My Performance - Indexed

When I first looked at my performance I was not too happy especially for this year. I made some mistakes on Oct 2008, Jan 2010 and May 2010. I did not follow my discipline completely. 2008 Aug - Oct was the worst performance in my 15 years investing in the stock market. I had gone through the Asian Crisis, dotcom bust and year 2000 bug, but none even close to what happened then. I was actually profitable during those years!

After a painstaking effort indexing my portfolio, I feel better. Here is the result:



The idea of indexing your performance takes care of injection or withdrawal.
Indexing is like pricing your fund on a per share basis i.e. imagine when you first start off, you sell shares to your fund at par or $1.00 each share. Any injection subsequently is added at the prevailing price of the fund.
So you start off with say, $1million with shares at $1.00 per share. Then 6 mths later when your fund has appreciated 20%, each share is worth $1.20 each. Any injection will be for shares at $1.20 share so the index would be 120 at this point in time.

So by indexing the performance of the fund, there's no need to worry about how any injection or withdrawal would affect the total nominal value (size) of the fund.

After beginning Oct 2009, I was more confident with my money when I upgraded my strategy using options and added funds to my portfolio.The injection of capital has made my performance looks good!

CAT - Bear Call

I have not done vertical trades for a while. These are more speculative trades. Normally, trade will be placed at 1/4 of position size of a covered call or just stock. It comprises less than 10% of my portfolio.

Many people are afraid of a bear call. They view it as risky as if the call are assigned.

To me, this is the same risk as a bull put except that if the put is assigned, the theoretical maximum loss is when the stock is zero.

But the key is the risk control. If you have a plan, a bull put is the same as a bear call.

In this case, I am ready to adjust the bear call if it goes against me. The risk is if I am not vigilant and failed to follow my plan.

CAT has been stagnant for almost a month. After a good earning results, the shares actually went down. It is taking a rest.

I am betting that it will stay stagnant or slightly bearish for the next 4 weeks. I like the stock very much longer term but believe it is taking a rest.




Trade:



STO Nov 80 Call = 1.52
BTO Nov 75 Call = .32
Credit = 1.2
Maximum Loss for Trade = 3.8

It is a very good return on risk for the trade.

PE: Maximum return of full credit for 1.2 minus commissions

SE: This is somewhat contrarian trade. I am bullish on CAT but short term bearish. If there is any news or drivers that suddenly send the stock up, I will adjust it to a bullish trade by:


- Adding a Long call making it a ratio spread or call calendar
- Take ownership of the stock to create a covered call.

The key point to watch is the BE point at 81.2. If it is getting close to this level fast or exceed this level, I will do the adjustment.

Also, this trade will make money when the stock is stagnant, bearish, slightly bearish, slightly bullish. I will need to adjust only if it is very bullish. It is a good probability trade.

Advice from the Masters

1. On diversification:

"Diversify your investments" - John Templeton
"Diversification is a hedge for ignorance" - William O Neil

2. On averaging down:

"You have to understand the biz of a company you have invested in, or you will not know whether to buy more if it goes down" - Peter Lynch
"Averaging down is an amateur strategy that can produce serious
Losses" - William O Neil


3. On bottom/top fishing

"Don't Bottom Fish" - Peter Lynch
"Don't try to buy at the bottom or sell at the top" - Bernard Baruch
"Maybe the trend is your friend for a few minutes in Chicago, but
for the most part it is rarely a way to get rich" - Jim Rogers
"I believe the very best money is made at the market turns. Everyone
says you get killed trying to pick tops & bottoms and you make all
the money by catching the trends in the middle. Well for 12 yrs
I have often been missing the meat in the middle but I have caught
a lot of bottoms and tops" - Paul Tudor Jones

The masters do not agree on how to make money but they do agree on one thing;
Losses!

"my basic advise is don’t lose money" - Jim Rogers
"I’m always thinking about losing money as opposed to making money
Don’t focus on making money, focus on protecting what you have"
- Paul Tudor Jones
"Investors 2 rules of investing: 1. Never lose money 2. Never forget
Rule NO. 1" - Warren Buffet
"The majority of investors stubbornly hold onto their losses when
it small & reasonable. They cud get out cheaply but being emotionally
involved and human, they keep waiting & hoping until their losses
get much bigger and cost them dearly"- William O Neil
"Learn to take losses quickly and cleanly. Don’t expect to be right
all the time. If you have a mistake, cut yr loss as quickly as
possible"- Bernard Baruch

Psychology of Trading

“There is one peculiarity about mass psychology in that when you are in a bubble, you can’t see it. Bubbles are invisible when you are inside the bubble,” said the charming Jim Dines, of The Dines Letter

"Sell them and you’llbe sorry
Buy them and you’ll regret
Hold them and you’ll worry
Do nothing and you’ll fret"



While I believe risk control is the single most important factor in trading, it is related to the trade psychology.

