Neuro-Economics

FOR MOST PURPOSES IN DAILY LIFE, your brain is a superbly functioning machine, steering you away from danger while guiding you toward basic rewards like food, shelter and love. But that brilliant machine can lead you astray when it comes to investing. You buy high only to sell low. You try to time the market. You follow the crowd. You make the same mistakes again. And again. How come? We're beginning to get answers. Scientists in the emerging field
of"neuroeconomics"-a hybrid of neuroscience, economics arid psychology-are making stunning discoveries about how the brain evaluates rewards, sizes up risks and calculates probabilities. With the wonders of imaging technology we can observe the precise neural circuitry that switches on and off in your brain when you invest. Those pictures make it clear that your investing brain often drives you to do things that make no logical sense-but make perfect emotional sense. Your brain developed to improve our species' odds of survival. You, like every other human, are wired to crave what looks rewarding and shun what seems risky.To counteract these impulses, your brain has only a thin veneer of modern, analytical circuits that are often no match for the power of the ancient parts of your mind. And when you win, lose or risk money; you stir up some profound emotions, including hope, surprise, regret and the two we'll examine here: greed and fear. Understanding how those feelings-as a matter of biology-affect your decision-making will enable you to see as never before what makes you tick, and how you can improve, as an investor,

Introduction to Options

Options are one of the most lucrative ways of making money in the markets. The flip side is that they can lead to huge losses if not dealt with correctly. Let us explore the world of options. To begin with there are 2 type of Options, Put option and a Call Option. Put Option gives the buyer to sell a stock or index at a particular strike. It gives the buyer the right to sell at a particular strike price but not the obligation to sell. It is similar to taking insurance on your house or car. Buying a call option gives the buyer the right to buy a stock or index at a particular price but not the obligation to buy the underlying. It is similar to giving a deposit amount to buy a house at a particular price.
Options are of 2 flavors. The American Options and the European options. The American Options can be exercised only on expiry day whereas the European options can be exercised on any day till expiry. In plain English, it means though you can buy sell these options every day as per market price of options, the actual difference between market price and strike price can be got only on expiry day for American Options and any day till expiry for European Options
Example:
1. Nifty 6000 CA Nov 26 is trading at 70 rupees and the underlying index is at 5950 with 10 days to expiry (Strike price 6000, Call Option, Flavor American)
What this means is I believe the Nifty will go much higher in the next 10 days and will expire say at 6200. On the day of expiry I will get 6200-6000 = 200 rupees. My net profit on the trade is 200-70 = 130 rupees. Now, let us assume the market falls to 5800 instead of going up. I will end up only losing the premium I paid.

2. Nifty 6000 PA Nov 26 is trading at 70 and the underlying index is at 6050 with 10 days to expiry
What this means is that I believe that Nifty will go down in the next 10 days and will expire say at 5800. On the day of expiry I will get 6000-5800 = 200 rupees if the Nifty expires at 5800. My profit is 200-70 = 130. Now, if against my expectations if the markets move up and expire above 6000, I end up losing only the premium paid.

Now, we have learnt what options are. There are 4 possible things one can do with Options.
1. Buy a Call Option
2. Sell a Call Option
3. Buy a Put Option
4. Sell a Put Option
What does all this mean? Buying a Call or Put Option means that we have the right to buy or sell an underlying stock or index at a particular strike price. The loss is limited to the amount of premium paid. Selling a put or call option means we are open to facing unlimited losses or profit if the market moves opposite to our direction.
1. Nifty 6000 CA Nov 26 is trading at 70 rupees and the underlying index is at 5950 with 10 days to expiry.
Now, I sell the 6000 CA option as I believe the markets will move down. So, if the expiry is below 6000, I pocket the entire 70 bucks premium. If my direction goes wrong and market moves to 6500, I have to pay 6500-6000 = 500 rupees to the option buyer. My net loss is 500-70 = 430 rupees

2. Nifty 6000 PA Nov 26 is trading at 70 and the underlying index is at 6050 with 10 days to expiry
I sell the Put Option because I believe the markets will go higher in the next 10 days. If they expire above 6000, I pocket the entire 70 rupees premium. If my direction goes wrong and market crash to 5500, I have to pay 6000-5500 = 500 rupees to the buyer. My net loss is 500- 70 = 430 rupees.

