October 28, 2021 • 38 mins
Season 4 ending?? We are shocked as this whole segment has been very packed with information and also moved so quickly. In this episode we talk about derivatives. Options, futures, and so on. This is the most commonly used tool in the market trading community, especially in the Hedge Fund sector. This means that there is something of value to learn and we want you to know more about it!
Thank you for following us on Season 4! Season 5 is just around the corner. We have so much to still talk about but we are also running out of basics. Make sure to visit our facebook page for suggestions for what you want to hear about!
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Chris Holling (00:00):
This is the truth about investing back to basics
podcast where we want to helpyou take control of your
personal finance and long terminvestments.
If you're looking for a way tolearn the why and how investing,
then you found the right place.
Thank you for taking the time tolearn how to better yourselves.
(00:26):
We can just introduced fromhere, that's fine. Well,
welcome. Welcome, ladies andgentlemen, everybody back to
another episode of The Truthabout investing back to basics.
My name is Chris Holling.
Sean Cooper (00:41):
And I'm Sean Cooper.
Chris Holling (00:42):
Today, we're going to talk about derivatives.
Right?
Sean Cooper (00:47):
Exactly,
Chris Holling (00:48):
exactly. Which actually, I believe this is our
our season finale of the season.
Oh, shoot, is this four is theseason four.
Sean Cooper (00:57):
Sounds right.
Chris Holling (00:58):
You know, we just do so many of these that you
kind of lose track after a whileof seasons. Yeah, that sounds
right. Yeah, you're right.
You're right. So yeah, we'rewrapping up season four. Which
is kind of crazy, actually.
Yeah, I don't know. I'm looking.
I'm looking forward to to newthings and different things. And
(01:20):
I don't know what I'm talkingabout. Now. Tell me about
derivatives. Seanski.
Sean Cooper (01:26):
Nah that's not the way it starts. You get a say
what you get to tell everybodywhat you think derivatives are
and then I take over. It's lotmore fun that way. At least for
me.
Chris Holling (01:38):
Okay.
Well, in case you all don'tknow, let me tell you exactly
what a derivative is. Aderivative clearly is a when you
own. I believe this is true. Soif I'm completely wrong, then
I'm going to be completelyembarrassed. I believe.
(02:09):
Yes.
Sean Cooper (02:11):
No.
Chris Holling (02:12):
Oh, what the hell am I describing? Nothing.
Something that doesn't evenexist
Sean Cooper (02:20):
Dividends? I mean,
Chris Holling (02:21):
oh, maybe I'm describing dividends. The
other D word? That is fancy infinance.
Sean Cooper (02:27):
Um, yeah, sometimes I wish I think we should have
like a video cuz then you couldhave seen my facial expression.
Chris Holling (02:38):
And it would have been good if like, I still
couldn't see your face. So like,I would just keep making it
worse and worse and worse andworse. No, I no. Yeah. See, I
have no idea. That's, I'm so I'mso glad that I can entertain
you. With me, yeah. Okay, well,then I have no idea what a
(02:59):
derivative is. So your turn.
Sean Cooper (03:04):
Okay. So people familiar with mathematics will
understand that the basic ideaof derivatives and the the idea
in finance is fairly similar,it's, as opposed to the original
thing, it's a additional infinance, it's an additional
means of owning it in, inmathematics it would be the
(03:25):
equivalent of measuring theslope of a line but it's a
different means of owning anunderlying so it's a derivative
of an underlying asset.
Chris Holling (03:39):
Okay.
Sean Cooper (03:41):
There are four basic versions of derivatives.
Now the the one that most peopleare probably the most familiar
with are going to be options.
The most commonly trader areactually futures contracts, and
they're actually probably thesimplest to understand in
general terms. So a futurescontract is literally an
(04:02):
agreement to buy or sell acommodity at a set price on a
future date.
Chris Holling (04:14):
Okay.
Sean Cooper (04:15):
So as opposed to, you know, you go into the market
and saying, Okay, I want to buya bushel of corn. Is it a bushel
of corn? I feel like that'sright. Maybe
Chris Holling (04:29):
you could be right I just, I even even if you
are right, I can't think of atime that I've told somebody you
know, I would like to buy abushel of corn today. So I'm
going to go to the store.
Sean Cooper (04:38):
Well now you should probably do so just to see what
the reaction is.
Chris Holling (04:45):
I have to look it up. Or or kind of like a Murder
of Crows. Maybe it's a murder ofcorn. I'm looking it up now
bushel okay. Is it a bushel ofcorn? Sure. per bushel is 56
pounds.
Sean Cooper (05:05):
Yeah, there you go see?
Chris Holling (05:06):
I'm gonna buy 56 pounds of corn today. That's,
that's amazing. Yep, sure. Soyou go to the store to buy 56
pounds of corn or a bushel,
Sean Cooper (05:19):
right? So instead of buying something today, you
actually set a contract with thestore, or more likely a farmer
and say, Hey, I'd like to buy Xamount of corn from you. This is
the price that we'll agree upon.
And I'll buy it on this day. Thereason people enter into these
transactions is, you know, froma farmer's perspective, or, you
(05:42):
know, whoever's harvesting thethe commodity, whatever it is
oil, soybeans, natural gas,timber, whatever it is, whatever
commodity we're talking about.
From their standpoint, there's aprice risk. Okay. Every year, if
(06:04):
I'm harvesting wheat, I know I'mgoing to have a bunch of wheat
available for sale. On this day,sometime, mid, late summer, I
would assume I don't knowexactly when they harvest wheat,
I can tell you,
Chris Holling (06:20):
Wheat?
Sean Cooper (06:21):
Yes,
Chris Holling (06:22):
you don't know when they harvest wheat
Sean Cooper (06:23):
I cant tell you when they harvest like timothy
hay or something. Out here, theynormally get a couple of
cuttings. But anyway, the pointis, they know roughly when it's
going to be available, what theydon't know is what their price
is going to be at that point. Sothey use futures contracts,
basically, as a hedge to say,Okay, I'm going to enter into
(06:48):
this deal with this person, whois has said they will buy X
amount of wheat, in this casefrom me, at this price. So if
the price drops between now andthen I no longer have the risk
of having to sell my wheat at amuch lower price or, you know,
selling it basically at a losspotentially.
Chris Holling (07:10):
Right?
Sean Cooper (07:11):
You know, I know what the price is, I'm set, this
will cover my costs a little bitof profit, I'll take that the
offsetting risk is the pricecould go up and they lose out on
that because they've alreadyentered into this contract. That
is a futures contract. They'revery, they're very fixed
contracts, they arepredetermined. And people can
(07:35):
buy and sell and trade them atwill, very easily. But the point
is this, this contract is notthe underlying thing. I'm not
actually buying corn, I'm notactually buying wheat. If I buy
the futures contract, I'm, I'mbuying an agreement to buy or
sell it, I'm not necessarilybuying the underlying product
(07:57):
the underlying commodity. Okay.
And for, for investors, that'svery, very typical. They're not
they don't they have no desireto actually take possession of
the corn,
Chris Holling (08:09):
the 56 pounds of corn,
Sean Cooper (08:11):
right? I thought you said was 50 Yeah, 56? Yeah,
yeah, anyway
Chris Holling (08:15):
a murderer of corn.
Sean Cooper (08:22):
But they are happy to, you know, take profits on if
I can buy this futures contractthat says I'm going to, with the
futures contract, they're moreinterested in the fluctuation of
the underlying futures futureitself. So in, if we're talking
about the, the wheat, forexample, if they enter a
contract to sell for X price,and the price goes down, then
(08:49):
that futures contract is on thehook to sell, or rather, is in a
position to sell at a higherprice. So that futures contract,
the value of that contract willactually go up if the price has
gone down. Conversely, if theprice goes up, then that futures
contract that has agreed to sellat a lower price becomes less
(09:12):
valuable. So they're actuallytrading the the change in the
value of the future itself.