It is the proper psychological state that gives you the discipline and mental state to control your trades. Risk control is simple but difficult to implement. To do it properly, one needs to be prepared psychologically.

No wonder top trading trainers like Van Tharp and Alexander Elder rate psychology as the number factor for success.

Van Tharp uses NLP (Neuro linguistic Programming ) to help you to trade. He believes that people are generally programmed to do everything the wrong way. They have internal bias that seems to lead them to do the exact opposite required for success. Many of the right trades are contrary to human instinct. His recommendation is to observe and emulate those who are successful. It is similar to what Anthony Robbins used for his self improvement techniques.

Elder uses Alcohol Anonymous 12 step approach to help his students especially those that has fallen into "addiction". A losing trader can get caught in a bad spiral, repeat the same mistakes mindlessly, loses control of all forms of money management and tries to recover his loses. He needs to be "sober" again and cured of his "addiction".

The most difficult part is to control the emotions of fear and greed. When you winning, you take profit prematurely. Even more difficult is when on a losing streak, you find difficulties to adjust, protect or even cut loss. Most big losses are the result of failure to stop the bleeding. This happened to me for 2 trades last year. I refused to get out of TBT and BSX. As a result, these were my biggest losses. It is not the result of my trading system but my poor discipline and emotional control. Fortunately, it was just 2 positions.

Therefore, I include "setting clear rules" as a cardinal law of my trading. I want to be alienated from any emotions of fear and greed.

If there is anyone in trouble, I highly recommend you read Alexander Elder book on Trading for a Living.

For serious traders, it is good that you read both the books to understand the psychology of trading.

If there is anything that can put you in the right mental or psychological state, it will be greatly helpful.

Double Diagonals - New Trades

I decide to enter 3 new trades on Double Diagonals - MY VERSION

They are WMT, HSY and PFE. I have drop JNJ for the LEAPs put from my list as the extrinsic is too high.

The key to selection of candidates for these trades are:

1. Sound companies with good cash flow, world leaders, good product line and trade in a range. I am not worry if it break up or down occasionally. The trade structure will protect any fluctuations. If somethings extraordinary happens that the stock shoots up to the moon or drops like a stone, the trade will do fine. Actually, the trade should make money because of its volatility increase. But this is not the reason for the trade.

2. Stock must issue consistent good dividends above 2 % and has no risk of terminating it.

3. LEAP puts has extrinsic value that can be paid back by SP and SC in 2-3 months. Many stock with high dividends tend to have high extrinsic as the dividends are built into the put.

Execution of the Trade:

o Execute monthly front month SC and SP to collect premium
o Never allow the SC or SP to go ITM. If ITM, just roll up and out the shorts to get a credit. There are times when the trend is strong, you may want to wait to roll until it stabilize. In my previous trade on WMT, I allowed one of my shorts to go ITM and was called out just 2 days before expiration. I lost some money but not enough to upset the overall profit of the trade. I will be cautious this time. The one key risk in this trade is if one of your shorts go ITM and be called out, you will lose money.

o One trick is to go with the trends. Add the shorts only if it is stagnating or hitting support and resistance.
o More adventurous trader may want to trade calendar within the stock and LEAP puts. This is not normally what I will do.


WMT

BTO 1000 stock = 53.65
BTO 10 Jan 2012 80 Put = 27.55
STO Nov 55 SC = .43
STO Nov 52.5 SC = 0.55

Extrinsic value = 1.2.

Most probably the trade will be risk free in 2.0 months.

Assuming a collection of average $800 per month from the shorts, it will collect $8000 in another 10 months or a return of about 10%. With the addition of 2.24% dividend, the total annual return should be about 12.24%

PE: Continue to short put and calls to achieve target ROI.

SE: At any time, if the annual ROI exceeds 20%, get out

2. HSY

Buy 1000 stock = 51.57
Buy Jan 2012 Put = 25.35
STO Nov 55 SC = 0.55
STO Nov 48 SP = 0.45

Extrinsic = 1.52

ROI should be similar to what was calculated for WMT above


3. PFE

Buy 1000 stock 17.64
BTO 10 Jan 2012 30 P = 13.25
STO Nov 17 SP = .22
STO Nov 18 SP = .2

Extrinsic = 0.89

I expect to pay back the extrinsic in about 2.5 months. This stock has a dividend of around 4.09%. The company is doing well although some patents are expiring for its leading drugs.