From the above examples, we can see buying options, the loss is limited and profit is unlimited. Selling options, profit is limited and the loss is unlimited. Yet, it is more lucrative to sell options rather than buy options.

Options are one of the most lucrative ways of making money in the markets. The flip side is that they can lead to huge losses if not dealt with correctly. Let us explore the world of options. To begin with there are 2 type of Options, Put option and a Call Option. Put Option gives the buyer to sell a stock or index at a particular strike. It gives the buyer the right to sell at a particular strike price but not the obligation to sell. It is similar to taking insurance on your house or car. Buying a call option gives the buyer the right to buy a stock or index at a particular price but not the obligation to buy the underlying. It is similar to giving a deposit amount to buy a house at a particular price.
Options are of 2 flavors. The American Options and the European options. The American Options can be exercised only on expiry day whereas the European options can be exercised on any day till expiry. In plain English, it means though you can buy sell these options every day as per market price of options, the actual difference between market price and strike price can be got only on expiry day for American Options and any day till expiry for European Options
Example:
1. Nifty 6000 CA Nov 26 is trading at 70 rupees and the underlying index is at 5950 with 10 days to expiry (Strike price 6000, Call Option, Flavor American)
What this means is I believe the Nifty will go much higher in the next 10 days and will expire say at 6200. On the day of expiry I will get 6200-6000 = 200 rupees. My net profit on the trade is 200-70 = 130 rupees. Now, let us assume the market falls to 5800 instead of going up. I will end up only losing the premium I paid.

2. Nifty 6000 PA Nov 26 is trading at 70 and the underlying index is at 6050 with 10 days to expiry
What this means is that I believe that Nifty will go down in the next 10 days and will expire say at 5800. On the day of expiry I will get 6000-5800 = 200 rupees if the Nifty expires at 5800. My profit is 200-70 = 130. Now, if against my expectations if the markets move up and expire above 6000, I end up losing only the premium paid.

Now, we have learnt what options are. There are 4 possible things one can do with Options.
1. Buy a Call Option
2. Sell a Call Option
3. Buy a Put Option
4. Sell a Put Option
What does all this mean? Buying a Call or Put Option means that we have the right to buy or sell an underlying stock or index at a particular strike price. The loss is limited to the amount of premium paid. Selling a put or call option means we are open to facing unlimited losses or profit if the market moves opposite to our direction.
1. Nifty 6000 CA Nov 26 is trading at 70 rupees and the underlying index is at 5950 with 10 days to expiry.
Now, I sell the 6000 CA option as I believe the markets will move down. So, if the expiry is below 6000, I pocket the entire 70 bucks premium. If my direction goes wrong and market moves to 6500, I have to pay 6500-6000 = 500 rupees to the option buyer. My net loss is 500-70 = 430 rupees

2. Nifty 6000 PA Nov 26 is trading at 70 and the underlying index is at 6050 with 10 days to expiry
I sell the Put Option because I believe the markets will go higher in the next 10 days. If they expire above 6000, I pocket the entire 70 rupees premium. If my direction goes wrong and market crash to 5500, I have to pay 6000-5500 = 500 rupees to the buyer. My net loss is 500- 70 = 430 rupees.

From the above examples, we can see buying options, the loss is limited and profit is unlimited. Selling options, profit is limited and the loss is unlimited. Yet, it is more lucrative to sell options rather than buy options.

Introduction to Options

Options are one of the most lucrative ways of making money in the markets. The flip side is that they can lead to huge losses if not dealt with correctly. Let us explore the world of options. To begin with there are 2 type of Options, Put option and a Call Option. Put Option gives the buyer to sell a stock or index at a particular strike. It gives the buyer the right to sell at a particular strike price but not the obligation to sell. It is similar to taking insurance on your house or car. Buying a call option gives the buyer the right to buy a stock or index at a particular price but not the obligation to buy the underlying. It is similar to giving a deposit amount to buy a house at a particular price.
Options are of 2 flavors. The American Options and the European options. The American Options can be exercised only on expiry day whereas the European options can be exercised on any day till expiry. In plain English, it means though you can buy sell these options every day as per market price of options, the actual difference between market price and strike price can be got only on expiry day for American Options and any day till expiry for European Options
Example:
1. Nifty 6000 CA Nov 26 is trading at 70 rupees and the underlying index is at 5950 with 10 days to expiry (Strike price 6000, Call Option, Flavor American)
What this means is I believe the Nifty will go much higher in the next 10 days and will expire say at 6200. On the day of expiry I will get 6200-6000 = 200 rupees. My net profit on the trade is 200-70 = 130 rupees. Now, let us assume the market falls to 5800 instead of going up. I will end up only losing the premium I paid.

