MONEY 2 - STOCKS

THIS IS MY SECOND POST ON UNDERSTANDING MONEY TOOLS

Money! Money! Money!  Now, we are going to continue on our venture into the financial market and try to gain a better understanding of the system, then in a following blog we will go into simple analysis. 

Within the realm of common stocks there can be classes, for instance a Class A and a Class B.  An illustration here is one class might have limited voting abilities and the other class full rights.  Another type of stock is Preferred Stock.  This stock is right behind corporate bonds as to hierarchy in the financial position, perhaps receiving a guaranteed dividend at a higher yield than the common stock.  Whether a company pays a dividend or not, or the amount is not necessarily related to how the company is doing, but more in line with it’s objectives.  A dividend is the decision of the Board of Directors. Some companies like Microsoft are sitting with billions of dollars being managed short term with the goal of having plenty of money on hand to purchase other companies if they wish, and yet financially they could pay much more in dividends.

We are familiar with the New York Stock Exchange, NASDAQ and Penny Stock Exchanges, but there are stock exchanges in countries all over the world. Also, our large investment banking firms have offices in many of these countries to offer our products and to assist in selling local stocks. The regulatory body for the US exchanges and licensing is the Securities Exchange Commission (SEC).

Let’s focus on how to buy stocks.  There are several ways to buy publicly traded stocks, most common are from stock brokerage firms, banks, trust companies licensed to do so and some corporations permit purchasing their stock directly without a commission involved. Brokers make their money mainly from commissions on a trade, buying or selling.  Some brokerages salary their employees so that commission incentives don’t sway the decision making process. Brokers and financial advisors sometimes receive what is called a 12b-1 fee, or “trailer fee” as part, or all of their commissions.  This is paid to the investment firm on an ongoing small percentage of money under management from a money manager, and usually on a quarterly basis. If the money manager does very well for a client the broker will receive a growing amount of money as the fee is based on a percent of the portfolio.  All parties to these trade transactions must be licensed in all states in which they are doing business, and it is strictly regulated.

Buying an “even lot” of shares, normally 100 shares at a time may have a lower commission than buying an “odd lot”, a number of shares different from exactly 100, especially if a person buys only a few shares, the commissions from a stock broker may be a high percentage of the overall costs.  Discount brokers or buying on our own over the internet with a brokerage house may be the cheapest and best avenue especially if you don’t need a broker’s advice on purchasing.

Regarding common stock there are two main ways to transact trades, buying a long position and selling a short position.  Normally, we think of buying a stock, this is a long position, and the stock certificate can be delivered to the person buying or it can be held in “street name” such as a brokerage firm and in the name/account of the buyer. You buy the stock because you believe it will increase in value. 

Another way to transact business is to sell a stock “short”.  You believe a stock is going to lose value and go down in price.  With this transaction you are selling stock you don’t own, but the brokerage firm owns in their name.  If the stock goes down you make money on “paper” and then you “buy” the stock when you deem it to be a price you are happy with. Of course, if you bet wrong and the stock goes up, the brokerage firm will want more money to protect the position of loss you are in.  In regard to this it is noteworthy that fear is a stronger emotion than greed, therefore the stock market and stocks will go down quicker than go up, however over the long term optimism has prevailed and the stock markets have risen. Staying power is important.

Stocks also have an options market.  Similar to the above only called differently are option “calls” and “puts”.  With an option you are paying an amount of money to have a right to exercise the option to buy/sell a certain amount of stock at a certain price point at a future set date in time.  Prior to that date you can sell your option.  A  “call” is buying an option on a stock at a certain price and being able to either buy that quantity of stock for that set amount within a time frame, or selling the option as it has increased. A “put option” is just the opposite, you believe the stock will go down and that is your position.  You make money if the stock goes down and the option reacts accordingly within a certain period of time. It is of note here that option prices don’t necessarily parallel the actual movement in the price of the stock. An option is normally on 1,000 shares of a stock.

These instruments and strategies can get very complex.  For instance, you can sell a “call” option versus buying it.  One use of options is to hedge your buying/selling position on a stock.  In this, you might buy a put option to hedge your long position on a stock you just bought. If the stock would go down, you have the put option price that should be going up. In the commodity markets many farmers use options to hedge their crops for the season.  The farmer could buy “crop loss insurance” which is very expensive, or hedge the loss of their plantings with options on the commodities market, corn for instance where the prices have gone up significantly across the US because of lack of rain the summer of 2012 and many crops were lost.

As a client of a major brokerage you may have the ability to borrow money from the “house”.  This is a regulated percentage backed by your stock holdings, and is referred to as buying on “margin”.  If your long position should go down in price you may have a “margin call” by the brokerage firm.  If you are in a short position and your stock goes up and you are losing money you may be asked to put more money into your account to cover the losses.