If I can get $300 per month, I should be able to generate a profit of $$2710 in 12 months ( 300 x 12 - extrinsic ). This is 8.8 % annual ROI. Together with the dividends, it is reasonable to target a 12% annual ROI for an almost risk free trade.

PE and SE are similar to the first 2 trades.

AEP - bear put calendar - II

I closed my AEP trade accidentally. This is my new trade.

BTO Feb 38 P = 2.7
STO Nov 36 SP = .46
Cost = 2.24 debit

I recorded my Net Position Delta this time. NPD = 0.3 ( good )
I am getting 17% short premium over the long put. Anything above 10% is reasonable.
The trade IV is relatively low now. A rise in IV should be beneficial for the trade.

Primary Exit:

- if the trade hits 20% ROI.

- I may decide to roll down the SP if the trend is really bearish or else I will just close the trade

Secondary Exit :

- If the trend goes bullish, roll up the SP or if very bearish, cut loss.

- If the trend goes very bearish, take out the SP and let the trade run. At some signs of support, add the SP.

Portfolio analysis, review and plan

I made a mistake on Monday 10/18. Accidentally, I click on "close all positions" for 80% of my portfolio - talk about "fat" figures! This is an unique feature with Interactive Brokers.

It was not a bad mistake. Precious metal corrected over the next 2 days. More important, it allows me to re evaluate my positions and its strategies before I reestablish all my trades again. It gives me time to analyze, review and establish the plan.

For those who are following some of my trades, I had closed the following:

- XEC covered call for 12.09% return over 38 days
- WMT double diagonal for 9.71% over 203 days or 17.46% ROI annualized. This trade was closed prematurely and I have restarted a new position which I will put the trade on a new post later.
- AEP bear put diagonal closed with positions neutral. Also, reestablished a new bear put calendar which I will post later.
- JNJ double diagonal - after less than a month and was closed accidentally, I was on break even. Not bad! This is supposed to be at least a 12 months trade.

My recent trade for BYD is intact. It is both positive for the stock and the SC now.

1. Analysis


"A great trader who has made tens of millions of dollars from the stock and commodities markets told me the one individual universal reason for failure is the inability to take a loss. This has become my motto, as the true path to riches lies not with the wins, but managing the losses in a prudent, confrontational manner," says Cook.

The performance below are extracted from my broker statements. Individual trades are derived from my personal trading journals. It should be sufficiently accurate though not perfect.

Performance - 2009

ROI = 33.87%




Performance - 2010 YTD

ROI for 9 months = 4.98%

It was a difficult year. I did not do well with the drop in Jan and May.I am still targeting to reach 8% ROI this year.





Analysis of trades

I did a total of around 106 trades for the last 18 months. Some of them were trades before I started using options. I started using options seriously only in September last year.

I have 21 losers out of 106 trades. The winning percentage is >80%. The biggest percentage gain is 44.3%. The biggest loss is -18.3%.





Directionally in terms of timing, I estimate I am right about 60% at the time of entering the trade.

Winners - percent gains vs no. of trades



Losers - percent gains vs no. of trades.



Trades and number of days held



Strategic Plan

Overview

This is the strategic plan going forward to 2011. My trading strategies are as posted on the blog. It includes choosing stocks using fundamentals, timing for entries and exits using my own technical system and the use of options for hedging. More than 80% will be using dynamic collars and double diagonals for safe returns and the remaining percent will be allocated to more speculative strategies like Calendars, Strangles and some small caps.

The average holding period is 2-3 months.

Portfolio can go long or short depending on the market. Most of time there will be some bearish trades even in a bullish environment.


Objectives

o Annual return of >10% ROI

o Risk management is a key part of the strategies. The execution will follow strict rules listed on this blog.

Competitive Advantages

o Based on many years of business experience including co-founder of a number of new start-ups, I believe I have sound understanding of what drives a company to perform and the ability to identify winners in the market in various environment.

o A proven technical system that has been used for >10 years with percentage wins more than 70%.

o A hedging strategy that :
- allow recovery of >50% of directionally wrong trade to turn from losers to winners and limit the loss.

- allow winners to ride the trend and maximize profits.

- allow trades to make money when market is stagnant, slightly bearish or slightly bullish.


Portfolio Allocation:

This is a key component of the strategy. The portfolio is divided into various category with allocated percent of the portfolio to trade.

1. Trading Income - 20%

These are short term trades of 1-2 months main for income. Trades are conservatives and will make about 1-5% per month.

Typical trades are ITM / NTM covered calls, collars and high probability bull puts.

Companies are usually aligned with the fundamental and technical directions but many of them are too big to ride longer term for double digits gains.


