Posted by Mark on October 30, 2015 at 06:53 | Last modified: October 21, 2015 11:41
One problem I have with the whole dividend concept is the belief they are “free money,” which I just debunked.
Remember that I began this blog mini-series with the question of whether dividends are income and YES took an early 3-0 lead. The score is now 3-3. If you survey many investors about dividends then I would guess very few realize dividends received now come at the cost of total stock price appreciation later. In financial terms, “income” does not imply offsetting loss.
One theme we occasionally see in Finance is that of “synthetic equivalents.” These are things that seem different but are actually the same. Sometimes they are workarounds: other ways of doing the same thing. In option trading, covered calls and cash-secured puts are exactly the same thing. Time and implied volatility are also synthetically equivalent or substitutes for each other. Far more pairings in Finance strike me as having trade-offs subject to different pros/cons rather than one being definitively better/worse than the other. I believe dividend payments (income) vs. capital appreciation (growth) falls under this umbrella too.
When we have multiple ways of doing the same thing, the problem for me arises when someone tries to assert a difference and advertise why one is better than the other. This is persuasion and propaganda along with marketing and advertising. This is sales and how to make a buck. This is optionScam.com.
When it comes to dividends, people do accentuate a difference and people do assert differences between “income” stocks and “growth” (no dividend) stocks. I will resume there in the next post.
Categories: optionScam.com | | Permalink
Posted by Mark on October 27, 2015 at 07:28 | Last modified: October 21, 2015 10:47
When a dividend is paid, a commensurate drop in stock price immediately takes place. And just like that, I’m back to categorizing this as optionScam.com because many people give props to dividends as if they come at no cost.
As I discussed, objectives recognized by the industry to personalize financial advice include growth (capital appreciation) and income (e.g. dividends).
With that commensurate drop in stock price, though, capital appreciation and dividend payment become two sides of the same coin!
How can that be?
If I buy a stock at $100 that has a 4% dividend yield, I will make $4/year in dividends. Suppose the stock appreciates 4% per year and the dividend remains unchanged.
After 25 years, I can sell the stock for exactly what I bought it for: $100. I also collected $100 in dividends. Had the stock paid no dividend then, assuming everything else remained constant, the stock would have been worth $200: twice what I bought it for! Whether “income” or “capital appreciation,” total return is equal: I make $100/share either way.
Some people will argue that were the dividend not paid, the company would be in a better position to grow the business. Perhaps they could buy out competitors and improve operating efficiency to make more money. Perhaps they could go into new areas or fill an untapped niche. Either way, they could boost profitability and generate more capital appreciation than they could otherwise with dividend payments. These are just theoretical arguments, however.
In a sense, income vs. capital appreciation is “pay me now or pay me later.” With income, I receive dividend checks along the way. With capital appreciation, I receive nothing until I sell the stock at the end. At that point, I receive at least the sum of all those dividend payments never made.
I could easily simulate a dividend stock by simply selling some shares on a periodic basis. This means the “pay me now or pay me later” may not even be a material difference because I can make “pay me now” out of “pay me later.”
Categories: optionScam.com | | Permalink
Posted by Mark on October 21, 2015 at 06:43 | Last modified: October 26, 2015 11:46
Since it’s 3-0, I’m not categorizing this as optionScam.com anymore. Nevertheless, I still have a problem with the dividend concept so I’m going to approach this debate from a different angle.
The financial industry is focused heavily on “the suitability standard.” When I pay someone for financial advice, the investment professional must make recommendations tailored to my personal situation. This is a Rule (2111) of the Financial Industry Regulatory Authority. For this reason, advisers compile an investment profile that includes:
- Client age
- Other investments
- Financial situation and needs, which includes questions about annual income and net worth
- Investment objectives (e.g. generating income, preserving wealth, or market speculation)
- Investment experience
- Investment time horizon
- Liquidity needs (i.e. withdrawal of cash to fund living expenses without incurring significant loss)
- Risk tolerance (discussed here)
Investment objectives may include growth and/or income.
Growth means capital appreciation, which according to Investopedia is:
> A rise in the value of an asset based on a rise in market price.
In other words, the positive difference between current stock price and the price of the stock when I bought it. Reading on:
> Capital appreciation is one of the two main sources of investment
> returns, with the other being dividend or interest income.
The kicker to all this is what happens to the share price when a dividend is paid.