Based on the change in the valueof the underlying commodity,
Chris Holling (09:23):
okay,
Sean Cooper (09:24):
now, technically speaking, these futures can
reach their date and the personmay still not want to take
possession of the corn or theoil or whatever it is, in which
case, they just do a cashsettlement and, you know, the
whoever, whatever the thetransaction differential is, one
person one party just pays theother one the difference. But
(09:49):
the point is, so this is justone type of derivative where
you're not actually investing inthe underlying commodity. You're
investing in a contract to buyor sell the commodity. As I
said, this was designed so thatpeople who actually wanted the
underlying commodity or want todo so wanted to buy or sell the
underlying commodity could do soand remove some risk, basically
(10:12):
hedge their risk to a certaindegree. But from an investor's
standpoint, in many cases, theyjust buy and sell the contracts
themselves so that they canprofit from the underlying
change in value.
Chris Holling (10:26):
Gotcha. Okay.
Sean Cooper (10:27):
So that would be a few future. That's one type of
derivative. And another would bea forward contract, which is
very much like a future exceptit's customized between two
parties. So there, there aren'ta bunch of forward contracts out
there that you can just click onand buy and trade and stuff like
that, you know, two partiesactually get together hash out
(10:48):
the deal, and say, Okay, this iswhat we're going to do. And it's
very, very specific to those twoparties. So it's over the
counter, there's no, there's notthe same type of third party
trading that goes on in forwardcontracts, which also involves
some more credit risk on theparties that are there are
(11:09):
entering into the contract.
Typically speaking, it alsomeans that the parties entering
the contract are more likely tobe the the types that are
ultimately trying to, you know,buy or sell the underlying
commodity as opposed to justtrading. But it is still a
derivative, it is not theunderlying product you are
(11:30):
buying or selling a forwardcontract.
Chris Holling (11:34):
Okay.
Sean Cooper (11:36):
Okay. The one that people are most, probably most
familiar with would be options.
So again, they they trade freelyon the exchanges, you can buy
and sell options pretty much atwill. The difference being
instead of with a futurescontract, it is a contract to
(11:58):
actually buy or sell somethingat a set price on a certain
date. Options. Don't say thatyou are going to buy or sell
something, it gives you theliterally the option to buy or
sell something.
Chris Holling (12:15):
Oh, okay.
Sean Cooper (12:17):
You see the distrinction there?
Chris Holling (12:18):
like claiming claiming dibs.
Sean Cooper (12:21):
Yeah, yeah, if you will, if you will. Yeah, but
Chris Holling (12:23):
Financial investing dibs.
Sean Cooper (12:26):
Right, but there's no actual obligation to do so at
least on one partys side, thereis on the other partys side. So
for example, if I there arecalls and puts. So a call is the
option to buy. A typically we'retalking about stocks here.
(12:47):
Whereas a put is the option tosell. So if so you can sell or
buy a call and sell or buy aput,
Chris Holling (12:57):
okay.
Sean Cooper (12:59):
So for example, if I sold you a call, I'm selling
you the option to buy a stockfrom me,
Chris Holling (13:09):
okay?
Sean Cooper (13:10):
What that means is you now if you bought it, so you
pay me something for thatoption. And you now have the
option to buy that stock fromme, within a certain time period
at a set price,
Chris Holling (13:24):
okay.
Sean Cooper (13:26):
But you are not in under any obligation to actually
execute that option. So you canchoose to let it expire
worthless, you can sell it toanother third party. Or you can
execute the option and say, Yes,I'm going to buy that from you.
Most likely, because the theprice has gone up. So for
example, if you buy an option tobuy a stock from me for $50, and
(13:51):
the price of that stock goes to$60, then you would execute your
option to buy from me at 50 andthen go into the market and sell
those shares that you justbought from me for $50. You
would sell them for $60 and makea nice profit, minus whatever
you paid me for the optionitself.
Chris Holling (14:10):
Okay.
I think that makes sense.
Sean Cooper (14:12):
So
Chris Holling (14:13):
So what
Sean Cooper (14:14):
go ahead
Chris Holling (14:14):
Sorry, well, I was I was gonna ask, so what if?
What if I decide to, to not gothrough with it? Like, is it
just a? Hey, thanks for givingme the chance or does it? Does
it cost you to to not go throughwith it? Or does the cost happen
on the initial side when you sayI want this option in the
future?
Sean Cooper (14:33):
Yeah, it happens on the the initial,
Chris Holling (14:36):
okay?
Sean Cooper (14:36):
You have to actually buy the option from me.
So we're talking probably inthat scenario, maybe you paid a
you know, a buck a share,
Chris Holling (14:45):
right.
Sean Cooper (14:46):
So, typical options contracts are 100 shares. So,
you honestly you probably paidlike 20 bucks,
Chris Holling (14:53):
okay
Sean Cooper (14:54):
to to control that option to buy. And so, for 20
bucks If you had the option tobuy 100 shares from me at $50
per share,
Chris Holling (15:04):
okay,
Sean Cooper (15:04):
which was, what five grand worth of the stock?
So? Yeah, and then in ourscenario, if it went to 60, you
could have sold for six, youmake $1,000. But you only paid
20 for the option itself.
Okay, so But inthat scenario I was obligated to
Chris Holling (15:21):
Okay?
sell to you, if you chose toexecute, you were not obligated
to actually execute the option.
Now, the way the markets set upif there was, you know, profit
on your end, even if you've hadforgotten about it, most, most
exchanges will automaticallyexecute it at the expiration
(15:42):
date on your behalf if there wasprofit to be had. So if it had
gone up to say, you know, $51 ashare, it would probably, it
would most likely automaticallyjust execute the option for you.
And you get your dollar a share,and basically breakeven in that
scenario. But you do a littlemore than breakeven?
(16:06):
Sure,
Sean Cooper (16:06):
you get about 80 bucks, I guess. But anyway,
conversely, so with a putt, if Isell you a putt, I'm selling you
the option to sell to me.
Chris Holling (16:22):
Right?
Sean Cooper (16:23):
Is that convoluted enough?
Chris Holling (16:25):
Perpetually, but I mean,
Sean Cooper (16:27):
Ok, so, so more more often than not, you're
looking at it from thestandpoint of the person buying
the putt. So if I bought a putt,I am buying the option to sell.
Chris Holling (16:37):
Okay.
Sean Cooper (16:40):
So I might buy the option to sell because I wanted
to hedge against the the marketgoing down. So for example, in
our $50 example, you know, Imight buy an up by a put at, say
$48. So it's less than thecurrent price. But if the market
(17:04):
does poorly, and my share pricegoes down to $40 per share, then
I can execute my option to sellat 48.
Chris Holling (17:13):
Okay,
Sean Cooper (17:14):
okay, so if I'm selling someone, a put, I'm
selling them the option to sellto me, which would mean I'm
obligated to buy if they chooseto, to execute. So as opposed to
being obligated to sell so youcan be the buyer of a call or
put and you can be the seller ofa call or put any of that you
(17:39):
need me to clear upor provide examples on
Chris Holling (17:40):
no, I guess not, I guess maybe where I'm trying
to, to figure that all out in myhead is that may I don't even
have a good way to describethis. Because then when you
exist as the buyer or seller,then you're you're going to be
transitioning into it again,later on. And but I guess it's
not like you're gonnaimmediately? I don't know, I
(18:03):
don't know, I don't know, Ithink I'm just trying to take
the whole picture in as a wholebecause it's just several moving
parts of like, this will happenin the future, but only if you
buy the option but only if youchoose to after you buy the
option and I'm I'm just I'mfollowing I think
Sean Cooper (18:21):
right right. So where the future contract is is
this is going to happen there isgoing to be some exchange some
of either the commodity andvalue for the commodity or
there's just going to be a cashsettlement. Whereas with the
option, there's not necessarilygoing to be any exchange that
occurs unless it unless theoption is executed. The initial
(18:45):
exchange is the purchase or saleof the option itself.
Chris Holling (18:51):
Okay.
Sean Cooper (18:52):
So you pay a small premium for the option to buy or
sell. And then down the road ifit's profitable to do so, you
execute that option to buy orsell or on the other side of the
coin you can be the seller ofthe option to buy or sell as
(19:16):
opposed to the buyer. So the thebuyer of a call is bullish on
the market. The seller isbearish. The buyer of a put is
bearish and the seller of a putis bullish. I think I said that
(19:41):
right.
Chris Holling (19:41):
I think so.