2. Growth Portfolio - 55%

This is a selection of stocks with objectives of 50% ROI over longer term. This is the bulk of the portfolio. While the risk and volatility are higher but it is believed that if you know how to control the risk, it is safe trading these stocks.

The holding period varies from 2 months to 2 years.

Positions will be hedged most of the time. From experience even if the stock drops 50%, the position may lose <10%. It will allow time to double the position and ride up once the uptrend resume. This is only done only if the fundamentals remain intact for the stock

At any time, no position will suffer more than 20% loss. If it close to 20% loss, the trade will be closed. Red alert will be activated if the stock loses >10%. Company fundamentals and trend will be seriously evaluated.

If the trend is stagnant, the trade will continue to make money

If trend is up, strategy will allow the position to ride on the trend and make good gains.


i. Growth Stocks - 15%

These are size companies with high growth in the right segment and has the potential to double its price in 2-3 years. Examples are stocks in the internet, alternative energy and technology ( electric cars etc ).

ii. Precious metals - Gold and Silver

I am very bullish on gold and silver for at least the next 2 years. It is my belief that these metals will go through a parabolic maniac phase as a matter of time. If it happens, strategies are in place to ride on this trends

Portfolio will consist of gold and sliver mining stocks and ETFs.

A small portfion will be allocated to speculative juniors that can return few 100%


iii. Commodities - oil, agriculture, palladium, rare metal etc

Also bullish on these commodities over the next 2 years.

Natural gas is the only commodity that is not as bullish. But once there is sign of turning around, it can yield handsomely.

3. Shorts - 10%

Most of the time there are some shorts in my portfolio. My experience is that in a bullish market, there will be still companies for shorts. I have made money consistently on these trades.

Trade strategies used are covered puts, synthetic puts and reversed collars

5. Safe, Pure Income trades for stocks with High Dividends - 15%

These are world denominators that pay out good dividends, good cash position, huge market capital and normally trade in a range. But year after year, they buy back shares and increase their dividends.

I use my proprietary "double diagonal" to trade. The trick is to find stocks with high dividend and with a low extrinsic value for the long term put.

The trade normally becomes risk free within 2-3 months. Premium are collected from short calls and short puts. With some management, it will be collected pure monthly income.


I will implement my trading according to the above strategies. From time to time I will change my allocation. For example, if the market goes bearish, I may increase my allocation for shorts.

Business environment is dynamic and thus the plan will be modified when necessary. For the time being, I do not anticipate major changes.

JNJ - an interesting variation of Double Diagonals

I have an interesting trade. It is a variation of a double diagonal.

Normally, for a double diagonal, you buy 2 deep ITM LEAPs for call and put. Then you sell, every month, short calls and short puts to recover the extrinsic value when you bought the LEAPS.

I did a trade on March 22nd on WMT.. I recovered all the extrinsic by May and am collecting income every month currently. I expect I will end the trade with around 15-18% return on an annual basis.

I decided to make an improvement on the trade for JNJ. This company has an annual dividends of 3.4%. If I strictly do a DD, I will not benefit from the dividend payout.

So instead of buying a LEAP call, I bought just the stock and a LEAP put. By buying the stock, I did not incur any extrinsic value as it was not an option. The mechanics of trading is the same. I will sell short call and short puts month to month for income. I expect this trade to be risk free in about 3 months.

Fundamentals.

JNJ is one of those big caps stock that is selling at a bargain now. The recovery is uncertain. But if it does recover, the stock should see nice gains from its current level. If it does not recover, this strategy is going to protect the stock from any downside because of the long term deep ITM LEAP put. As the stock declines, the put will gain in value roughly equal to the stock because it is deep ITM.

Like many other value stocks, it has gone nowhere. The stock today is about the same price as it was 11 years ago but the company has grown substantially. If you measure growth by book value, JNJ is 70% cheaper today than it was in 1999. Back then, the stock traded 10 times book value and today it trades 3 times book value.

Johnson & Johnson is a no-debt business. (With $18 billion in cash, it has more cash than debt.) It has an incredible collection of brands, which should insulate it, somewhat, from economic downturns.

At some point, these stocks will break up. It is almost impossible to predict the time. It may go down if there is another market crisis but if the recovery is intact, then the stock is almost certain to break up.

JNJ dipped below 4 X book value in early 1994, the shares soared 150% within 2 years.

JNJ is trading at 13 X PE now. J&J fell to 11.9 times earnings in March 1980. The stock doubled in less than three years. In June '84, it traded down to 10.9 times earnings. The stock nearly tripled over the next three years. Its next big valuation low was April 1994, at a P/E of 13.8. The stock tripled in three years.