2. Nifty 6000 PA Nov 26 is trading at 70 and the underlying index is at 6050 with 10 days to expiry
What this means is that I believe that Nifty will go down in the next 10 days and will expire say at 5800. On the day of expiry I will get 6000-5800 = 200 rupees if the Nifty expires at 5800. My profit is 200-70 = 130. Now, if against my expectations if the markets move up and expire above 6000, I end up losing only the premium paid.

Now, we have learnt what options are. There are 4 possible things one can do with Options.
1. Buy a Call Option
2. Sell a Call Option
3. Buy a Put Option
4. Sell a Put Option
What does all this mean? Buying a Call or Put Option means that we have the right to buy or sell an underlying stock or index at a particular strike price. The loss is limited to the amount of premium paid. Selling a put or call option means we are open to facing unlimited losses or profit if the market moves opposite to our direction.
1. Nifty 6000 CA Nov 26 is trading at 70 rupees and the underlying index is at 5950 with 10 days to expiry.
Now, I sell the 6000 CA option as I believe the markets will move down. So, if the expiry is below 6000, I pocket the entire 70 bucks premium. If my direction goes wrong and market moves to 6500, I have to pay 6500-6000 = 500 rupees to the option buyer. My net loss is 500-70 = 430 rupees

2. Nifty 6000 PA Nov 26 is trading at 70 and the underlying index is at 6050 with 10 days to expiry
I sell the Put Option because I believe the markets will go higher in the next 10 days. If they expire above 6000, I pocket the entire 70 rupees premium. If my direction goes wrong and market crash to 5500, I have to pay 6000-5500 = 500 rupees to the buyer. My net loss is 500- 70 = 430 rupees.

From the above examples, we can see buying options, the loss is limited and profit is unlimited. Selling options, profit is limited and the loss is unlimited. Yet, it is more lucrative to sell options rather than buy options. Why is this so? Let us look at this in my next post. I plan to write a series of posts every month which would take us from the basics of options trading to complex strategies

SIMPLE INVESTING

Investing isn’t all that difficult-at least, it doesn’t have to be.

Warren Buffett: I have three boxes on my desk: In, Out, and Too Hard.

The point is simple: Don’t invest in things (or in ways) that you do not easily understand. Sounds simple enough. What’s the catch?

The catch is…you have to do it. You have to be able to say, “No.” You have to say it a thousand times before you say, “Yes.” You have to be bored-practically to tears-at the lack of truly wonderful investment opportunities that are (or aren’t) available.

On top of it all, you have to have a solid, rational reason for buying a stock. You have to buy it as if you were buying the entire company. Then, you have to hold onto it regardless of what the professional gamblers do to the price. You have to believe that you are right-not because the price is changing, but because your rationale and reasoning is right.

When Is It Too Hard:There is a simple test to determine whether an investment opportunity is a Yes, No, or Too Hard: If you do not understand it in five minutes…it’s Too Hard. If you do not love it ten minutes after that, it is a No.

Will that eliminate 99.9% of your investment options? Yes-and that’s the point!. If 99.9% of 8000 companies traded in BSE are Too Hard or an automatic No, then there are five or so out there that are truly wonderful, easily understandable businesses selling at a discount to their true value.

Diversification: If you only invest in wonderful, easy-to-understand businesses, and you buy them on sale to their true value, you do not need to run out and diversify for the sake of diversifying. Your portfolio will eventually become diversified.

Think about it: We all know the story of Infosys, ITC, HUL. Selling for pennies in the 1980/90s. Anyone who bought it became a millionaire many times over. If you had the chance to go back in time, wouldn’t you put everything you owned into Microsoft back then?