Do you know? This is not a secret but I suspect it is not common knowledge especially to the layperson. I went to a presentation on dividends the other night and it was not even mentioned until I asked about it.
When a dividend is paid, the price of the stock decreases by the dividend amount.
From an accounting standpoint this makes complete sense. If stock XYZ pays out $100M as a dividend then it would make no sense for the market capitalization to be unchanged. The number of outstanding shares does not change so the loss is reflected in a lower share price.
Sleep on this for a night or two because I’m going to come with this pretty hard in the next installment.
Categories: Financial Literacy | | Permalink
Posted by Mark on October 19, 2015 at 10:55 | Last modified: October 20, 2015 07:12
Today I begin an inquiry into whether dividends are income.
While I am skeptical (I believe you have to be in this business), I have no financial interest hinging on the outcome of this inquiry. I have currently categorized this under optionScam.com but I will re-categorize as I see fit. This is a good example of blogging to organize my thoughts about the financial industry.
Google “dividend income” and you will find numerous hits. At investopedia.com, part of the description includes the words:
> Mutual funds pay out interest and dividend income received from
> their portfolio holdings as dividends to fund shareholders.
I googled “what is income” and found:
> Money received, especially on a regular basis, for work or through
> investments. “He has a nice home and an adequate income.”
Dividends are received as part of the investing process, which makes the score 2-0 in favor of dividends as income.
I get hung up on the conventional meaning of income and I believe the latter example given is more typical of common usage. Most people work and earn income.
Accounting would probably recognize this as wage income, or “wages.”
The IRS also defines active income and passive income! Maybe I just need an accounting course or two to get to the bottom of this. Once again, from Investopedia, passive income is:
> Earnings an individual derives from a rental property, limited partnership
> or other enterprise in which he or she is not materially involved.
That doesn’t sound like investment returns but if I read on:
> Portfolio income is considered passive income by some analysts, in which
> case dividends and interest would be considered passive [italics mine].
So maybe it is and maybe it isn’t passive income depending on who you ask?
It does seem to be some sort of income, though, so score it 3-0 thus far in favor of dividends as income. I will continue in the next post.
Categories: optionScam.com | | Permalink
Posted by Mark on October 15, 2015 at 06:20 | Last modified: October 26, 2015 11:44
I’ve been reviewing an article by Michaely et. al that suggests Friday evenings are used to hide bad news.
The authors conclude:
> Additional results show that Friday evening announcements are also
> more likely to be followed by a delisting event or merger completion,
> suggesting that managers may announce on Friday evening to avoid
> market scrutiny.
More specifically, they found Friday night announcers were five times more likely to be dropped from an exchange or liquidated. They were more than twice as likely to be delisted due to merger completion within 120 days of the announcement.
> Friday evening announcements are rare (only 1.08% of earnings
> announcements), which implies that most firms do not engage in
> opportunistic announcement timing. Nevertheless, this small portion
> of announcements provides rather robust evidence that the market
> is inefficient with respect to certain aspects, such as the
> response to the timing of news releases.
I found this study very interesting.
Is there really any trading edge here? That would be a different study but this gives at least some reason to think so. Liquidity is important and I would want to get a better profile for what kind of companies make Friday night announcements. Certainly we don’t see an AAPL or GE announcing earnings on Friday night.
I don’t often read full texts of financial manuscripts. I will come back to this in a future blog post to detail some of their good science and give implications for other trading strategy analysis.
Categories: Financial Literacy | | Permalink
Posted by Mark on October 12, 2015 at 06:36 | Last modified: October 26, 2015 11:24
On July 23, 2015, Roni Michaely, Amir Rubin, and Alexander Vedrashko posted an article to the Social Science Research Network called “When Is the Best Time to Hide Earnings News?”
Their study sample included all quarterly earnings announcements in I/B/E/S from 1999 through 2013 that also have daily return data in the Center for Research in Securities Prices database. They divided earnings announcements into 15 “timing cells:” before market open, during the trading day, and after market close (evenings) for each day of the week. They looked at delay in stock price change called post-earnings announcement drift (PEAD).
Michaely et. al write:
> There are two necessary conditions to conclude that management
> opportunistically times earnings announcements. First, firms must
> have an incentive to time the news, for example, to hide bad
> earnings; and second, this opportunistic behavior must be
> effective–that is, such behavior must enable the firm to affect
> the market reaction. In this paper, we find evidence for both…
> …the Friday evening timing cell tends to be associated with more
> negative earnings news than any other timing cell, including other
> evening or Friday announcements.