The stock is cheap today. Most of the risks are priced into the stock.

But I am not going to be presumptuous. The trade below will cater for the downside but will ride on the upside.

Trade:

Buy 1000 stock at 63.15
BTO Jan 2012 P for 19.7. This gives an extrinsic value of 2.85
STO Nov 60 SP for .29
STO Nov 65 SC for .48.

Manage the trade on a month to month basis by selling front months call and puts.

Never all the SC or SP to go ITM. If it is close to ITM, you can always roll it up to the next month. You have 14 months to roll the shorts - plenty of time. If the shorts are ITM, there is also a risk of getting assigned and it will mess up the whole trade.

If the stock suddenly gaps up or down ( unlikely ), the trade will make money because of volatility spike. This is in theory a strangle trade.

At some point, if the stock spikes up on a clear up-trend, I may close the LP and decide to play a bullish direction.

If it goes down, the stock is always protected by the put for 14 months.

The immediate objective is to sell enough shorts to pay back the extrinsic value of 2.85 for the put. Once it is paid, the trade is a risk-free trade. It becomes a pure income trade with minimum risk if you manage it every month.

From the options premium, it will take about 3 months for the trade to repay the extrinsic.

A target of about 15% is achievable. Together with the 3.4% dividend, the objective is make a return of 20% annual. If the stock breaks up and we adjust the trade bullishly, we can make 50-100%. Downside risk is almost zero.

This trade can be applicable to any solid big caps with good dividends like COP, WMT, MSFT, etc. Once I have proven successful, I will probably add 1-2 two more similar trades to my portfolio.

AEP - bear put calendar

There was a request by a blog reader for me to do a pure option trade.

To do this, I am putting a bear put calendar trade on AEP

Fundamentals

AEP is a mainly coal-fired power producer in the United States.

In 2009, AEP incurred a huge loss on a cash basis. After earning $2.4 b in cash from operations, it spent $2.8 b on capital investments / plant maintenance. It has lost money on a cash basis since 2006 but it continues to increase its dividends payments from $663 to $761 m. This accounts for why the stock is so popular. Investors are buying for the dividends.

The key question is, how has the company been getting the cash to pay the dividends. It borrowed more than $10 b since 2005. Recently, it stopped borrowing but instead, decided to sell stocks to finance the dividends! This sounds alarmingly like a ponzi scheme. AEP actually sold new shares worth about $1.7 billion. It has to constantly raise capital simply to stay in business and pay its dividends. This is not sustainable. It is now drowning in debt.

The other factor against AEP is that coal price is going up, with all other commodities. Seventy-eight percent of China's power production is coal based. The demand from China is so huge that this will drive up coal price. Soon, many coal-fired power stations will get more expensive operationally. There is not much room to raise the price of electricity to consumers as it had already been up enormously since 2007. Yes, I will be looking to buy some coal stocks, but not in the context of this discussion. Additionally, there has been all kinds of expensive regulations that makes running more expensive while the company is not allowed to raise price for the repair. A huge increase in coal price will literally bankrupt the company.


Technical

I have been waiting for the right timing to short AEP. Because of the high dividends, if I am wrong about the timing, I will not only lose money on my shorts and I have to pay the dividends too.

The stock has been climbing despite the weak fundamentals. A lot of people are looking for high-dividend stocks. Apparently, it looks like a growth stock if you ignore the debt and capital expenditure.

The best trade for me now is to do a bear put.

It has recently reached new highs and is coming down. It is consolidating at 36.2. I expect it to break down from here.



Trade

A bear put is better that shorting the stock. I do not have to worry about the dividends.

Below is my trade.

BTO May 37 2011 PUT = 3.3
STO Nov 36 PUT = .95
Net Debit = 2.35

Delta difference = .64-.48 =.16 ( acceptable )
% of SP / LP = .95/3.3 = 28.8% ( good )

The risk profile is displayed below:



At option expiry, I will not be losing money if the stock stays below 37.4

If volatility increases, my break-even point will be better.

PE: Continue to roll the SP from 36 to 35 once the downtrend is confirmed within the next 1 to 2 weeks when it goes slightly ITM.

If it continues to be bearish and cannot hold 35, roll it down to 34 which is a major support.

My objective is that it will hit 34 in 1-2 months if the the trend is on my side.

SE: If AEP reverses together with positive technical signal and hits > 37, roll the SP up to 37 or close the trade for a slight loss.

XEC - Updates

I first started the trade on August 16th 2010 with a covered call.



All the fundamentals were listed clearly. It is a solid stock.

But it was the wrong timing. There were the Hindeburg Omen, S&P falling on the verge to break down its reversed Head and Shoulder and the sentiments were very negative. I decided to hold off the trade, and took a small profit.