Patience Is THE Virtue: Assuming you had purchased Infosys, ITC, HUL how long would you have held it? Would you have dealt with the daily, weekly, monthly, and annual fluctuations of 30% or more at any given time? How long before you would be “shook out” of your position?

Patience isn’t a virtue in investing-it is the virtue. You know who held on to these companies the entire time? People who understood its business and saw value in the company-regardless of the stock price that the gamblers set on a particular day.

Invest Like Warren Buffett

At any given time, in any given market condition and economy, some gambling guru will make a killing-in the stock market, in real estate, whatever-and everyone will take that gamblers word as gold, try to replicate the gamblers success, and usually lose money. Why do they lose money? A gambler can only make money for so long-a few months, a few years-before the market conditions change and the gambler’s system is no longer good.

On the other hand, for some 70 years, Warren Buffett has been successfully buying wonderful, easy-to-understand businesses when they are at a discount. And he has made billions from it.

When will you finally decide to stock worshiping gamblers and follow in the footsteps of the billionaire who made his money the easy way?

OnlineAccountingDegree.net

Why Warren Buffett Hates Gold

Warren Buffett is an investing legend, and when he talks about the financial market,individual investors and Wall to Dalal Street take notice.

But perhaps Buffett's most controversial investment advice regards gold prices. Gold,Gold miners stocks and gold ETFs simply have no place in Warren Buffett's portfolio. And to hear Buffett tell it, gold should have no place in yours, either.
So why does Warren Buffett hate gold so much? He has been pretty clear on this. In a word, gold is useless. Just look at what Warren has said publicly about gold.
· As early as 1998, Buffett was criticizing gold bugs. The oracle of Omaha emphasized the non-productive aspect of gold in a speech at Harvard that included this gem: Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it.It has no utility. Anyone watching from Mars would be scratching their head.
· More recently, in 2009, he echoed these thoughts in a CNBC interview. He was asked, "Where do you think gold will be in five years and should that be a part of value investing?" I have no views as to where it will be, but the one thing I can tell you is it won't do anything between now and then except look at you. Whereas,you know, Coca-Cola will be making money, and I think Wells Fargo will be making a lot of money and there will be a lot — and it's a lot — it's a lot better to have a goose that keeps laying eggs than a goose that just sits there and eats insurance and storage and a few things like that.
· In October, Warren Buffett told Ben Stein: You could take all the gold that's ever been mined, and it would fill a cube 67 feet in each direction. For what that's worth at current gold prices, you could buy all — not some — all of the farmland in the USA. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value? He has certainly stayed on message over the years. Key talking points for Buffett appear to be that gold is expensive to store, has no practical use and doesn't generate and income. Those are all pretty good reasons to hate gold.
However, whatever Warren Buffett's reasons may be, it's hard to argue against performance.
In 1998, when Buffett made his remarks at Harvard, gold averaged around $300 an ounce for the year – meaning the precious metal has quadrupled in value! Buffett's Berkshire Hathaway, traded on NYSE, on the other hand, has tallied gains of only about 150% from its 1998 lows to present day. That's three times the broader market, but doesn't come close to gold prices.
In the short term, however, the results are mixed. At the time of the March 9, 2009, CNBC spot, gold closed at about $923 an ounce – meaning the precious metal has gained a bit under 50% since that date. Berkshire Hathaway stock, on the other hand, is up 60% and has outpaced gold. And at the time of the Ben Stein interview on Oct. 19, gold was trading at $1,339 an ounce. That's essentially flat compared with a small loss for Buffett's Berkshire Hathaway in the same period. It's hard to tell what the future holds for gold prices. But one thing is for sure — Buffett will continue to sit out the gold rush. He hasn't changed his mind on gold just yet, and it's hard to believe that he will change anytime soon

Two Key Ratios: Accounts Receivable and Inventories:

· One of these simple ploys to predict future downwards earnings revisions by dalal Street security analysts is a careful analysis of accounts receivable and inventories a larger than average accounts receivable situation, and/or a bloated inventory. When U see these, bells go off in my head telling me to analyze that particular stock in a devil's advocate manner. accounts receivable and inventories analysis can be a terrific barometer for forecasting negative earnings surprises, usually well before Wall Street analysts come to the party.