Because the bullish is up,bearish is down like the bullish
of a horn sweeping up and abearish of a claw coming down is
how I Remember from our previousendeavors, right?
Sean Cooper (19:58):
Right.
So even though this is Morecomplicated to understand, per
se, and gets even morecomplicated if you get into some
of the interesting tradingstrategies behind it,
Chris Holling (20:08):
right.
Sean Cooper (20:10):
This is actually the most commonly traded for
most investors is options, notfutures and forwards,
Chris Holling (20:18):
okay.
Sean Cooper (20:18):
So, now futures are volume wise futures are traded
more actively because, you know,hedge funds and the like are are
trading them in massivequantities, whereas options are
typically not traded in suchmassive quantities per se.
Chris Holling (20:39):
So, because futures are more commonly
happening in in volume is thatbecause of what you're
describing, like different hedgefunds account and whatnot or
Sean Cooper (20:49):
right, the account size is much larger.
In fact, the futures market islarger than the market for the
underlying commodities.
Chris Holling (20:59):
And what about for you? Where do you tend to do
a majority of your stuff? Do youdo a lot of options? Do you tend
to get involved in a lot offutures? Just you personally or
Sean Cooper (21:08):
me? Personally, I trade options. However, I do
utilize strategies that tradefutures.
Chris Holling (21:19):
Okay,
Sean Cooper (21:20):
so since I'm not trading them directly, I still
like them to be in a portfolio.
For various reasons. We talkedabout managed futures in our
prior episode on alternatives.
So that's where, where that fitsin.
Chris Holling (21:33):
Okay,
Sean Cooper (21:34):
but I'm not doing the trading myself, I'm
outsourcing that basically to amutual fund or a hedge fund.
Chris Holling (21:41):
Okay.
Sean Cooper (21:42):
Yep. So specifically where I trade
options, the most would becovered calls. So we've talked a
little bit about thispreviously, but a covered call.
So there's, obviously calls andputs but a covered call would be
where you actually own theunderlying so if I'm selling a
(22:04):
call, so I sell you the optionto buy from me
Chris Holling (22:08):
Right
Sean Cooper (22:08):
a covered call would be where I already own the
underlying stock. So I alreadyown it, I sell you the option to
buy from me, I'm covered becauseI already have the stock, I
don't have to, you know, if youdecide to execute your option to
buy, I have the stock, I canjust give it to you at the sale
price, we're good to go. A nakedcall would be I sell you that
(22:30):
call the option to buy from me,but I don't actually have the
underlying stock. That would bea naked call selling a naked
call,
Chris Holling (22:39):
because you would have it attached elsewhere for
you to make that purchase. Orit's just, that's just
Sean Cooper (22:48):
literally if you if you decide if you decide to
execute your option to buy fromme,
Chris Holling (22:54):
right,
Sean Cooper (22:55):
I would the exchange would instantly have to
go out and buy this underlyingstock on my behalf so that I
could then sell it to you. Whichmost likely would result in me
taking a loss of some sort.
Chris Holling (23:10):
Gotcha. And is that something that you have to
like look for? Or is that a isthat part of a discussion that
you have, like, hey, I can seethis option, but it's a it's a
covered call? Or it's not? Orwhat?
Sean Cooper (23:21):
When you buy a call, you don't know if it's
covered or naked?
Chris Holling (23:25):
Oh, okay.
Sean Cooper (23:26):
It doesn't matter the the exchange is going to
automatically make it happen.
Chris Holling (23:30):
Okay,
Sean Cooper (23:31):
so yeah. The, but the risk in that that naked call
is on the the seller in thatscenario,
Chris Holling (23:41):
okay, that makes sense
Sean Cooper (23:42):
Because, yeah, if, if the markets gone way up,
they're on the hook to buy that,that stock so that they can
actually then sell it to youwith that most likely much lower
price that you've agreed to.
Chris Holling (23:54):
Got it. Okay.
Sean Cooper (23:57):
So that's why the covered call is a much safer
play. In fact, selling coveredcalls creates a nice stream of
profit from the sale of thecall, plus you sell them out of
the money meaning that if ifthey're going to be executed, at
least I do, you sell them out ofthe money so that if they are
executed, in addition to takingthe profit from the the premium
(24:20):
from selling the call in thefirst place, you also make a
little bit more money on theunderlying stock when you sell
it too, maybe not as much aswhat the market has gone to. But
you've still made additionalmoney as well. And typically
what I found just out of marketvolatility, you can still get
back in wherever you sold out ifyou really want to. So
Chris Holling (24:39):
Gotcha.
Sean Cooper (24:41):
Those that little profit from the premium can help
buoy returns a little bit indown markets and add a little
bit especially in a flat market.
It doesn't add as much in a bullmarket because most likely
you're going to be the option isgoing to be executed, in which
case you sell. And you hopefullycan still keep pace with the
(25:05):
bull market, but it depends onhow things go.
Chris Holling (25:09):
Right? Okay.
Sean Cooper (25:12):
So yeah, so that's, that would be options calls and
puts. option to buy. The calloption to sell is the put and
you can be a buyer or seller ofeither the last derivative I was
going to talk about would be aswap, and derivative and swaps
(25:36):
are actually on a completelydifferent asset. So, futures
forwards, typically we'redealing with commodities,
options, most commonly arestocks. Swaps are actually
interest rates. So for the mostpart, and so you're actually
dealing with swapping outinterest rate risk hedging
(25:58):
interest rate, because that'swhat most, most derivatives are
designed, or utilized as ahedge. So, for example, if
you're repaying a loan forsomething, and it is tied to
prime, so the prime rate or theinterbank offer rate, the
(26:21):
interest rate that you're payingis probably that that prime rate
plus x plus two or somethingalong those lines. So you have a
variable rate, it's like an ifyou have like an arm on a
mortgage, where you pay a fixedrate for like five years, and
then after that it floats basedon the LIBOR or prime, or you
(26:45):
know, depending on where you'reat plus a certain percentage. So
as if interest rates go up, theinterest that you're paying goes
up, if they go down the interestthat you're paying, that goes
down. So if you want to takesome of that risk off the table,
some of the risk that theinterest rates could go up, and
that causes your payment to goup, you can actually do a swap
where someone else you, you swapwith someone else, and you pay
(27:09):
them a fixed rate and mostlikely a slightly higher fixed
rate, but they will end uppaying you the variable rate. So
you end up just if if the fixedrate is still higher than the
variable, you pay them thedifference, and if the variable
rate ends up going higher thanthe fixed rate, they pay you the
difference. So you're hedgingthat, that risk away.
Chris Holling (27:35):
Okay, so it's it's not just like the action of
saying a refinance of any sort,like it's, I mean, like, I
imagine taking a loan to a bankand going through the process of
refinancing with them would bekind of like a, a small, more
direct version of doing your ownkind of swap. But you're saying
(27:56):
that this exists as a I'm doinga swap option between interest
rates, and then if if thisvariable rate fluctuates, then
the payout lands somewhere? Isthat what I'm understanding?
Sean Cooper (28:08):
Correct? Yeah. This typically isn't something done
by your average person on amortgage, we're typically
talking about very largecompanies dealing with, you
know, hundreds of millions orbillions of dollars of loans
that they are trying to hedgetheir rates. And no, it's not
not the equivalent to arefinance. They're not actually
refinancing anything. They'reliterally taking one payment and
(28:32):
swapping it out for a differentpayment with a most likely a
different company.
Chris Holling (28:38):
Gotcha. Okay, that makes a lot more sense.
Sean Cooper (28:40):
Yeah. And like I said, Yeah, most most of the
time, you're dealing with somekind of variable rate and
swapping it out for a fixed or,and swapping it out for a fixed
or vice versa. Depending on whatside of the coin you're on, if
you think interest rates aregoing to go down, maybe you want
to swap your fixed out for avariable.
Chris Holling (29:01):
And the swap is something that I've I've just
never even heard of before. Theother things I've at least heard
of, and I can always understanda little bit better. But with
the swap, it's, it's justsomething I haven't even come
across. So is that the sameprocess that you would that you
would talk through a custodianto get access to a swap or what
where do you find swaps anyways?
