Investment Basics: Gross Margin, Operating Margin and Net Margin

The formula to calculate the margin is as follows.

Gross margin = gross profit / sales
Operating margin = operating income / sales
Net margin = net income / sales

The higher the margin, the better the company.

China Miracle: China Mobile

Since I started using hand phone, I have been a customer of China Mobile (Symbol: CHL). Its service is not cheap though, especially when you make long distance call using your hand phone. But people never stop using its service.

Just 5 to 10 years ago, mobile phones are luxury goods for most Chinese, especially those people in the rural area. I have seen people who do not have a stable income but spend RMB100 (US$13.5) a month on calls and sms. All the hard earned money quietly goes to China Mobile bank account. No wonder the share price of China Mobile tripled in 2007!

China Miracle: CTrip.com

I went back to China in Nov and traveled many cities such as Hong Kong, Shenzhen, Shanghai, and Wuhan. Do you know how did I get all my tickets and book my hotel?

I guess you may not know. So here I show you a quite nice company, CTrip (Symbol: CTRP) through which I booked all my tickets and hotel. Actually, every time I want to buy tickets or book a hotel, the first thing I think about is to call CTrip. You may take a closer look at this company. Its share price almost doubled during the past one year.

4 Steps to a 100% Return Overnight by Investing in Options. Believe It or Not.

You may think that I am kidding. But I have already shown you how. Please read my success story here.

Why the premium for the options of DLB and PCLN increased by 100% overnight? The answer these two companies were reporting earnings on Nov 11, 2007. The two companies reported earnings that beat the analyst's estimates and the stock price of these two companies gapped up on Nov 11, 2007. As a result, my previous out-of-the-money options became in the money and the positive intrinsic value makes the value of DLB and PCLN options double over night.

Four steps.

Step 1: Check which companies are going to report earnings after market close today and before market open tomorrow. You can do so by checking the earnings calendar on my homepage (left panel).

Step 2: Identify those winning trades. To buy put options, you need to follow a 3-steps method.

Step 3: Buy to open the options of those companies you have identified in step 2 before the market close today. You may read "How to Determine Strike Price?"

Step 4: Sell to close the options you have purchased after the market open tomorrow.

How to Determine Strike Price?

Whether you buy call or put, choose the strike price that is just out of the money. Be careful when you buy options that are far out of the money. You may check the question No 3 of step 2 that I discussed in the following post "3 Steps to Identify Winning Trades"

3 Steps to Identify Winning Trades

We win the battle by simply buying and selling options. Call options are my focus here.

Step 1: Fundamental Analysis. You may focus on those companies whose business model you can understand. Remember Warren Buffett? He invests only in those companies whose products and services he could understand. You need to answer the following questions:

1) What's the company is doing? Can you understand how the company makes money?
2) Does the industry in which the company is situated attractive? Is the industry growing or shrinking? You may need to draw supply chain and conduct industry analysis. Don't forget Porter's 5 forces.
3) Who are the company's customers? are the company's customer increasing? Does the company have a competitive advantage over competitors that can not be easily copied?
4) What's the company's gross margin, operating margin and net margin, compared with its competitors and industry average? Is the margin improving over the years?
5) What are analyst's earning estimates? Upgrade or downgrade recently?
6) Is the company's earning increasing over the past 2 years and 8 quarters?

Step 2: Technical Analysis
1) Does the stock price keep increasing for several weeks already?
2) Is the recent volume above historical average volume?
3) Historically, does the stock price of the company change a lot on the day it report earnings?

Step 3: Key Development
1) What are the major news for the company? Positive or negative?

If you find that all these questions have positive answers, congratulations. You have identified a winning company.

Some website you need to know for identifying winning trades:
Yahoo Finance
MSN MoneyCentral
Google Finance
Briefing.com

Double or triple your money in one year!

Assume you have had your own option investment strategy already. If not, please read this post and create one before you invest.

As you may have known already, the success of option investment depends on five parameters (If you do not know the five parameters, please read my post "Investment success, the ultimate formula" here). To double your money in one year, your quarterly return need to be at least 18%. To triple your money in one year, your quarterly return need to be 31%.

