Trader,

Here are a couple more great questions that I wanted to pass along.

Hopefully, you’ll find them helpful to your investing — again, let me know if you have any burning questions like these that you want answered…

*** QUESTION ***

I am looking to try investing in the stock market but I want to do it the cheapest way possible thru the internet. I know about scottrade and fidelity and all those websites, but I want to know which one is the cheapest and most convenient?

MY COMMENTS

Hey — you’ve got a good head on your shoulders to be concerned about costs.

Overall, you want to make the most money possible. One way to do that is to reduce your costs of investing, but there are a number of things to weigh…

If your investment strategy is to engage in a lot of trades per day, then I suppose you’d want to be worried about how much you’re paying per trade. A lot of trades makes those costs really add up (hopefully, your investment strategy will more than make up for it…)

Of course, I’m a big advocate of value investing (finding great companies to invest in, buying them at the right price, and only selling once they become overvalued

As a value investor, I generally do not worry that much about what the transaction (buy/sell) costs are, because I don’t trade a lot. If I decide to sell, and I’ve made, say, $10,000 on my total investment, I’m probably not going to be concerned with whether the price is $7 or $12 per trade.

Regarding costs, pick a good discount broker (Scotttrade, Charles Schwab, E*Trade, Fidelity, TD Ameritrade — all are good) and choose the one that works best for you. Some have low (or no) minimum balance requirements, while others charge $7 per trade or $12 per trade.

Of course, another cost factor is short-term versus long-term capital gains taxes. If you engage in a high-turnover trading strategy, you’re going to end up paying short-term capital gains on all of your profits.

If, however, you keep the stock you purchase for more than one year, you can cut your capital gains taxes by half or more. So, $7 per trade wouldn’t matter here — your total tax bill would be your biggest cost…

So, I would say, first, learn more about and pick your investment strategy. If you become a long-term value investor, I wouldn’t worry so much about the transaction costs — your strategy (and your discipline in applying your strategy) will be the determining factor about how much you make… Just pick the discount broker that you are the most comfortable with…

— ASIDE - By the way, if you want to know my favorite overall investment strategy that will keep your costs down, compare to those other “investors” who trade a lot, then read THIS:

http://www.independentvalueinvestor .com/MultiplyYourMoney.html —

*** QUESTION ***

What are put and call options?

- rick

MY COMMMENTS

Hey Rick,

Options can be a long and complicated subject, but let’s see if we can break it down simply.

Stocks are actually shares of a real company. When you own stock, you own a percentage of that company. They are yours until you sell them to somebody else…

Options are really agreements between two people about what these two people agree to do with their shares.

An option says that one person is buying the right to do something (either buy or sell shares) with the other person — and they are charged a premium for getting this right.

(Now, it’s really more complicated than this, because there are things called naked options which are options written with no underlying stock to back them up. Then you could sell the options you just bought, so that transfers the rights to somebody else.. But these are other stories — let’s try to keep this simple…)

A “call” option is the right to BUY a certain number of shares of stock at a certain price on or before a certain date.

A “put” option is the right to SELL a certain number of shares of stock at a certain price on or before a certain date.

The owner of the option has the RIGHT to exercise the terms of the options contract.

The seller of the option has the OBLIGATION to honor the terms of the options contract.

Let’s use some examples…

Let’s say Investor A has 100 shares of stock, and Investor B wants to buy these shares.

Let’s further say that the current price is $10 per share and that Investor B is interested in buying the right to purchase these shares in 3 months at $10 per share (because he thinks the shares will go up but not buying them now.

In this case, Investor B would be interested in buying a “call” option that expires in 3 months with an exercise price of $10 per share.

Depending on the shares and the volatility of how the stock prices swings up and down, this “call” option may cost, say, $2 per share, or $200 for the right to buy 100 shares at $10 per share in 3 months’ time. The $2 per share is called the PREMIUM of the option.

Since Investor B is purchasing the option at $2 per share, Investor A receives this $2 per share. This is the agreement between Investors A and B.

Now, let’s say that the price jumps to $15 per share in 3 months. Investor B now has the right to purchase these shares from Investor A for $10 per share, and Investor A is obligated to surrender the shares at this price. That’s what the options contract stated. Investor B took the risk of paying $2 per share for this right, but made $3 per share in profit ($5 per share from the increase in value minus the $2 per share for the options contract).

Investor A lost out on some upside gain, but made $2 per share in profit from selling the option in the first place. Overall, both sides made out nicely…

If, however, the stock price was $9 per share, then Investor B wouldn’t exercise the option, since it’s cheaper to buy shares on the open market ($9) than from Investor A under the terms of the option ($10).

Investor A, however, keeps the $2 per share premium, and the shares, since the option expired before being exercised.

An example of a “put” option would be if Investor B wrote a “put” option, giving Investor A the right to sell 100 shares to Investor B at $10 per share. Investor A might pay $2 per share to Investor B for this right. Now, Investor B is the one that’s obligated to buy the shares, which would happen if the stock price dropped below $10…

Whew!

As you can see, options can be a bit tricky, and there are some good books out there to help (one I know if is “Getting Started with Options

***

Well, I’m going to wrap it here for now. Again, thanks to everyone for your great questions — keep them coming!!

Take care,

Mic

micfarris@independentv alueinvestor.com

P.S. I’ve spent the last decade focused on discovering the secrets of value investing… and enriching my life in the process. If you want to see EVERYTHING I’ve learned, then go download a copy of “Multiply Your Money” right NOW:

http://www.independentvalueinvestor. com/MultiplyYourMoney.html

CF Media, 3217 Peppermint Street, Thousand Oaks, CA 91320, USA