Sean Cooper (29:20):
Nah you're most likely dealing with a bank, some
kind of large lender, largelender, custodians typically not
going to be dealing with that.
Chris Holling (29:28):
Okay. Cool. That makes sense.
Sean Cooper (29:33):
Yep. That is the extent of what I was gonna plan
on covering with derivatives. Iguess I could I've mentioned a
number of different tradingstrategies with options I mean,
you've got spreads, straddles,iron condors, all sorts of
(29:53):
different random tradingstrategies that you can employ
with. I mentioned covered calls
Chris Holling (29:57):
man straddles.
Iron condors bushel of corn
Sean Cooper (30:03):
They have some fun names,
Chris Holling (30:05):
this is a a heck of a day of visualizations,
Sean Cooper (30:10):
options traders, the really successful options
traders will narrow in on onestrategy and they get really,
really good at it. And that'sall they do. They don't mess
around with other strategies asthey go along. And that's just
Yeah. So something something tolook up, maybe something we'll
talk about in the future, ifsomebody is interested, but
(30:32):
Well, I guess I'll leave it atthat for now.
Chris Holling (30:36):
We cool
Sean Cooper (30:36):
pique your interest.
Chris Holling (30:37):
Okay. Well, then derivative, you know, and I
mean, I knew about some ofthese, like I was talking about,
like, I feel like I was aware ofan option. And maybe that's
because we talked about it atsome point in time, but I think
this is a good in depth portionof of some of these things and
some of these considerations.
Sean Cooper (30:56):
Good.
Chris Holling (30:58):
I like that?
Okay?
Sean Cooper (30:59):
Yeah. So all those times that we've talked about
derivatives in the past now.
Now, people will actually knowwhat we're talking about,
Chris Holling (31:06):
right?
Sean Cooper (31:06):
Maybe we should have put this a little earlier
but, what the heck
Chris Holling (31:10):
woulda, coulda, shoulda. That's okay. At least
at least now we know it's notwhatever I was trying to
describe at the start of this.
if I knew I was gonna be thatwrong, I would have gone down
the road of like, oh, you know,a derivative is this, this
process that you do when you'rewhen you're at the circus,
(31:32):
right? You you go and you getthis the sack of derivatives and
you go down the road? And you'relike I would have I would have
completely gone the other waywith it. If I knew I was going
to be that wrong. What do Iknow?
Sean Cooper (31:46):
Well, I feel like there was one that you did that
with
Chris Holling (31:49):
a
Sean Cooper (31:50):
I can't remember which one it was
Chris Holling (31:52):
man, that was security analysis. Yes, I
decided that there was a therewas a you analyze the security
company and and
Sean Cooper (32:06):
I liked that one though. It was creative.
Chris Holling (32:08):
Bowser shows up or something like that. Thank
you. Yeah, I appreciate that.
But it clearly drained all mycreative juices, because now I'm
just flat wrong.
Sean Cooper (32:17):
The irony is I think you actually understood
security analysis to a certaindegree, it was just not
necessarily something you weregoing to explain to someone else
per se.
Chris Holling (32:27):
Well, now you're just giving me too much credit.
Let's wrap it up
Sean Cooper (32:34):
Oh, yeah. Next season.
Chris Holling (32:37):
Next season, we should talk about next season
next season. We are kind ofwe're kind of dipping back into
insurance a little bit again.
And
Sean Cooper (32:49):
Life insurance
Chris Holling (32:50):
life insurance specifically. It was it was
something that we talked aboutwhere we said hey, we should
touch on this. Oh, my we need toactually do two of these. Oh,
wait, did did you? Did you wantto do like actually digestible
amounts? Or do you want to justabsolutely hit one big long one
(33:10):
I said I can't, I can't, Sean.
I can't.
So we're doing small dosages.
And so we're hoping for theepisodes to be a little bit
shorter than we typically do sothat you can take it as it comes
in. It's not one big overloadingthing. But it's it's kind of
turned into I guess you couldcall it a bonus season, but it
will be Season Five for uscoming up next. And we're gonna
(33:31):
be getting that out to justreally just as soon as we can. I
think we got a break happeningin between a couple of seasons
here and there, but we're gonnaget on it. Is there anything
else on it on the on the futureseason then you can think of
Sean Cooper (33:47):
no that sounds pretty good.
Chris Holling (33:48):
Okay, well good.
Sean Cooper (33:50):
Good summary
Chris Holling (33:51):
Good. I'm glad.
Well, thank you everybody forcoming back out enjoying the
season four as we're rounding upon that. And then we're, you
know, I keep saying that we'recoming closer to the end. But we
we kind of are we after seasonfive that we have a very
specific goal than we haveseason six and we have like,
four or five episodes listed inthere right now. And then the
(34:14):
then the world is our burrito.
Or chimichanga I likechimichangas actually
Sean Cooper (34:22):
Isn't the saying the world is our oyster.
Chris Holling (34:24):
Yeah, well, I don't listen to that. I think it
was weird Al that gave me theworld is our burrito. So I've
stuck with it.
Sean Cooper (34:29):
I mean, I definitely prefer burritos over
oysters.
Chris Holling (34:32):
I did have oysters the other day. It was
delicious. Okay, see, now thisis this is why we need to have a
season that just has absolutelynothing to do with any of this.
We'll talk about oysters andburritos an oyster burrito.
Perhaps that'd be great.
Sean Cooper (34:44):
Didn't Phylecia start this on us the whole
California burrito concept withfrench fries
Chris Holling (34:48):
Yeah, well, you know, what if somebody would if
somebody would actually link toour page, a picture of a
burrito? Then maybe
Sean Cooper (34:55):
That's right
Chris Holling (34:56):
maybe we'd talk about burritos more often
Sean Cooper (34:57):
both of us failed
Chris Holling (34:59):
Yeah, well You know, so did our followers
failing. Okay, now I'm insultingour followers. I'm sorry I
Sean Cooper (35:05):
speaking of maybe you
maybe you should post some ofthese on Facebook
Chris Holling (35:12):
I know.
Sean Cooper (35:15):
Anyway, thanks again.
Chris Holling (35:18):
Thanks. Thanks for joining us. Here at the
truth about investing back tobasics. My name is Chris
Holling.
Sean Cooper (35:24):
And I'm Sean Cooper,
Chris Holling (35:25):
and we will catch you in the next season. Podcast
disclaimer disclaimer. Thedisclaimer following this
disclaimer is the disclaimerthat is required for this
podcast to be up and running andfully functioning. Moving
forward. This is going to be thesame disclaimer that you will
(35:46):
hear in each one of ourepisodes. We hope you enjoy it
just as much as we enjoyedmaking it. all content on this
podcast and accompanyingtranscript is for informational
purposes only opinions expressedherein by Sean Cooper are solely
those of fit financialconsulting LLC unless otherwise
specifically cited. ChrisHolling that's me is not
(36:10):
affiliated with Fit financialconsulting LLC nor do the views
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This podcast is intended to beused and it's entirety. Any
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in this podcast is intended aslegal accounting or tax advice
(36:34):
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This podcast may refer towebsites for the convenience of
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(36:56):
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(37:19):
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(37:44):
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consumer should contact theirstate securities administrator.
Amen. You know, actually youwant to know something real
stupid. I was just thinking tomyself just now. Oh, I just
(38:07):
heard this funny joke. Thismorning. I should tell him that
joke. That was pretty good. Andthen I realized the reason that
I heard it this morning was Iwas editing our previous podcast
it would have been the exactsame
Sean Cooper (38:21):
It was one of your jokes
Chris Holling (38:23):
It was even one that I told like it was I like
this.
Sean Cooper (38:26):
This is a great joke. I should totaly tell him.
Chris Holling (38:29):
I wonder. I wonder if he knows this joke
Sean Cooper (38:31):
Oh, wait I guess I already have
Chris Holling (38:32):
I was I was literally in the midst of
editing that joke and I waslike, what was that? Oh, that
was that was pretty.
Sean Cooper (38:40):
Sounds like the joke's on you buddy.
Chris Holling (38:44):
Well said
This is the truth about investing back to basics
podcast where we want to helpyou take control of your
personal finance and long terminvestments.
If you're looking for a way tolearn the why and how investing,
then you found the right place.
