaking even, and therefore, at this point, you have nothing to gain or lose if you exercise the option or let it expire worthless. So, you can decide to exercise or let it expire ‘worthless”.
[READ MORE: Understanding Derivatives as investment products (1)]
What if Access Bank shares went up to N10.5 per share? Your intrinsic value becomes N10.5 minus N6.75, that is N3.75; now the call option is in the money. You are now paying N0.5 for the opportunity to make N3.75. In that case, you will exercise the option, by going to the seller of the call for one share of Access Bank for which you will pay him N6.75. Then, you take that share to the stock market and sell it for N10.5, making a gain of N3.75 less premium of N0.5 paid upfront, for a final profit of N3.25.
Should I buy the Call or the Stock?
Call option buyers oftentimes are confronted with the question of whether to buy the call or the underlying. I will explain this seeming dilemma by looking at Access Bank again. If the price of Access Bank share had ended up at N5 on the expiration date of the call option, the call would have had no intrinsic value and therefore would have expired worthless, in that case, you lose the N0.5 you paid for the option.
Compare that with a situation where you bought the Access Bank share at the then price of N6.6, instead of buying a call at N0.50, now that the price is N5, you would have lost N1.6 per share on each Access Bank share you bought at N6.6 but with the call option, you only lost N0.50 per call option bought.
That is the beauty of buying a call, it gives you unlimited potential to make gains, but exposes you to loses that are limited to the premium you paid. What do you mean by unlimited potential? What if you had the option, and following another acquisition by Access Bank, the share price rises to N10,000 per share, you will buy it from the option writer at the agreed N6.75 and sell it for N10,000 or whatever the price has risen to.
A look at Call Option from a Seller’s eyes
When you sell a call, you give the buyer the right to buy and you must sell if he comes ready to exercise. Taking the example of Access Bank still, and at a current price of N10.5, the call writer or seller will now sell Access Bank share at N6.75 to the call buyer, instead of selling it in the stock market at the prevailing price of N10.5. In that case, he has lost N3.75 but he received N0.5 premium upfront, leading to a total loss of N3.25 (which was the gain that the buyer made).
If the price of Access Bank share had ended up at N5 on the expiration date, the buyer would not exercise and the seller will keep his shares and still keep the N0.5 premium that the buyer paid upfront. Therefore, with an option, the much the seller can made is limited to the premium but there is no limit to what he can lose.
Again, as an illustration, what if Access Bank shares went up to say N10,000 per share after acquiring another bank. The seller will be forced to sell to the call buyer at N6.75, thereby losing the difference between N10,000 and N6.75 plus the N0.5 premium.
[READ ALSO: Understanding Derivatives as investment products (2)]
When to buy or write a call option
Having known the profit and loss potentials of a call option, when should you buy or sell a call option? The buyer of a call option anticipates and hopes that the price of the underlying will increase beyond the strike price plus the premium, while the writer anticipates and hopes that the price of the underlying will decrease.
So, when you think that the price will rise but you are not quite sure and you want to limit your loss, buy a call. If you think the price will fall and you want to profit from the fall, by keeping your shares and making money off the premium, write or sell a call.
In the next article, I will talk about Naked Calls and the dangers of writing or selling them.
Emergency Fund: Can you raise N50,000 cash tomorrow?
Focus on building up your emergency funds before building a portfolio of assets.
Can you raise N50,000 cash tomorrow? Yes cash, without selling any asset of yours; Can you? This is a very important question you need to ask yourself. One generally accepted lesson from the 2020 economic downturn for both corporations and individuals is to always have an emergency fund (EF). So, what is an Emergency Fund? How is it set up? How is it used? Let us explore.
What is Emergency Fund
An EF is a savings account set up to pool and hold a minimum of three months of calculated Non-Discretionary Income (NDI). The EF is advised as the first activity any investors should undertake. Specifically, before even investing a cent, set up and maintain an EF because this fund acts as an “insurance” or stop-gap for your income or investment portfolio.
How is an Emergency Fund set up?
An EF captures a minimum of three months of Non-Discretionary Income (NDI). What is NDI? These are expenses incurred that must be settled irrespective of income. For instance, rent must be paid, groceries must be paid, we cannot simply stop paying utility bills because we lost our job and thus income.