All the negative sentiments were proven wrong. XEC began to climb again. I decided to get back on the trade on Sept 7.

I bought the stock for 66.95 and sold at Oct, 65 SC for 2.55.

I was still negative on the market but I like the stock. I did a ITM covered call.

Cost position: 64.45

On Sept 9th, I confirmed the bullish move on the stock after RIG announced that it had limited the liability on the BP's oil spill. It was bullish for all drillers. The market also looked positive.




I roll the Oct 65 SC to Oct 70 SC

I bought back the Oct 65 SC for 1.65 for a profit of .9 and sold another Sct 70 SC for 2.55.

My new cost basis is now: 64.45+1.65-2.55 = 63.55

On Oct 5th, the stock continued its bullish trend and was breaking up. Since I am keeping the stock, I decided to roll the SC up from Oct 70 to Nov 75SC.

I bought back the Oct 70 SC for 2.2. There was a profit of .3. I sold the Nov 75 SC for 1.85.

My new cost basis is now 63.55 + 2.2 - 1.85 = 63.9.

The stock as of Oct 8th closed at 75.65. I am now holding to a paper profit of 16.8 percent.

I do not intend to let the stock go ITM. If the trend is still positive, I may still roll the SC up. However, I have enough time till Nov expiry to decide.

If the stock breaks down, I may need to roll the call down.

Bottom-line, I am holding onto this stock until the fundamentals changes to negative.

I will continue to update my blog on this trade.

BYD

I try to identify clear winners at an early the stage in the market – the next GOOG, AAPL, AMZN or MSFT. It is like investing in a venture fund. The business has not yet caught the mainstream media and big hedge fund managers’ attention.

BYD is a potential candidate.

Fundamentals:

It is a play on the electric car market.

In general, there are still plenty of skepticism about electric cars but they are quickly breaking into the main stream market. They are probably here to stay.

The concept of battery-powered cars has been around for decades. Concerns about rising oil prices and climate change, as well as tougher fuel efficiency standards, government subsidies and venture funds, have propelled these concepts into reality.

Pike Research expects electric vehicles to grow 106% per year or 3.2 m vehicles for the next 5 years. European researcher Glass’s Information Services is predicting that market share for electric vehicles in the UK, Italy, France, and Germany will be more than 20% each. Electric vehicles will become 25% of the US market.

China will be the largest market for electric vehicles, ultimately capturing 27% of worldwide electric vehicle sales. The reason for the hot market is that its government wants it to be so. The Ministry of Industry and Information Technology is committed to developing up to 5 Chinese companies into competitive makers of all-electric cars or plug-in hybrids by 2020, and allocated as much as 100 billion Yuan ( $15 b US) to this end. In China, what the government wants, the government gets.

BYD is the largest auto manufacturer in China. I like BYD because:

1. The technology of electric cars is not something fraught with challenges. It is actually less complex than regular combustion engines. The key competitive advantage needed is low cost. China has the low-cost structure needed. By 2000, BYD had become one of the world’s largest manufacturers of cell phone batteries. By 2008, BYD F3 became the no. 1 selling car in China, beating Volkswagen and Toyota. BYD has 10,000 good engineers at salaries of <$1000 per month.
2. BYD has the access to the biggest growth market in the world, which is China. BYD is on the way to becoming the biggest auto manufacturer in the world!
3. Having done quite a bit of business in China, I know that the Chinese government will protect their own manufacturers over foreign companies and joint ventures. BYD will be the biggest, for sure.
4. Warren Buffet likes the stock. BRK bought 10% of BYD for $230m in 2008. After a recent visit, there are rumors that he is increasing his share of the company. If Warren Buffet sees value, I believe I do not need to dig deeper into the company. It has probably the business moat we are looking for. It can easily defend against all competitors.
5. BYD has a very sound management team. The CEO is a visionary - highly energetic and smart. Charles Munger of Berkshire commented “ Thus guy, Wang ChuanFu ( the founder ) is a combination of Thomas Edison and Jack Welch – something like Edison in solving technical problems, and something like Welch in getting done what he needs to do. I have never seen anything like it.” Wang is now one of the richest men in China. However, he has not let his success change his lifestyle and is still a very humble man. He pays himself a modest $265,000 and lives in a BYD-owned apartment complex with other engineers. His only indulgences are a Mercedes and a Lexus, and they have a practical purpose. He takes apart their engines to see how they work. Wang owns roughly 28% of the shares of the company that is worth about US$2b. He has proven ability to execute as he has brought BYD to its present stage with only $300K capital borrowed from friends and relatives.
6. BYD is not just a car company. It is the biggest battery manufacturer. It supplies to the biggest phone manufacturers like Nokia and APPLE iPhone. Its new generation of lithium-ion ferrous phosphate batteries costs 50% less than standard lithium-ion batteries, and lasts longer. BYD batters are 100% recyclable and non-toxic. The battery is a critical component of the electric car. It is a core competence that leads to a distinctive competitive advantage.