Thank you for taking the time tolearn how to better yourselves.
(00:26):
We can just introduced fromhere, that's fine. Well,
welcome. Welcome, ladies andgentlemen, everybody back to
another episode of The Truthabout investing back to basics.
My name is Chris Holling.
Sean Cooper (00:41):
And I'm Sean Cooper.
Chris Holling (00:42):
Today, we're going to talk about derivatives.
Right?
Sean Cooper (00:47):
Exactly,
Chris Holling (00:48):
exactly. Which actually, I believe this is our
our season finale of the season.
Oh, shoot, is this four is theseason four.
Sean Cooper (00:57):
Sounds right.
Chris Holling (00:58):
You know, we just do so many of these that you
kind of lose track after a whileof seasons. Yeah, that sounds
right. Yeah, you're right.
You're right. So yeah, we'rewrapping up season four. Which
is kind of crazy, actually.
Yeah, I don't know. I'm looking.
I'm looking forward to to newthings and different things. And
(01:20):
I don't know what I'm talkingabout. Now. Tell me about
derivatives. Seanski.
Sean Cooper (01:26):
Nah that's not the way it starts. You get a say
what you get to tell everybodywhat you think derivatives are
and then I take over. It's lotmore fun that way. At least for
me.
Chris Holling (01:38):
Okay.
Well, in case you all don'tknow, let me tell you exactly
what a derivative is. Aderivative clearly is a when you
own. I believe this is true. Soif I'm completely wrong, then
I'm going to be completelyembarrassed. I believe.
(02:09):
Yes.
Sean Cooper (02:11):
No.
Chris Holling (02:12):
Oh, what the hell am I describing? Nothing.
Something that doesn't evenexist
Sean Cooper (02:20):
Dividends? I mean,
Chris Holling (02:21):
oh, maybe I'm describing dividends. The
other D word? That is fancy infinance.
Sean Cooper (02:27):
Um, yeah, sometimes I wish I think we should have
like a video cuz then you couldhave seen my facial expression.
Chris Holling (02:38):
And it would have been good if like, I still
couldn't see your face. So like,I would just keep making it
worse and worse and worse andworse. No, I no. Yeah. See, I
have no idea. That's, I'm so I'mso glad that I can entertain
you. With me, yeah. Okay, well,then I have no idea what a
(02:59):
derivative is. So your turn.
Sean Cooper (03:04):
Okay. So people familiar with mathematics will
understand that the basic ideaof derivatives and the the idea
in finance is fairly similar,it's, as opposed to the original
thing, it's a additional infinance, it's an additional
means of owning it in, inmathematics it would be the
(03:25):
equivalent of measuring theslope of a line but it's a
different means of owning anunderlying so it's a derivative
of an underlying asset.
Chris Holling (03:39):
Okay.
Sean Cooper (03:41):
There are four basic versions of derivatives.
Now the the one that most peopleare probably the most familiar
with are going to be options.
The most commonly trader areactually futures contracts, and
they're actually probably thesimplest to understand in
general terms. So a futurescontract is literally an
(04:02):
agreement to buy or sell acommodity at a set price on a
future date.
Chris Holling (04:14):
Okay.
Sean Cooper (04:15):
So as opposed to, you know, you go into the market
and saying, Okay, I want to buya bushel of corn. Is it a bushel
of corn? I feel like that'sright. Maybe
Chris Holling (04:29):
you could be right I just, I even even if you
are right, I can't think of atime that I've told somebody you
know, I would like to buy abushel of corn today. So I'm
going to go to the store.
Sean Cooper (04:38):
Well now you should probably do so just to see what
the reaction is.
Chris Holling (04:45):
I have to look it up. Or or kind of like a Murder
of Crows. Maybe it's a murder ofcorn. I'm looking it up now
bushel okay. Is it a bushel ofcorn? Sure. per bushel is 56
pounds.
Sean Cooper (05:05):
Yeah, there you go see?
Chris Holling (05:06):
I'm gonna buy 56 pounds of corn today. That's,
that's amazing. Yep, sure. Soyou go to the store to buy 56
pounds of corn or a bushel,
Sean Cooper (05:19):
right? So instead of buying something today, you
actually set a contract with thestore, or more likely a farmer
and say, Hey, I'd like to buy Xamount of corn from you. This is
the price that we'll agree upon.
And I'll buy it on this day. Thereason people enter into these
transactions is, you know, froma farmer's perspective, or, you
(05:42):
know, whoever's harvesting thethe commodity, whatever it is
oil, soybeans, natural gas,timber, whatever it is, whatever
commodity we're talking about.
From their standpoint, there's aprice risk. Okay. Every year, if
(06:04):
I'm harvesting wheat, I know I'mgoing to have a bunch of wheat
available for sale. On this day,sometime, mid, late summer, I
would assume I don't knowexactly when they harvest wheat,
I can tell you,
Chris Holling (06:20):
Wheat?
Sean Cooper (06:21):
Yes,
Chris Holling (06:22):
you don't know when they harvest wheat
Sean Cooper (06:23):
I cant tell you when they harvest like timothy
hay or something. Out here, theynormally get a couple of
cuttings. But anyway, the pointis, they know roughly when it's
going to be available, what theydon't know is what their price
is going to be at that point. Sothey use futures contracts,
basically, as a hedge to say,Okay, I'm going to enter into
(06:48):
this deal with this person, whois has said they will buy X
amount of wheat, in this casefrom me, at this price. So if
the price drops between now andthen I no longer have the risk
of having to sell my wheat at amuch lower price or, you know,
selling it basically at a losspotentially.
Chris Holling (07:10):
Right?
Sean Cooper (07:11):
You know, I know what the price is, I'm set, this
will cover my costs a little bitof profit, I'll take that the
offsetting risk is the pricecould go up and they lose out on
that because they've alreadyentered into this contract. That
is a futures contract. They'revery, they're very fixed
contracts, they arepredetermined. And people can
(07:35):
buy and sell and trade them atwill, very easily. But the point
is this, this contract is notthe underlying thing. I'm not
actually buying corn, I'm notactually buying wheat. If I buy
the futures contract, I'm, I'mbuying an agreement to buy or
sell it, I'm not necessarilybuying the underlying product
(07:57):
the underlying commodity. Okay.
And for, for investors, that'svery, very typical. They're not
they don't they have no desireto actually take possession of
the corn,
Chris Holling (08:09):
the 56 pounds of corn,
Sean Cooper (08:11):
right? I thought you said was 50 Yeah, 56? Yeah,
yeah, anyway
Chris Holling (08:15):
a murderer of corn.
Sean Cooper (08:22):
But they are happy to, you know, take profits on if
I can buy this futures contractthat says I'm going to, with the
futures contract, they're moreinterested in the fluctuation of
the underlying futures futureitself. So in, if we're talking
about the, the wheat, forexample, if they enter a
contract to sell for X price,and the price goes down, then
(08:49):
that futures contract is on thehook to sell, or rather, is in a
position to sell at a higherprice. So that futures contract,
the value of that contract willactually go up if the price has
gone down. Conversely, if theprice goes up, then that futures
contract that has agreed to sellat a lower price becomes less
(09:12):
valuable. So they're actuallytrading the the change in the
value of the future itself.
Based on the change in the valueof the underlying commodity,
Chris Holling (09:23):
okay,
Sean Cooper (09:24):
now, technically speaking, these futures can
reach their date and the personmay still not want to take
possession of the corn or theoil or whatever it is, in which
case, they just do a cashsettlement and, you know, the
whoever, whatever the thetransaction differential is, one
person one party just pays theother one the difference. But
(09:49):
the point is, so this is justone type of derivative where
you're not actually investing inthe underlying commodity. You're
investing in a contract to buyor sell the commodity. As I
said, this was designed so thatpeople who actually wanted the
underlying commodity or want todo so wanted to buy or sell the
underlying commodity could do soand remove some risk, basically
(10:12):
hedge their risk to a certaindegree. But from an investor's
standpoint, in many cases, theyjust buy and sell the contracts
themselves so that they canprofit from the underlying
change in value.
Chris Holling (10:26):
Gotcha. Okay.