Based on the formula discussed in the post "Investment success, the ultimate formula", I have conducted a scenario analysis. Here is the result.

So you will more than double your money if

• you stick to 5% investment rule,


• have a winning percentage of 70%,


• trade 20 times every quarter,


• the average return of your winning trades is 60%,


• and the return of your losing trades is -60%.

And you will almost triple your money if you increase the average return of your winning trades to 70%.

The annual return depends largely on your winning percentage, the average return of your winning and losing trades. Next, I will discuss the steps I use to identify winning trades.

You must Have an Investment Strategy Before You Invest!

It is very important that you have an investment statement/strategy before you invest. This investment statement will guide you when you buy and sell securities. I hope my posts will give you some clue for you to create your own option investment strategy. Some people focus on earnings report. Some others focus on news (such as M&A). No matter what, you must have your own winning strategy.

Options Basics: What's the risk?

Option investment offers investors the opportunities to get a high return with a small capital (click here to see an example). The risk is also very high. You may end up losing a significant amount if not all of your investment in a short period of time.

As every option has an expiry day, your option will be worthless if it is not likely that the option will be in the money. Those people who buy options that are far far out of the money and will expire in a very short period of time will most likely end up losing all their money in the option investment.

Certain type of options have unlimited risk. For example, if you sell a call option instead of buying a call option, you have the obligation to sell the shares of a stock at a specific day if the purchaser chooses to do so. If the price of underlying stock is sky high, you will end up losing a lot. Click to read more about the risk of writing naked call.

Posts that discuss options basics:
What's Stock Option?
Premium, Intrinsic Value and Time Value
Option Investment, How it Works?
Why Option Investment?
What's the risk?

Options Basics: Why Option Investment?

Why option investment? Why not invest in stocks directly?

The main obstacle of stock investment is the large amount of capital needed. For example, the current Apple share price is $199.83. One hundred apple shares will cost around $20,000, which is beyond the ability of many investors.

On the contrary, option investment is perfect for people with limited capital. The premium of AAPL Jan 2008 200 call option is $9.00. One such a call option will requires only $900. As share price goes up to above $200, the intrinsic value of your call option increases and so does the value of your call option.

Another advantage of option investment is the possibility of gaining a high return in a short period of time. In my blog "Interesting trading experience in China!", I have shown you two option investments that gives me 100% over return in just 2 days.

In sum, option investment gives those investors who have limited capital more opportunities in investment.

Posts that discuss options basics:
What's Stock Option?
Premium, Intrinsic Value and Time Value
Option Investment, How it Works?
Why Option Investment?
What's the risk?

Options Basics: Option Investment, How It Works?

As all other investments, the principal of option investment is "buy low and sell high". As we know, the premium of stock option is the summation of intrinsic value and time value. The increase of either intrinsic value and time value will increase the value of the option investment.

What factors may change an option's intrinsic value? Any variable that can change the stock price of an underlying asset may change the intrinsic value. For a call option, strong earnings report and guidance, positive management discussion, news of being an acquisition target, etc are some factors that can positively change the stock price and increase the intrinsic value of a call option if the stock price surpasses strike price.

For a put option, factors such as negative earnings report and guidance can change the strike price negatively and increase the intrinsic value of a put option if the stock price drops between the strike price.

So, if you anticipate the stock price will fall, buy put option. If you expect the stock price to go up, buy call option.

Posts that discuss options basics:
What's Stock Option?
Premium, Intrinsic Value and Time Value
Option Investment, How it Works?
Why Option Investment?
What's the risk?

Options Basics: Premium, Intrinsic Value and Time Value

The cost of an option is knows as the premium. Let's use Apple example again. The current stock price of Apple is $199.83. The premium of AAPL Jan 2008 200 call is $9.00. The premium of AAPL Jan 2008 195 call is $11.65.