Once we decide on an investment plan, the first thing to do is to list out all expenses we will incur and attach a cost to them per month or annual basis but corresponding to the period of payment. We do this to identify the necessary expenses which we refer to as the NDE.
List of expenses
- Rent N1,500
- School fees N500
- Camping/Holiday N300
- Go to Movies N100
- Groceries N400
- Cable TV N200
- Gas for cars N200
- Phone Bill N300
- Eating out Dinner N200
Total expenses for the month are 3,500
Next, decide which of the expenses listed above are Non-Discretionary. In other words, which of these expenses must be settled irrespective of income? Let us assume our client chooses the following as NDE:
- Rent N1,500
- School fees N500
- Groceries N400
- Gas for car N200
- Phone bills N300
These expenses above come to a monthly NDE of 2,900, with a three months minimum of 8,700. This minimum sum means that should the client lose his job or suffer any other income interruption, these necessary expenses will be paid from the emergency fund, without the need to sell down investment assets at fire-sale prices just to raise income.
How is it used?
The Emergency Fund is simply a piggy bank. Once it is set up, you can increase the minimum saving from 3 to 4 and as high as you want to go. What is does is insulate your investment portfolio from losing any compounding or dissipation in principal because you must sell. So, if there is income interruption due to job loss or you simply want to take a long holiday and write a book, you can do so and still meet your expenses from these savings.
An EF is not only for downturns, as it is also good for opportunities. A friend of mine bought an almost brand new car from a work colleague that was emigrating abroad because he could pay cash immediately in short notice. Cash is always king when you are in a tight negotiation with a seller.
Your Emergency Fund should be kept in cash or near cash investments. Return on investment for the EF is secondary to access to those savings. Also, you want your EF in an investment class with fixed income with no variation in returns. this means in practical terms do not invest your EF portfolio in equities that pay a variable return or even any asset which may need documentation and visits before you can access your funds. I am also wary of a commodity like gold, which does hold value, but cannot easily be converted to cash. The recommended asset classes to invest your EF are:
- Call or Fixed Deposit in Banks
- Sovereign Treasury bills, they are easily discounted and converted to cash
- Certificates of Deposit with bank
If the asset call cannot be converted to cash in one activity should be avoided. Also, ask the institution if they charge fees for early withdrawal and what those fees are.
What can I do tomorrow?
- Start an emergency fund immediately. Do the expense exercise, determine your Non-Distortionary Expenses, start to build up a savings pot.
- Focus on building up your emergency funds before building a portfolio of assets.
What bad stocks have in common with bitter relationships
The feeling you get from marrying the wrong partner is similar to that felt after buying the wrong stocks.
I have always argued that stocks cannot be summarised into one statement for a newbie, until recently when a friend told me that it could.
“Simply put, buying stocks can be likened to relationships,” he said.
I did not immediately agree, but over the next few minutes, he explained to me what he meant, and drew several analogies to back his claims.
While he is no expert, I understand that he has drawn his conclusion from his experience buying stocks for himself over the past 5 years, so I took his points seriously. These points have been summarised in this article.
When it crashes, there is no telling how far it can go
My friend mentioned of some company’s stock he bought in 2016 in the hope of selling short-term. At the time he bought, there was a dip and he expected things to pick up within some months so he could sell-off.
Two years later, the stock price had plummeted 50% down from the price at which he bought. Without saying, he became a long-term investor because he was not ready to sell off at a loss.
How does this liken to being in a bad relationship?
As the value plummets, you keep hoping it will rise again and then before you know it you are stuck for the long haul. Same thing can happen with a wrong partner. You remain there hoping things will be better but it gets worse.
It could happen sometimes that a company’s stock market price comes crashing and it never goes back to where it was again. The factors which triggered its fall, may not even be able to return it to its starting price.
The stock price is not indicative of the company’s profitability
For some reason, there are company stocks market prices that remain low year after year despite the billions declared in profits, and the dividends paid out to shareholders.
Sometimes, the stock market price could still slump even when the company has positive records in its financials. Market experts are not always able to explain this, but it remains true. Some of the most profitable stocks are undervalued.