Sean Cooper (10:27):
So that would be a few future. That's one type of
derivative. And another would bea forward contract, which is
very much like a future exceptit's customized between two
parties. So there, there aren'ta bunch of forward contracts out
there that you can just click onand buy and trade and stuff like
that, you know, two partiesactually get together hash out
(10:48):
the deal, and say, Okay, this iswhat we're going to do. And it's
very, very specific to those twoparties. So it's over the
counter, there's no, there's notthe same type of third party
trading that goes on in forwardcontracts, which also involves
some more credit risk on theparties that are there are
(11:09):
entering into the contract.
Typically speaking, it alsomeans that the parties entering
the contract are more likely tobe the the types that are
ultimately trying to, you know,buy or sell the underlying
commodity as opposed to justtrading. But it is still a
derivative, it is not theunderlying product you are
(11:30):
buying or selling a forwardcontract.
Chris Holling (11:34):
Okay.
Sean Cooper (11:36):
Okay. The one that people are most, probably most
familiar with would be options.
So again, they they trade freelyon the exchanges, you can buy
and sell options pretty much atwill. The difference being
instead of with a futurescontract, it is a contract to
(11:58):
actually buy or sell somethingat a set price on a certain
date. Options. Don't say thatyou are going to buy or sell
something, it gives you theliterally the option to buy or
sell something.
Chris Holling (12:15):
Oh, okay.
Sean Cooper (12:17):
You see the distrinction there?
Chris Holling (12:18):
like claiming claiming dibs.
Sean Cooper (12:21):
Yeah, yeah, if you will, if you will. Yeah, but
Chris Holling (12:23):
Financial investing dibs.
Sean Cooper (12:26):
Right, but there's no actual obligation to do so at
least on one partys side, thereis on the other partys side. So
for example, if I there arecalls and puts. So a call is the
option to buy. A typically we'retalking about stocks here.
(12:47):
Whereas a put is the option tosell. So if so you can sell or
buy a call and sell or buy aput,
Chris Holling (12:57):
okay.
Sean Cooper (12:59):
So for example, if I sold you a call, I'm selling
you the option to buy a stockfrom me,
Chris Holling (13:09):
okay?
Sean Cooper (13:10):
What that means is you now if you bought it, so you
pay me something for thatoption. And you now have the
option to buy that stock fromme, within a certain time period
at a set price,
Chris Holling (13:24):
okay.
Sean Cooper (13:26):
But you are not in under any obligation to actually
execute that option. So you canchoose to let it expire
worthless, you can sell it toanother third party. Or you can
execute the option and say, Yes,I'm going to buy that from you.
Most likely, because the theprice has gone up. So for
example, if you buy an option tobuy a stock from me for $50, and
(13:51):
the price of that stock goes to$60, then you would execute your
option to buy from me at 50 andthen go into the market and sell
those shares that you justbought from me for $50. You
would sell them for $60 and makea nice profit, minus whatever
you paid me for the optionitself.
Chris Holling (14:10):
Okay.
I think that makes sense.
Sean Cooper (14:12):
So
Chris Holling (14:13):
So what
Sean Cooper (14:14):
go ahead
Chris Holling (14:14):
Sorry, well, I was I was gonna ask, so what if?
What if I decide to, to not gothrough with it? Like, is it
just a? Hey, thanks for givingme the chance or does it? Does
it cost you to to not go throughwith it? Or does the cost happen
on the initial side when you sayI want this option in the
future?
Sean Cooper (14:33):
Yeah, it happens on the the initial,
Chris Holling (14:36):
okay?
Sean Cooper (14:36):
You have to actually buy the option from me.
So we're talking probably inthat scenario, maybe you paid a
you know, a buck a share,
Chris Holling (14:45):
right.
Sean Cooper (14:46):
So, typical options contracts are 100 shares. So,
you honestly you probably paidlike 20 bucks,
Chris Holling (14:53):
okay
Sean Cooper (14:54):
to to control that option to buy. And so, for 20
bucks If you had the option tobuy 100 shares from me at $50
per share,
Chris Holling (15:04):
okay,
Sean Cooper (15:04):
which was, what five grand worth of the stock?
So? Yeah, and then in ourscenario, if it went to 60, you
could have sold for six, youmake $1,000. But you only paid
20 for the option itself.
Okay, so But inthat scenario I was obligated to
Chris Holling (15:21):
Okay?
sell to you, if you chose toexecute, you were not obligated
to actually execute the option.
Now, the way the markets set upif there was, you know, profit
on your end, even if you've hadforgotten about it, most, most
exchanges will automaticallyexecute it at the expiration
(15:42):
date on your behalf if there wasprofit to be had. So if it had
gone up to say, you know, $51 ashare, it would probably, it
would most likely automaticallyjust execute the option for you.
And you get your dollar a share,and basically breakeven in that
scenario. But you do a littlemore than breakeven?
(16:06):
Sure,
Sean Cooper (16:06):
you get about 80 bucks, I guess. But anyway,
conversely, so with a putt, if Isell you a putt, I'm selling you
the option to sell to me.
Chris Holling (16:22):
Right?
Sean Cooper (16:23):
Is that convoluted enough?
Chris Holling (16:25):
Perpetually, but I mean,
Sean Cooper (16:27):
Ok, so, so more more often than not, you're
looking at it from thestandpoint of the person buying
the putt. So if I bought a putt,I am buying the option to sell.
Chris Holling (16:37):
Okay.
Sean Cooper (16:40):
So I might buy the option to sell because I wanted
to hedge against the the marketgoing down. So for example, in
our $50 example, you know, Imight buy an up by a put at, say
$48. So it's less than thecurrent price. But if the market
(17:04):
does poorly, and my share pricegoes down to $40 per share, then
I can execute my option to sellat 48.
Chris Holling (17:13):
Okay,
Sean Cooper (17:14):
okay, so if I'm selling someone, a put, I'm
selling them the option to sellto me, which would mean I'm
obligated to buy if they chooseto, to execute. So as opposed to
being obligated to sell so youcan be the buyer of a call or
put and you can be the seller ofa call or put any of that you
(17:39):
need me to clear upor provide examples on
Chris Holling (17:40):
no, I guess not, I guess maybe where I'm trying
to, to figure that all out in myhead is that may I don't even
have a good way to describethis. Because then when you
exist as the buyer or seller,then you're you're going to be
transitioning into it again,later on. And but I guess it's
not like you're gonnaimmediately? I don't know, I
(18:03):
don't know, I don't know, Ithink I'm just trying to take
the whole picture in as a wholebecause it's just several moving
parts of like, this will happenin the future, but only if you
buy the option but only if youchoose to after you buy the
option and I'm I'm just I'mfollowing I think
Sean Cooper (18:21):
right right. So where the future contract is is
this is going to happen there isgoing to be some exchange some
of either the commodity andvalue for the commodity or
there's just going to be a cashsettlement. Whereas with the
option, there's not necessarilygoing to be any exchange that
occurs unless it unless theoption is executed. The initial
(18:45):
exchange is the purchase or saleof the option itself.
Chris Holling (18:51):
Okay.
Sean Cooper (18:52):
So you pay a small premium for the option to buy or
sell. And then down the road ifit's profitable to do so, you
execute that option to buy orsell or on the other side of the
coin you can be the seller ofthe option to buy or sell as
(19:16):
opposed to the buyer. So the thebuyer of a call is bullish on
the market. The seller isbearish. The buyer of a put is
bearish and the seller of a putis bullish. I think I said that
(19:41):
right.
Chris Holling (19:41):
I think so.
Because the bullish is up,bearish is down like the bullish
of a horn sweeping up and abearish of a claw coming down is
how I Remember from our previousendeavors, right?
Sean Cooper (19:58):
Right.
So even though this is Morecomplicated to understand, per
se, and gets even morecomplicated if you get into some
of the interesting tradingstrategies behind it,
Chris Holling (20:08):
right.
Sean Cooper (20:10):
This is actually the most commonly traded for
most investors is options, notfutures and forwards,
Chris Holling (20:18):
okay.
Sean Cooper (20:18):
So, now futures are volume wise futures are traded
more actively because, you know,hedge funds and the like are are
trading them in massivequantities, whereas options are
typically not traded in suchmassive quantities per se.