Depending on the stock price and strike price, an option may be in the money, at the money, or out of the money. For a call option, if the stock price is higher than the strike price, we say the option is in the money. For the above example, the call AAPL Jan 2008 195 is in the money since the stock price, $199.83, is higher than the strike price, $195. On the contrary, the call AAPL Jan 2008 200 is out of the money since the stock price is lower than the strike price. An option is at the money if the stock price is equal to the strike price.

The premium of an option includes two parts: intrinsic value and time value. Intrinsic value is the difference between strike price and stock price if an option is in the money. The intrinsic value is 0 if the option is out of the money or at the money. The more an option is in the money, the higher the intrinsic value. The longer the time till expiry day, the higher the time value.

Posts that discuss options basics:
What's Stock Option?
Premium, Intrinsic Value and Time Value
Option Investment, How it Works?
Why Option Investment?
What's the risk?

Options Basics: What's Stock Option?

An stock option is a contract that gives the buyer the right, but not the obligation, to buy or sell a stock at a specific price (aka strike price) on or before a particular day (aka expiry day).

There are two types of options, call or put. A call stock option gives the buyer the right to buy 100 shares of a stock at a specified price while a put stock option gives the buyer the right to sell 100 shares of a stock at a specified price.

For example, an AAPL Jan 2008 195.0000 call is a call option that gives the option holder the right, but not the obligation, to buy 100 Apple shares at $195 before Jan 2008. The strike price of this option is $195 and the expiry day is Jan 2008.

Most exchange-traded options are American options, which can be exercised at any time before or on the expiry day. By contrast, European options can be exercised only on the expiry day.

Posts that discuss options basics:
What's Stock Option?
Premium, Intrinsic Value and Time Value
Option Investment, How it Works?
Why Option Investment?
What's the risk?

Investment success, the ultimate formula

Investment return depends on five parameters.

1) Investment per trade, the amount of money that you decide to put in each trade. It depends how much risk you are willing to take. Some people have a 5% rule, others have a 2% rule, and still others have a fixed amount (say no more than $5000 per trade)
2) How many trades you want to play in a given period, say a quarter or a year? Some people may trade everyday while other may trade once or twice every week.
3) How many trades do you win? It is also known as winning percentage
4) Average return of winning trades.
5) Average return of losing trades.

Here is an example. Suppose

1) your investment per trade is 5%
2) you play 30 trades in a quarter
3) your winning percentage is 60%
4) your average return of winning trades is 70%
5) and your average return of losing trades is -50%

You will get a handsome return of 33% for the quarter, which is quite good. The formula I use is:

(30 * 60% * 5% * 70% - 30 * 40% * 5% * 50%)

Among the five, I would rather focus on winning percentage and return of losing trades. It is possible to increase the winning percentage to 70% if we analyze companies more carefully (my current winning percentage is very close to 70%). With respect to return of losing trades, we really have to control our feeling. Do you have the experience of holding your losing trades and waiting for your position to get to positive territory? We may end up losing almost all of our capital. I now find that it is better to close our position if the value of our positive has gone down too much, say 50%. Sensitivity analysis show that how we manage our losing trades has a significant impact on the total return.

If the average return of your losing trades is -80%, your quarterly return would be 15% (while others parameters remain the same). But if your average return of losing trades is -40%, you will get a quarterly return of 39%. How will these numbers make sense to you? Well, it will take you around 5 quarters to double your money with a quarterly return of 15%. It will only take you less than half a year to double your money with a quarterly return of 39%.

I hope the total return formula help you do your own planning.

Technorati : formula, total invest return, winning percentage

Long Term VS Short Term Investment

I used to believe in long-term investment. That is, I buy a stock and hold the stock for several years. I got this idea mainly from books written about Warren Buffet, such as "The Warren Buffett Way".

Now, I find I am getting a little bit impatient. Thinking about waiting for 1 year or two to turn $100 into $120 makes me sick. It is interesting to know that by being committed to long-term investment, Warren Buffett consistently beats the market. Warren Buffett can accurately predict whether a company will do well in the next 5 or 10 years and he also knows that what price is a bargain price for that company. The problem is most of us don't have the capability. Probably that's why some people hold a losing/boring stock for years and still do not know whether their position will generate positive return or not.