· QUESTION: Why is accounts receivable analysis so important?

ANSWER: Conventional accounts receivable analysis involves running a ratio called days sales in accounts receivable. This ratio, which indicates receivable turnover, can illustrate the granting of more liberal credit terms and/or difficulty in obtaining payment from customers. However, even more importantly, the analysis of sale$ and accounts receivable may provide a clue as to whether a company is merely shifting inventory from the corporate level to its customers because of a "hard sell" sales campaign or costly incentives. In such an instance, this type of sales may constitute "borrowing from the future." Within this context, it is important to note that in most instances, a sale is recorded by a company when the goods are shipped to the customer. Also, there is an added cost to the company in carrying an above-average amount of accounts receivable.

· QUESTION: Why is inventory analysis so important?

ANSWER: Obviously, higher trending inventories in relation to sales can lead to inventory markdowns, write-offs, etc. In addition, it is important to note that an excess of inventories, time and time again, is a good indicator of future slowdown in production. Within this context, it is important to analyze the components of inventories. If the finished goods segment of inventories is rising much more rapidly than raw materials andl or work-in-process, it is likely that the company has an abundance of finished goods and will have to slow down production. Akin to accounts receivable, bulging inventories are costly to carry.

· The difficulty comes when accounts receivable rise substantially over what they had been in the same reporting period during previous years. This can result from any of several factors. A spell of economic hard times for the country, industry, or region will often cause stretchouts in payments. A poor collection job might be another reason. Perhaps the retailer, his back against the wall and eager to make sales, has offered his customers liberal credit terms. This often happens in the auto industry during slack periods. In retail business, this is the equivalent of end-of-season sales and the dumping of unfashionable merchandise.

. Whatever the cause, major increases in accounts receivable is a danger sign.

· An analysis of the relationships between sales, accounts receivable, and inventories may provide a clue as to whether a company is merely shifting inventory from the warehouses to its customers due to "hard sell" campaigns or costly incentives. incentives. In such an instance, these kinds of sales may constitute borrowing from the future or rectifying past errors. In this context it is important to recall that in most instances, revenues are recorded by a company when the goods are shipped to the customer. Also, there are the added money costs of carrying accounts receivable

· for inventories. These are stores of raw materials and finished and semifinished products. Manufacturing concerns may have very large inventories as a ratio to sales, while service companies have smaller ones. Indeed, the key distinction between the manufacturing and service sectors is just that: companies can stockpile inventory products, but not services. For example, a stock market advisory service has an inventory of paper, back copies, postage stamps, and the like, which can be quite minor when set beside gross income. Knowing the inventory for such an operation isn't very useful. On the other hand, a furniture factory can have an inventory larger than annual sales. As , the specific amount of inventory is not particularly meaningful in and by itself. What matters is comparisons with the same reporting period in previous years.

· Sometimes a phenomenon exists which I call "positive inventory component divergence," meaning simply the reverse of some of the illustrations described thus far, which were of negative inventory divergences. The positive version transpires when the raw materials component of inventories is advancing much more rapidly than the work-in-process and finished goods components. Imagine what this might mean. The company receives many new orders, and management realizes that an inventories buildup is required. So it simultaneously ships products from -its finished goods inventory (which declines) while ordering raw materials in larger amounts (so this component of inventories is enlarged). This, of course, is good news, and should trigger the bullish impulses in your psyche.

Investors who ignore accounts receivables and inventories especially in high tech and consumer-sensitive industries-run unnecessary risks without the chance of commensurate rewards. Next time you hear some wild story about a glamour stock and are tempted to buy without investigating, think about Ben Smith and that factory with the smokeless smokestacks

7 Deadly Warning Signs On An Annual Report

Annual reports consist of equal parts marketing glitz, feel-good platitudes, and hard financial data. After you get past all the hype, plenty of interesting data is just waiting to be viewed and analyzed. As you review the data in an annual report, stay on the lookout for the following seven deadly warning signs:

• Sign#1. Revenues Stagnant or Falling: By comparing a company’s revenues across two or more years, you can get a sense of how fast its revenues are growing. You also can see whether revenues are likely to continue to trend upward in the future. When revenues stop growing—or, worse, begin to fall—this is a major warning sign of trouble within the organization. Stagnant or falling revenues can be the result of all kinds of problems: poor product quality, increased market competition, or internal management problems, to name a few. You have to decide whether this change is a one-time aberration or a trend that’s going to get worse before it gets better. To find out more, search for articles in the financial press that discuss the company and its prospects, as well as prospects for the industry as a whole.
• Sign#2. Earnings Per Share Inconsistent With the Company’s Profit: The value of a company’s stock is to some extent based on the firm’s profitability and the number of shares in the hands of investors. So, if profit increases 15 percent from one year to the next, you may expect the earnings per share of stock to also increase by 15 percent. This won’t be the case if the company dilutes (reduces) the value of the stock by issuing more shares during the course of the year. If earnings per share are lagging behind the company’s profitability, raise the red flag because this requires further investigation. Be aware, however, that stock price frequently is affected by things that have nothing to do with the business itself. For example: institutional investors, concerned about a recent announcement from the federal government, may pull their investments out of the sector, driving the price down.
• Sign#3. Indications of Financial Distress: A company can have phenomenal growth in sales and profit but still go out of business. Have you ever heard someone who went out of business lament that he or she was a victim of his or her own success? As odd as it sounds, it can happen. If a company isn’t solvent — in other words, it doesn’t have enough cash in the bank to cover its current liabilities — it’s in trouble. Run some numbers on companies of interest — specifically, a quick ratio and an acid-test ratio — to see whether they’re solvent. If the results are marginal and the trend is downward, the ratio doesn’t bode well for the future.
• Sign#4. Unusual Gains or Losses: Although every company goes through natural and regular business cycles during the course of months or years, unusual gains or losses can be red flags deserving of your attention. Unusual gains or losses are to be expected from time to time, but they should be just that — unusual. Ongoing unusual gains or losses are cause for concern because they indicate a fundamental problem in the company’s ability to manage its operations and finances.
• Sign#5. Profit Ratios Falling: Because profit is the best measure of success for many companies, growing — or, at minimum, maintaining—profit ratios is an important goal of management. If a company’s profit ratios are falling from year to year, the financial health of the firm is in clear jeopardy. Something in the company is broken and needs to be fixed.
• Sign#6. Adverse Auditor Opinion: For the most part, the letter of CPA opinion is a perfunctory exercise that confirms that a company’s financial statements are accurate.
  Occasionally (today it happens more often because of Sarbanes-Oxley), however, a CPA firm takes exception to a company’s financial results and issues an adverse opinion. Pay close attention to the letter of CPA opinion. Watch for words such as “fairly present” (good) or “adverse opinion” or “reservations” (bad).
• Sign#7. Disconnect Between Narrative and Financials: If an annual report’s narrative doesn’t match up with the realities of the company’s financial position, you can bet that the company’s spin doctors are in high gear. The chairman may go on and on about what a great job the company did in a tough business environment, and about the tremendous prospects for the company in the future. But if the leading financial indicators are pointing in a different direction, there’s more to the report than meets the eye.

Don't Trust Your Auditor

Don't Trust Your Auditor

· "Probably the first item to check is the auditor's opinion to see whether or not it is a clean one-'in conformity with generally accepted accounting principles consistently applied'-or is qualified in regard to differences between the auditor and company management in the accounting treatment of some major item, or in the outcome of important litigation."

· In fact, there are four categories of opinions that might be awarded, in order of occurrence: (1) "clean," which is unqualified acceptance and is usually presented in two short paragraphs; (2) "subject to" in which the auditor accepts the financials subject to pervasive uncertainty that cannot be adequately measured such as relating to the value of inventories, reserves for losses,or other matters subject to judgment; (3) "except for" meaning that the auditor was unable to audit certain areas of the company's operations because of restrictions imposed by management or other conditions beyond his control. (It should be noted that the SEC generally will not permit publicly owned companies to get away with an "except for" opinion); and (4) a statement from the auditor disclaiming any opinion regarding the company's financial condition which is in effect a disclaimer of ~ p i n i o n

· "Many of our clients are treating the audit as a commodity, like shopping for cheaper gasoline,"