Chris Holling (20:39):
So, because futures are more commonly
happening in in volume is thatbecause of what you're
describing, like different hedgefunds account and whatnot or
Sean Cooper (20:49):
right, the account size is much larger.
In fact, the futures market islarger than the market for the
underlying commodities.
Chris Holling (20:59):
And what about for you? Where do you tend to do
a majority of your stuff? Do youdo a lot of options? Do you tend
to get involved in a lot offutures? Just you personally or
Sean Cooper (21:08):
me? Personally, I trade options. However, I do
utilize strategies that tradefutures.
Chris Holling (21:19):
Okay,
Sean Cooper (21:20):
so since I'm not trading them directly, I still
like them to be in a portfolio.
For various reasons. We talkedabout managed futures in our
prior episode on alternatives.
So that's where, where that fitsin.
Chris Holling (21:33):
Okay,
Sean Cooper (21:34):
but I'm not doing the trading myself, I'm
outsourcing that basically to amutual fund or a hedge fund.
Chris Holling (21:41):
Okay.
Sean Cooper (21:42):
Yep. So specifically where I trade
options, the most would becovered calls. So we've talked a
little bit about thispreviously, but a covered call.
So there's, obviously calls andputs but a covered call would be
where you actually own theunderlying so if I'm selling a
(22:04):
call, so I sell you the optionto buy from me
Chris Holling (22:08):
Right
Sean Cooper (22:08):
a covered call would be where I already own the
underlying stock. So I alreadyown it, I sell you the option to
buy from me, I'm covered becauseI already have the stock, I
don't have to, you know, if youdecide to execute your option to
buy, I have the stock, I canjust give it to you at the sale
price, we're good to go. A nakedcall would be I sell you that
(22:30):
call the option to buy from me,but I don't actually have the
underlying stock. That would bea naked call selling a naked
call,
Chris Holling (22:39):
because you would have it attached elsewhere for
you to make that purchase. Orit's just, that's just
Sean Cooper (22:48):
literally if you if you decide if you decide to
execute your option to buy fromme,
Chris Holling (22:54):
right,
Sean Cooper (22:55):
I would the exchange would instantly have to
go out and buy this underlyingstock on my behalf so that I
could then sell it to you. Whichmost likely would result in me
taking a loss of some sort.
Chris Holling (23:10):
Gotcha. And is that something that you have to
like look for? Or is that a isthat part of a discussion that
you have, like, hey, I can seethis option, but it's a it's a
covered call? Or it's not? Orwhat?
Sean Cooper (23:21):
When you buy a call, you don't know if it's
covered or naked?
Chris Holling (23:25):
Oh, okay.
Sean Cooper (23:26):
It doesn't matter the the exchange is going to
automatically make it happen.
Chris Holling (23:30):
Okay,
Sean Cooper (23:31):
so yeah. The, but the risk in that that naked call
is on the the seller in thatscenario,
Chris Holling (23:41):
okay, that makes sense
Sean Cooper (23:42):
Because, yeah, if, if the markets gone way up,
they're on the hook to buy that,that stock so that they can
actually then sell it to youwith that most likely much lower
price that you've agreed to.
Chris Holling (23:54):
Got it. Okay.
Sean Cooper (23:57):
So that's why the covered call is a much safer
play. In fact, selling coveredcalls creates a nice stream of
profit from the sale of thecall, plus you sell them out of
the money meaning that if ifthey're going to be executed, at
least I do, you sell them out ofthe money so that if they are
executed, in addition to takingthe profit from the the premium
(24:20):
from selling the call in thefirst place, you also make a
little bit more money on theunderlying stock when you sell
it too, maybe not as much aswhat the market has gone to. But
you've still made additionalmoney as well. And typically
what I found just out of marketvolatility, you can still get
back in wherever you sold out ifyou really want to. So
Chris Holling (24:39):
Gotcha.
Sean Cooper (24:41):
Those that little profit from the premium can help
buoy returns a little bit indown markets and add a little
bit especially in a flat market.
It doesn't add as much in a bullmarket because most likely
you're going to be the option isgoing to be executed, in which
case you sell. And you hopefullycan still keep pace with the
(25:05):
bull market, but it depends onhow things go.
Chris Holling (25:09):
Right? Okay.
Sean Cooper (25:12):
So yeah, so that's, that would be options calls and
puts. option to buy. The calloption to sell is the put and
you can be a buyer or seller ofeither the last derivative I was
going to talk about would be aswap, and derivative and swaps
(25:36):
are actually on a completelydifferent asset. So, futures
forwards, typically we'redealing with commodities,
options, most commonly arestocks. Swaps are actually
interest rates. So for the mostpart, and so you're actually
dealing with swapping outinterest rate risk hedging
(25:58):
interest rate, because that'swhat most, most derivatives are
designed, or utilized as ahedge. So, for example, if
you're repaying a loan forsomething, and it is tied to
prime, so the prime rate or theinterbank offer rate, the
(26:21):
interest rate that you're payingis probably that that prime rate
plus x plus two or somethingalong those lines. So you have a
variable rate, it's like an ifyou have like an arm on a
mortgage, where you pay a fixedrate for like five years, and
then after that it floats basedon the LIBOR or prime, or you
(26:45):
know, depending on where you'reat plus a certain percentage. So
as if interest rates go up, theinterest that you're paying goes
up, if they go down the interestthat you're paying, that goes
down. So if you want to takesome of that risk off the table,
some of the risk that theinterest rates could go up, and
that causes your payment to goup, you can actually do a swap
where someone else you, you swapwith someone else, and you pay
(27:09):
them a fixed rate and mostlikely a slightly higher fixed
rate, but they will end uppaying you the variable rate. So
you end up just if if the fixedrate is still higher than the
variable, you pay them thedifference, and if the variable
rate ends up going higher thanthe fixed rate, they pay you the
difference. So you're hedgingthat, that risk away.
Chris Holling (27:35):
Okay, so it's it's not just like the action of
saying a refinance of any sort,like it's, I mean, like, I
imagine taking a loan to a bankand going through the process of
refinancing with them would bekind of like a, a small, more
direct version of doing your ownkind of swap. But you're saying
(27:56):
that this exists as a I'm doinga swap option between interest
rates, and then if if thisvariable rate fluctuates, then
the payout lands somewhere? Isthat what I'm understanding?
Sean Cooper (28:08):
Correct? Yeah. This typically isn't something done
by your average person on amortgage, we're typically
talking about very largecompanies dealing with, you
know, hundreds of millions orbillions of dollars of loans
that they are trying to hedgetheir rates. And no, it's not
not the equivalent to arefinance. They're not actually
refinancing anything. They'reliterally taking one payment and
(28:32):
swapping it out for a differentpayment with a most likely a
different company.
Chris Holling (28:38):
Gotcha. Okay, that makes a lot more sense.
Sean Cooper (28:40):
Yeah. And like I said, Yeah, most most of the
time, you're dealing with somekind of variable rate and
swapping it out for a fixed or,and swapping it out for a fixed
or vice versa. Depending on whatside of the coin you're on, if
you think interest rates aregoing to go down, maybe you want
to swap your fixed out for avariable.
Chris Holling (29:01):
And the swap is something that I've I've just
never even heard of before. Theother things I've at least heard
of, and I can always understanda little bit better. But with
the swap, it's, it's justsomething I haven't even come
across. So is that the sameprocess that you would that you
would talk through a custodianto get access to a swap or what
where do you find swaps anyways?
Sean Cooper (29:20):
Nah you're most likely dealing with a bank, some
kind of large lender, largelender, custodians typically not
going to be dealing with that.
Chris Holling (29:28):
Okay. Cool. That makes sense.
Sean Cooper (29:33):
Yep. That is the extent of what I was gonna plan
on covering with derivatives. Iguess I could I've mentioned a
number of different tradingstrategies with options I mean,
you've got spreads, straddles,iron condors, all sorts of
(29:53):
different random tradingstrategies that you can employ
with. I mentioned covered calls
Chris Holling (29:57):
man straddles.