So I would rather save the trouble by doing short-term prediction. I think I am doing quite well up to now :)

Interesting trading experience in China!

When I was in Shanghai several weeks ago, I stayed in a budget hotel where there is limited Internet access. The bandwidth for the whole 5-story hotel is only 2MB. What makes it worse is that the Internet connection is not stable. But at the end I managed to solve the problem and won several hundreds dollars. It is a quite interesting experience.

Nov 11, 2007. 9PM. I returned to the hotel (by the way, the hotel is Rujia Kuaijie) and tried to warm up (read news, etc.) before the market opens. I planned to sell two option positions (Dolby Laboratories and PriceLine.com, DLB/PCLN) that I had held. Actually I had to close my positions and get out the market at the market's opening. I tried to login my account. To my surprise, I could not login because of the unstable Internet connection and the limited bandwidth (many people were accessing the Internet at that point of time). I was very worried. What can I do? I remember there is a Internet bar nearby. I packed my notebook and rushed to the Internet bar. I was very disappointed to find out that the company does not allow me to use my personal computer to access the Internet even if I am willing to pay.

I had no choice but to go back to my hotel and. The market was open already and I completely had no idea whether the stock price is going up or down. I talked to the IT technician and told him that I may lose a lot of money if you can not solve my problem (I did not threaten to ask him to compensate me if I lose :D ). Obviously he could not help much because he told me it was the problem of Netcom, the Internet Service Provider.

I was about to give up when he surprisingly decided to cut the Internet access of other guests and only allow me to use the Internet. Of course, I was very glad (I guess he knows that other guests won't complain. The Internet access is not stable anyway). You guess what? It worked this time! (I think the other staff felt happy also because she wanted to know how to buy/sell stocks in the US stock market ^-^ ). It was 10:30 PM then. I quickly logged in and luckily, the share price of these two companies were going up. I closed my positions and made some good money (I bought DLB for 1.7 and sold @ 5. I bought PCLN for 2.9 and sold @ 5.7). It is a good feeling. The two hotel staff who helped me were happy as well (They know I will not complain any more. haha).

It is a good experience that I think I will remember forever.

Welcome to InvestingCool.Blogspot.com

If you are also interested in investing in stocks and options, you came to the right place.

This blog is primarily created for people who wants to make some cool investment in the stock market and to exchange for trading ideas. I trade mainly in the US stocks market.

Investing is just my hobby. In 2007, I have closed 14 deals, winning 9 and losing 5, with a winning percentage of 64%. My average holding period return is 26.6% (after considering losing trades). I plan to significantly improve my investment winning percentage and holding period return in 2008 :)

Hi, friends, hope you have made some good money in 2007. Let's work smarter in the coming year to make more $$$.

Invest in US stock market? Consider exchange rate risk

Some "experts" may advise you to invest in the US market (check this book). Their argument is , over the years, the annual return of US stock market is around 12%. By investing in an index mutual fund or ETF, you can earn an annual return of 12% easily.

But be careful, if currently you own stronger currency(such as RMB, S$) and you need to convert your money into US$. Since July 2005, RMB has appreciated by 9.9% and it will continue to appreciate. Compared with Singapore dollar, US$ has depreciated by 9%.

So if you wan to get a real annual return of 12%, you need to achieve a return of 21% (12% + 9%) in the US market, which is deemed to be difficult. Even such a great investor as Warren Buffett, has only achieved an average annual return of 16.1% during the past decade (source: money central).

Please consider exchange rate risk when you invest overseas. Don't follow experts' advise blindly.

Options Investment Winning Trade on Dec 18, 2007 (Adobe)

BUY TO OPEN: at $1.20 on Dec 17, 2007
SELL TO CLOSE: at $2.00 on Dec 18, 2007
TICKER: ADBE (Adobe)
EXPIRY DATE: Jan 2008
STRIKE PRICE: $42.5
OPTION TYPE: Call
RETURN: 67%