You can never take stocks at face value
That a stock has been on an upward trend in the last few months does not mean it will remain so. One must always consider several other factors before purchasing a stock.
While it is important to look at past performance, there are other things that could point to the likely future of such stocks.
Say, for instance, the company has just announced a new board chairman who was implicated in some fraud cases in the past. It doesn’t matter how well the stocks have performed in the last 365 days, or the chairman’s competence, the stock prices are most likely to slump due to loss of investor confidence.
There was a recent case where the CEO of an internet service provider company was alleged to have been involved in sexual harassment, and was eventually pressured by shareholders to resign. The pressure came not necessarily because they thought he was guilty, but because of the implications on the company.
You have to probe to discover the real qualities.
The most expensive stocks are not necessarily the best.
If you ever heard a stock described as under-priced or over-valued, then you should understand that the price you pay is not necessarily suggestive of the value.
Some great stocks, with good potentials, high liquidity, good company profile and adherence to corporate governance ethics, are not as expensive as they should be. While some other stocks are ridiculously overpriced, even when they do not have as much promise. Some of these overpriced stocks could still be basking in past glory or just positive media hype.
This explains why investors must conduct due diligence before putting in their hard-earned money. Sometimes the media hype around a company’s stock might not be giving you all the information you need to make a decision, so you necessarily have to go the extra mile.
Subscribe to newsletters from financial news websites if you need to, take courses if you have to, but ensure to learn all you can.
Remember price is what you pay for the stock, but value is what it is really worth, and there is no law stating that one must justify the other.
When you get the wrong stocks, you get stuck!
You know that feeling when you are sure that you have made the wrong choice, but also know that there is no way out? That’s the feeling you get when you marry the wrong partner, as my friend said. And that’s the same feeling you get when you get the wrong stocks.
You simply get stuck.
No returns. No dividends. Probably, no way to sell either because no one else is interested in buying from you. And if you do succeed in selling off at this point, you would most likely be doing so at a loss.
If you study trends in the stock market, you will see some dormant stocks that have remained stagnant for long periods of time. No rise in share price, no fall in share price, and no share is being traded either.
READ ALSO: Best time to make money trading BTCs
It is not a nice position to be in, and that is why you want to be sure of the company, its management, and board members who take the decisions before you decide to buy or not, even more so when you are a long-term investor.
And even then, with the wrong stocks, you could suddenly find that your proposed short term investment of 6 months will run into years because you keep waiting for things to pick up before you sell.
130 farmers to receive seed funding of N100,000 each
The target of the programme is to adopt farmers in 774 LGAs across the country.
The National Information Technology Development Agency has kick-started a job and wealth creation programme where 130 farmers will each receive seed funding of N100,000. The programme will be supervised by the Federal Ministry of Communication and Digital Economy.
According to a statement from the agency, the National Adopted Village for Smart Agriculture (NAVSA) programme is in line with the government’s drive to lift 100 million Nigerians out of poverty, and it will start with 130 farmers in Jigawa state.
In line with President @MBuhari's administration drive to lift 100m Nigerians out of poverty, @NITDANigeria, under the supervision of @FMoCDENigeria kick starts job and wealth creation programme by adopting 130 farmers on National Adopted Village for Smart Agriculture (NAVSA). pic.twitter.com/Z4cWdrlQgs
— NITDA Nigeria (@NITDANigeria) June 29, 2020
The target of the programme is to adopt farmers in 774 LGAs across the country, open the platform to all agriculture ecosystem players with access to information, facilitate and improve productivity, reduce the cost of production, and facilitate access to local and international markets.
With all of this in place, it is expected that the farmers will be able to build sustainable business models and digital business opportunities that will create not less than 6 million well-paying jobs in the next 10 years.
“NAVSA Platform is aimed at digitalising agriculture to drive Digital Economy, as part of President Buhari’s agenda to leverage on technology and innovation to revolutionise the agriculture value chain,” the statement read.
Dowmload the Nairametrics News App
Among other things, the farmers will be empowered with a digital platform, smart devices (tablets), connectivity for data and calls, Digital agripreneurship skills, and enrolment with telecom operators and the National Identity Management Commission (NIMC) for identification.
All of these will be given to them at the end of the programme, which will last from July 1 to July 13, 2020.