Stock options - What experts try to explain and you never understand - Part I

Do you really know how to get good earnings from stocks you hold on the long run? Do you know all the benefits of keeping a long term stock portfolio, increasing its size every month, consistently, no matter if you are positive or negative in profits for a specific month? What if you knew that a short to middle term sacrifice, reinvesting all you profits along one or two years, could ensure your lifetime retirement by giving you a constant and safe cash flow to complement your penny pension payments?

Most of us - plain vanilla human beings sitting on a sofa spending countless hours in front of TV - don't really worry about our retirement or even an additional income to grant ourselves a little safety for the future. The point is that if you call your bank manager and ask him for an advice about how to invest your penny surplus for the future, of course he/she will show you a dozen options of pension and mutual funds that will give you slightly above inflation returns, deducting huge administration fees that make banks skyrocket their profits.

What almost every small investor doesn't know is that you can do it by yourself, investing small amounts every month in the stock market (yes, the haunted stock market), monetizing your portfolio with covered call options and reinvesting all profits (option premium, dividends, etc.) buying more stocks. If your choice is a pension fund, you may just add a life insurance to support any event that may cause a serious loss (disability/life) if you have a family.

All these strategies will be detailed in upcoming hubs when I will explain exactly what you need to do, the best strategies to be followed according to your profile, and even some psychological tips that will prevent you to go panic when economic crisis hit the ground and everybody start behaving like freightened wild animals rushing towards the same direction.

For now, let's talk about two concepts that are the foundation of this simple, direct, results oriented strategy: stocks and call options. I'm not talking about technical explanation nor unreal formulas to make your brains melt. After a short to mid-term practice along with the study of the foundation of this market, you should be able to buy stocks, monetize with covered call options and stay calm either when markets are going up or down.

Stocks

Simply stating, it's a small piece of a company. As far as we know, companies are not created by act of God (although some companies behave like it was). Some of them were created by a small family investment, while others were born like giants with huge investments. But not differently, they have owners. Sometimes it can be one, two, ten, a hundred up to millions of owners. But how can a company manage such a broad range of owners and what's the advantage of doing that?

Well... diversity of ideas and opinions is one of them. If a company has thousands of owners it's much harder for a single person to take over control of every decision without the support of others. This way, they created stability and credibility because the market, clients, suppliers and investors know that a single crazy king won't start taking decisions based on his ego.

On the other hand, such companies must streamline the communication process and avoid bottlenecks that could slow down or even stop the information flow. Big companies don't follow the market, they create the market. At this point we're talking about giants such as Exxon, Google, Intel, Microsoft, JPMorganChase, among others. So, how the hell did I get 100 shares of Amazon.com? Does it mean I own the company?

Yes, you got it. You are one of millions of owners of Amazon, as well as others are owners of the above mentioned companies just to mention a few examples. You're probably a drop of an investor in the ocean of the stock market, but you have rights, as well as obligations, as you own part of that company. And when you own part of it, you may have profits, as well as losses. It's the same as if you had part of the bakery business on the corner of your neighborhood. If they sell much bread over the weekend, that's profit in your pocket. But if they couldn't make it for the month... well, you'd rather write off your losses.

When you buy 100 shares of a company it means that such company, somewhere in time, decided to leverage some funds to invest in its expansion, for instance. When they do that, they decide to "sell" part of the company in a big market place called stock exchange. If they need $1 billion to suit their needs, they will go there and offer to the market a certain number of shares that would add up to $1 billion in value. You, as well as thousands of other investors believe that the company will do great with this money, so you buy a certain number of shares.

That's it. You're now one of the owners and the company will give you part of its profits as a compensation for your investment. But the great news is that, once you buy the stocks, it's yours. You may realize that you invested $1,000 but now you got only $900. It means that the market thinks the company is not performing accordingly and its total market value is not $1,000 anymore. But rather than selling the shares because you're mad about it, you may keep it for a long period.

Why? Because very often these companies pay interest to their shareholders. Interest? Yes, they got your money as investment and now they need to give you a compensation. It's like saying to the shareholders "Thank you for your confidence. Here's your piece of the profit.". They also pay dividends, profit share and every other sum of money that the company is not using for expansion of the business or to cover extra expenses. On the long run, if you keep the shares in your portfolio you may have all your investment back within a decade and most probably will have an asset that is worth more than what you paid for it.

Buying stocks is almost the same as buying properties for rental. Investors who like buying properties are interested in accumulating properties rather than having small profits buying and selling stuff. They know there's a high cost in doing that. They pay commissions, taxes, documentation, and also spend a lot of time searching for bargains to buy and good clients to sell to. When it comes to stocks, if you start buying and selling them all the time, such behavior can wipe the money from your account because of the sum of commissions and taxes you're paying all the time.

Therefore, next time you consider buying stocks, think about it carefully. Just buy shares from companies you're a believer. If you don't believe the business will be successful, jump to another one. It's best when you buy shares from a company that is not in the spotlight but is always in the top 20 list along several years. Bear in mind that you have to take care of your future through the actions you take in the present. Don't be a fool thinking that you can be a millionaire overnight. It happens once in a million times, so you'd rather bet in the lottery if you think that way.

Now that you know something about shares, stocks and how companies get to the stock exchange, I feel it's time to explain a little bit more about investing in stocks. Perhaps some real data, mathematics and a couple graphics may help you understand. I'm writing hub # II so it doesn't became a book into a single capsule.