September 2011 Webinar: Covered Options
Preferred Procedure - Or Is It?
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InvestEd Inc. Free Webinar
Covered Options: A Tool for the Fundamental Investor
Sunday, September 25, 2011
9 PM-10:30 PM ET / 6 PM-7:30 PM PT
Instructor: Paul Madison
This webinar will demonstrate how covered calls and cash-secured puts can augment a fundamental investor's toolbox.
Do you own stocks that you are holding for future capital appreciation? In the meantime do you want to generate short term returns? Would you like your portfolio's cash to earn more than the current money market rate?
Discover how you may generate income by selling covered options.
- Learn how and why selling covered options works
- The importance of commissions for the options seller
- Translate option premiums into rates of return for analysis
- Evaluate the "Reward to Risk" ratio for selling an option
- Volatility is important to the options seller
Paul Madison has a BS in Chemical Engineering and is retired after working in several different areas at Conoco, which included a few years as a crude oil commodity trader. He is a director and teacher for the Greater Tulsa Area Chapter of BetterInvesting, and has been an investor in individual stocks for over 30 years.
to attend this online investor education session. Space is limited.
Preferred Procedure - Or Is It?
Part 2 of 2
By Saul Seinberg
Saul Seinberg concludes his August 2011 article describing why he chooses to project future earnings growth based on the historical growth of earnings per share (EPS) adjusted to accommodate analyst projections and/or current and recent events. The other approach to estimating a company's future earnings involves use of the Preferred Procedure, also known as Revenue-based EPS Estimate in Toolkit 6 stock study software. Toolkit 6 Version 6.4.2 allows investors to resume using BetterInvesting terminology (e.g. Preferred Procedure) by resetting the appropriate menu choice in Preferences.
Part 1 of the article is available for review in the August 2011 InvestEd Inc. Monthly Newsletter
. Scroll approximately one-third of the way down the page or use the "find" feature for "Preferred Procedure" to locate Saul's original article.
A reason often given for using the Preferred Procedure, despite the higher number of items to project, is that using this method is not as arduous as it seems, since you already project sales at the bottom of Section 1 of your stock study, and few companies pay preferred dividends. I agree with respect to the preferred dividends part. However, when preferred dividends are present, you still need to determine how much they will change over time.
Sales are another story. As it turns out, you do NOT need to estimate sales at all if you decide to project EPS on a historical basis. The sales growth projection on your stock study is used only for purposes of the Preferred Procedure. Therefore, you need to project sales growth only if you decide to use the Preferred Procedure.
Otherwise, you can leave the sales growth projection box in Section 1 blank, set it to zero, or insert any other amount, including a negative number. The rest of your stock study, except for the Preferred Procedure determination, will not be affected. However, if you leave the sales growth box blank, the software will consider your stock study incomplete. Thus, if you use historical EPS to make your earnings growth projection, you don't need to take time searching for sales estimates and agonizing over what sales growth will be for the next five years.
When using the Preferred Procedure, pre-tax profit margin, taxes, and shares outstanding are based on historical values. These items, along with sales, can be tweaked in accordance with your determination about whether something will change and how much that change is likely to be. For this purpose, trends and/or potential changes can be estimated from references such as Value Line or Standard & Poor's and further adjusted by an investor as he or she deems necessary. In addition, if preferred dividends are present, they also may require attention.
Users of the Preferred Procedure have the ability to change the elements of a projected income statement and see the effect of such changes. This is important to some investors. However, unproven and far from certain is the assumption that EPS as determined by the Preferred Procedure is any better, more accurate, or more suitable for use in a stock study than projecting earnings growth on the basis of historical EPS by itself. In fact, we might argue that having to consider changes in the Preferred Procedure by projecting four or five items is unlikely to be more accurate than a straightforward projection based on historical earnings alone.
Nothing is wrong with the Preferred Procedure per se. Those investors who favor this approach for estimating future EPS growth certainly can continue to use it without additional concern. For the reasons given earlier in this article, I simply don't see any compelling basis on which to prefer the Preferred Procedure. My choice is to use historical earnings to project future EPS. I take the time I save by not using the Preferred Procedure and apply it to completing the rest of my stock study.
Saul Seinberg is an InvestEd
instructor, presents InvestEd Inc. free online investor education webinars, and is an associate director of the corporation. He is vice president of the online CGAB Alumni Investment Club. With degrees in electrical engineering and law, Saul spent most of his career as a corporate attorney.
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By Brian White
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Brian White is an InvestEd instructor and began teaching for the BetterInvesting Massachusetts Chapter in 1997. He served as the chapter president, helped start the computer group, and received the national Dick Dwyer Award for extraordinary service to a chapter. He is a mechanical engineer and enjoys hiking and geocaching in New England with his wife and two children.
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