For a review of this company, you can watch interview with Mr Wang on CNN or watch the youtube videos below.








Technical



BYD stocks took a 19% decline after they revised their forecast sales target from 800,000 to 600,000. Also, they have had to revise their claim that the e6 has a range of 249 miles per charge and goes from zero to 60 in 8 seconds and has a top speed of 100 mph, and recharges for 50% of capacity in just 10 minutes. These are jaw-dropping claims in the electric car business. Unfortunately BYD has had to adjust some of these claims downward. Zero-to,-60 mph is now 14s, range is 180 miles and top speed is 85 mph.

The stock has fallen and now broken up and reaching at support. As soon as BYD works out these performance bugs, it will rebound to its previous high point.

BYD certainly has the characteristics of the kind of 10 baggers growth stocks that I am looking for.



Trades


This is a stock listed in Hong Kong. It is NOT the same BYD listed in USA. Fortunately using Interactive Brokers, I can buy HK stocks online. I just need to pay slightly higher commissions and a monthly fee of about $15 for real-time data from the Hong Kong Stock Exchange.

The Hong Kong market is not open yet. Also, for the short-term, the stock seems to be under some selling pressure because of some concerns by analysts on growth and valuation. But this is long-term buy.

Trade:

Buy stock at 56
STO Nov 60 SC for 2.4

Cost: 53.6

PE:SC expires and roll out SC next month. Since this is a long term bullish trade, I will not allow the SC to go ITM

SE: If stock goes below 53.6, consider rolling SC down to 50 or add a put to make it a collar if the downtrend is fast. Continue to manage this stock as posted in Dyanmic Collar and use of put in this blog.

The liquidity for options in the HK stock market is very low. Thus it is important to place limit order and wait for it to be filled.

Managing Risk - Part II : Set clear rules

I wrote an important post on managing risk.

It is often a psychological warfare.

One can be totally paralyzed by fear that you refused to take any actions.

A common thought is that since I have lost so much, it cannot go much lower. I will wait it out for the long term. It will recover. During the dot.com bust and 2008 housing bubble market crash, you can lose 90% and never recover.

It is helpful to set some cardinal rules that must not be broken in any circumstances. It will allow you to recover if you fall into such a situation.

1. Never allow a position to loose more than 2% of the total portfolio size. If the portfolio is $100,000, and you invested $20,000, then the maximum loss is 10%. If you think you want to allow a maximum loss of 20% because the volatility of the stock is higher, then you should only invest $10,000. With options, you can monitor the whole trade structure. Any time, it is getting close to the maximum loss cut off point, be ready to get out. Often, it is better to get out even earlier. Never allow it to shoot above the maximum cut off point. It is not difficult with options. My normal loss is usually less than 10%. Sometimes it is only 1 or 2% because I do not want to waste time to continue to manage the trade as I have started on the wrong foot and the fundamentals are not to my expectations.

2. Never allow your whole portfolio to sink more than 20%. For example, if you have $100,000, and you lose $20,000, you should stop trading. Re think and re examine your strategies.

If you are using puts to protect your portfolio, you will some time to rethink before going back to readjust the strategies again. The put will protect the portfolio from further loss for a period of time.

If necessary, go back to paper trade and gain a level of confidence and success again. If you are well diversified into 4-5 segments and using options to hedge all your portfolio and maintain your discipline, you should not get into this situation. But it is hard to predict. If you get into such a situation, stop trade for a while. Take a break. Regain your mental strength, strengthen your system, design new rules, test it with paper trading before you start again.

If you follow the rules, you will survive even if are on a losing streak. You will have time to recover. It is called capital preservation – a most important concept in trading.

Income stock versus Growth Stock

Many investors hope to invest for income. They look for a consistent income say of 1.5% to 2.0% to supplement their bills or even pay for their monthly expenses.

Financial advisers often ask whether you are investing for income or investing for growth. It is advised that if you are more advanced in age, you should take less risk and thus invest for income. If you are younger, you have more time and thus you should be more aggressive and invest for growth. If you are wrong, you have more time to allow the growth stock to perform.

Contrary to popular beliefs, I like to explain why these concepts are flawed.

First, it is not a matter of income or growth. The issue is really how you manage the risk. Stock market fluctuates. It goes in cycles. It has volatility. It is also unpredictable short term.