Iron condors bushel of corn
Sean Cooper (30:03):
They have some fun names,
Chris Holling (30:05):
this is a a heck of a day of visualizations,
Sean Cooper (30:10):
options traders, the really successful options
traders will narrow in on onestrategy and they get really,
really good at it. And that'sall they do. They don't mess
around with other strategies asthey go along. And that's just
Yeah. So something something tolook up, maybe something we'll
talk about in the future, ifsomebody is interested, but
(30:32):
Well, I guess I'll leave it atthat for now.
Chris Holling (30:36):
We cool
Sean Cooper (30:36):
pique your interest.
Chris Holling (30:37):
Okay. Well, then derivative, you know, and I
mean, I knew about some ofthese, like I was talking about,
like, I feel like I was aware ofan option. And maybe that's
because we talked about it atsome point in time, but I think
this is a good in depth portionof of some of these things and
some of these considerations.
Sean Cooper (30:56):
Good.
Chris Holling (30:58):
I like that?
Okay?
Sean Cooper (30:59):
Yeah. So all those times that we've talked about
derivatives in the past now.
Now, people will actually knowwhat we're talking about,
Chris Holling (31:06):
right?
Sean Cooper (31:06):
Maybe we should have put this a little earlier
but, what the heck
Chris Holling (31:10):
woulda, coulda, shoulda. That's okay. At least
at least now we know it's notwhatever I was trying to
describe at the start of this.
if I knew I was gonna be thatwrong, I would have gone down
the road of like, oh, you know,a derivative is this, this
process that you do when you'rewhen you're at the circus,
(31:32):
right? You you go and you getthis the sack of derivatives and
you go down the road? And you'relike I would have I would have
completely gone the other waywith it. If I knew I was going
to be that wrong. What do Iknow?
Sean Cooper (31:46):
Well, I feel like there was one that you did that
with
Chris Holling (31:49):
a
Sean Cooper (31:50):
I can't remember which one it was
Chris Holling (31:52):
man, that was security analysis. Yes, I
decided that there was a therewas a you analyze the security
company and and
Sean Cooper (32:06):
I liked that one though. It was creative.
Chris Holling (32:08):
Bowser shows up or something like that. Thank
you. Yeah, I appreciate that.
But it clearly drained all mycreative juices, because now I'm
just flat wrong.
Sean Cooper (32:17):
The irony is I think you actually understood
security analysis to a certaindegree, it was just not
necessarily something you weregoing to explain to someone else
per se.
Chris Holling (32:27):
Well, now you're just giving me too much credit.
Let's wrap it up
Sean Cooper (32:34):
Oh, yeah. Next season.
Chris Holling (32:37):
Next season, we should talk about next season
next season. We are kind ofwe're kind of dipping back into
insurance a little bit again.
And
Sean Cooper (32:49):
Life insurance
Chris Holling (32:50):
life insurance specifically. It was it was
something that we talked aboutwhere we said hey, we should
touch on this. Oh, my we need toactually do two of these. Oh,
wait, did did you? Did you wantto do like actually digestible
amounts? Or do you want to justabsolutely hit one big long one
(33:10):
I said I can't, I can't, Sean.
I can't.
So we're doing small dosages.
And so we're hoping for theepisodes to be a little bit
shorter than we typically do sothat you can take it as it comes
in. It's not one big overloadingthing. But it's it's kind of
turned into I guess you couldcall it a bonus season, but it
will be Season Five for uscoming up next. And we're gonna
(33:31):
be getting that out to justreally just as soon as we can. I
think we got a break happeningin between a couple of seasons
here and there, but we're gonnaget on it. Is there anything
else on it on the on the futureseason then you can think of
Sean Cooper (33:47):
no that sounds pretty good.
Chris Holling (33:48):
Okay, well good.
Sean Cooper (33:50):
Good summary
Chris Holling (33:51):
Good. I'm glad.
Well, thank you everybody forcoming back out enjoying the
season four as we're rounding upon that. And then we're, you
know, I keep saying that we'recoming closer to the end. But we
we kind of are we after seasonfive that we have a very
specific goal than we haveseason six and we have like,
four or five episodes listed inthere right now. And then the
(34:14):
then the world is our burrito.
Or chimichanga I likechimichangas actually
Sean Cooper (34:22):
Isn't the saying the world is our oyster.
Chris Holling (34:24):
Yeah, well, I don't listen to that. I think it
was weird Al that gave me theworld is our burrito. So I've
stuck with it.
Sean Cooper (34:29):
I mean, I definitely prefer burritos over
oysters.
Chris Holling (34:32):
I did have oysters the other day. It was
delicious. Okay, see, now thisis this is why we need to have a
season that just has absolutelynothing to do with any of this.
We'll talk about oysters andburritos an oyster burrito.
Perhaps that'd be great.
Sean Cooper (34:44):
Didn't Phylecia start this on us the whole
California burrito concept withfrench fries
Chris Holling (34:48):
Yeah, well, you know, what if somebody would if
somebody would actually link toour page, a picture of a
burrito? Then maybe
Sean Cooper (34:55):
That's right
Chris Holling (34:56):
maybe we'd talk about burritos more often
Sean Cooper (34:57):
both of us failed
Chris Holling (34:59):
Yeah, well You know, so did our followers
failing. Okay, now I'm insultingour followers. I'm sorry I
Sean Cooper (35:05):
speaking of maybe you
maybe you should post some ofthese on Facebook
Chris Holling (35:12):
I know.
Sean Cooper (35:15):
Anyway, thanks again.
Chris Holling (35:18):
Thanks. Thanks for joining us. Here at the
truth about investing back tobasics. My name is Chris
Holling.
Sean Cooper (35:24):
And I'm Sean Cooper,
Chris Holling (35:25):
and we will catch you in the next season. Podcast
disclaimer disclaimer. Thedisclaimer following this
disclaimer is the disclaimerthat is required for this
podcast to be up and running andfully functioning. Moving
forward. This is going to be thesame disclaimer that you will
(35:46):
hear in each one of ourepisodes. We hope you enjoy it
just as much as we enjoyedmaking it. all content on this
podcast and accompanyingtranscript is for informational
purposes only opinions expressedherein by Sean Cooper are solely
those of fit financialconsulting LLC unless otherwise
specifically cited. ChrisHolling that's me is not
(36:10):
affiliated with Fit financialconsulting LLC nor do the views
expressed by Chris Holling meagain, represent the views of
fit financial consulting, LLC.
This podcast is intended to beused and it's entirety. Any
other use beyond the author'sintended distribution or copying
of its contents of this podcastis strictly prohibited. Nothing
in this podcast is intended aslegal accounting or tax advice
(36:34):
and is for informationalpurposes only. All information
or ideas provided should bediscussed in detail with an
advisor, accountant or legalcounsel prior to implementation.
This podcast may refer towebsites for the convenience of
our users. Our firm has nocontrol over the accuracy or
(36:56):
content of these other websites.
advisory services are offeredthrough fit financial
consulting, LLC, an investmentadvisory firm registered in the
states of Washington andColorado. The presence of this
podcast on the internet shallnot be directly or indirectly
interpreted as a solicitation ofinvestment advisory services to
(37:19):
persons of another jurisdictionunless otherwise permitted by
statute, follow up orindividualized responses to
consumers in a particular stateby our firm in the rendering of
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(37:44):
concerning the status ordisciplinary history of a broker
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consumer should contact theirstate securities administrator.
Amen. You know, actually youwant to know something real
stupid. I was just thinking tomyself just now. Oh, I just
(38:07):
heard this funny joke. Thismorning. I should tell him that
joke. That was pretty good. Andthen I realized the reason that
I heard it this morning was Iwas editing our previous podcast
it would have been the exactsame
Sean Cooper (38:21):
It was one of your jokes
Chris Holling (38:23):
It was even one that I told like it was I like
this.
Sean Cooper (38:26):
This is a great joke. I should totaly tell him.
Chris Holling (38:29):
I wonder. I wonder if he knows this joke
Sean Cooper (38:31):
Oh, wait I guess I already have
Chris Holling (38:32):
I was I was literally in the midst of
editing that joke and I waslike, what was that? Oh, that
was that was pretty.
Sean Cooper (38:40):
Sounds like the joke's on you buddy.
Chris Holling (38:44):
Well said
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