The premise of income stock is to assign minimum risk to the market. The problem is that the market risk is higher than expectation.

Choosing a wrong stock and blindly wait for it to perform despite clear downtrend can be disastrous.

Looking at some “safe” income stocks during the 2008 market crash, it went down together with the market. Some lost control and went bankrupt. Situation changed. One example is GE. I am sure many people thought it was a good income stock that you can hold for good, collect dividends and double the shares when it goes down. It is a highly respected blue chip. GE consistently delivered growth, earnings and dividends for many years until the housing bubble exposed its huge weakness in its finance division that should have bankrupt the company if not for a government bail out.

There are more important decision processes when investing in the stock market.

The most important point is to ensure that the underlying fundamentals of the stock are intact. However, it is often too late when you realized the fundamentals have broken down.

So the next important key is the ability to control the risk until the situation is clear. The first sign of a breakdown in fundamental is usually revealed technically from a chart. It goes from bullish to bearish or it goes from an up trend to a downtrend. They are many ways to determine that but it is not in the scope here to discuss this. It is important that damage control is done immediately upon first sign of a breakdown.

The way to do damage control is by using options. The important tool I have is the use of puts and a collar trade.

But, the stock may not be performing because it is just going through a temporary setback caused by sentiments and the overall market negative performance. Even the stock may go down 30%, you may just lose 5-6 % if you use the options hedging strategies properly. The breakdown must be controlled. Buy time to allow one to react to the fundamentals.

If you know how to hedge, control risk and trade using options, my argument is that an income stock is not a lot different from a growth stock.

There is room for income stock. Certainly, there are stocks who are clear leaders in the market.. Many value investors have argued a case for IBM, INTC, MSFT. WMT and XOM. I agree that these are good stocks – great business model and good cash flow. But business environment can change. Management can make grave errors on long term strategies. If you were to look at the performance of these companies, they have gone nowhere for the last few years. Certainly, I have done better on investing in other growth stocks given that the risks are similar if you http://www.blogger.com/img/blank.gifcontrol it properly. Alternatively, you can embark on a Double Diagonal or its variation to trade these stock. For this, I will keep to 30% of my portfolio as its upside is limited until it breaks out.

I have different ways to manage these income stocks. Examples are given in my WMT double diagonal or the recent trade on JNJ. You can also buy the stock when it is cheap and hope that it will break out while earning income via its dividends. There are definite risks involved and it must be controlled.

Business environment is dynamic. Some of these companies will make a breakthrough because of re-engineering, new product or a new CEO. The downside is limited but it must be managed in case it goes against some fundamental change in the business environment that adversely affect the performance of the company.

Thus, similar to controlling the break down, you can also control the break up using a collar.

If you set your mind to think that you can make a fixed percentage every month, you will be disappointed. Stock prices fluctuate and sometimes violently. You cannot treat the stock market like getting a fixed salary every month. I just think it is flawed concept. Over the years, I know there will be some losing months. But overall, I keep my losses small and let the winners run. It is therefore possible to shoot for an annual gains of >10% but at the same time, when opportunity presents, I go for the 50% without compromising on my risk.

Many traders go for 80% of their portfolio on "safe" stocks and leave 20% for speculative strategies. I agree that if I were to use more speculative strategies like Iron Condors, Butterfly, Calendars, and many pure options play, I will not allocate more than 20% of my portfolio. I will also keep my position sizing small. I use these strategies only once in a while. In actuality, it is less than 2% of my portfolio.

I invest in highly volatile stocks. For example, I invest in precious metals, commodity and related stocks. I invest in growth stocks like BIDU,AMZN,SNDK, SU and AAPL. These are highly volatile stocks. But I believe I know how to handle the volatility and risk. It has been very profitable for me. These are also very sound companies fundamentally.

I try to identify stocks that are clear market leader – the next google, apple, bidu or amzn. If possible, identify it at an early stage and ride it all the way. It is not easy. These stocks are normally volatile. In many cases, you are scared away by its volatility half way. With options, you can keep you emotions in check. As long as the fundamentals are intact, it is easier to hold on to wild ride until the fundamentals clearly breaks down, then you close the trade. I have also give an example of these my my trade for BYD.

So for me, I go for 70% growth stock and 30% income stock. My strategies for growth stock are primarily covered calls and collars manipulating the various instruments like the pieces in a chess game. If you do it properly, you can go quite far with it. For income stocks, I use month to month covered calls, long term ITM SCs for high dividend stock and double diagonals. But it is from the growth stocks I derive most of my profit.

The primary factors for success are understanding the fundamental; manage the price trends, volatility and risks using options.