>
> Although the concentration of negative news on Friday evening
> indicates the possibility of making opportunistic announcements at
> that time, rational managers would only engage in such opportunistic
> behavior if they can successfully reduce the market reaction to the
> news. We posit that the defining attribute for testing opportunism
> would be to analyze PEAD in different timing cells. We find that…
> …Friday evening announcements are associated with the highest
> positive and negative drifts following positive and negative news,
> respectively. A trading strategy that trades in the direction of the
> surprise after earnings releases on Friday evening is highly
> profitable and implies that the market is inefficient when
> announcements are made on Friday evening. Because Friday evening
> news is not fully reflected in prices immediately, according to our
> analysis, managers and other insiders seem to exploit this trading
> opportunity.
I will continue in the next post.
Categories: Financial Literacy | | Permalink
Posted by Mark on October 9, 2015 at 06:38 | Last modified: October 26, 2015 09:59
This probably belongs in the “I didn’t know that!” file, which is why I created “Financial Literacy” as a new blog category.
Attention mutual fund shareholders: if you fail to maintain contact with the fund company then a state may consider you lost and claim your assets under certain conditions.
In general, this may occur in two ways. First-class mail sent to the shareholder and returned as “undeliverable” is one. The second way is to have no contact with the fund company for a given period of time. Specific details vary by state.
“No contact” means the shareholder does not contact the fund company every 3-7 years regarding the account. Automated features like investments and redemptions do not necessarily qualify as “contact.”
The SEC requires mutual fund companies to use at least two national databases to find a valid address, but the responsibility of maintaining updated contact information ultimately lies with the investor. To be safe, contact all financial institutions you deal with annually to confirm contact and beneficiary information. This may include banks, brokerage firms, credit unions, etc. Cashing all dividend checks and reviewing mail sent from financial institutions would also be prudent.
For more details, I refer you to “Frequently Asked Questions About Lost Property” at www.ici.org.
Disclaimer: in no way does this article about mutual funds suggest that I would recommend one for anybody.
Categories: Financial Literacy | | Permalink
Posted by Mark on October 6, 2015 at 07:18 | Last modified: October 23, 2015 10:41
In Part 1 I presented Summa’s notorious option myth and in Part 2 I presented its debunking. Today I bring in one more voice of reason.
If you have spent time in the option education circles then you’ve probably heard of Brian Overby. Overby has given many presentations on different option topics and he has also authored a book on option trading. He is or has been Senior Options Analyst and/or Director of Education for TradeKing brokerage. I feel being associated with a prevalent brokerage house like TradeKing gives Overby some credibility. I think he’s less apt to spread fictional/fraudulent claims because the reputation of his employer hangs in the balance. This is no guarantee (e.g. Peregrine Financial Group) but…
Addressing the question what percentage of options get exercised, Overby writes:
> the correct answer is this: according to the Options
> Clearing Corporation’s 2006 trading year results…
> around 17% of all options contracts opened got
> exercised. About 35% expired worthless, and almost
> half (48%) of the rest got bought or sold to close
> in the open market.
>
> If these numbers seem surprising go back to the
> basics of option for an answer. It’s easy to lose
> sight of the fact that an option is a contract. We
> often think of options as hot potatoes that get
> passed around until they wind up in someone’s hands
> at expiration. But actually, if an option contract
> gets closed in the marketplace, it just ceases to
> exist and will therefore never make it to expiration.
I think we can pretty much put this option myth to bed. No, most options contracts do not necessarily expire worthless and no, this is certainly no reason to sell option contracts. We may come up with other reasons but certainly not this one.
Categories: optionScam.com | | Permalink
Posted by Mark on October 1, 2015 at 06:44 | Last modified: October 23, 2015 10:14
In the last post I detailed what I believe to be the root of this notorious options myth. Today I bring some critical analysis to the party.
I’m going to let some other writers do the heavy lifting. Let’s begin with this:
> A common claim is that 90% of options expire worthless,
> and that therefore it is better to be a seller of options
> than a buyer of options. This claim misstates a statistic
> published by the Chicago Board Options Exchange (CBOE),
> which is that only 10% of option contracts are exercised.
>
> But just because only 10% are exercised does not mean
> the other 90% expire worthless. Instead, according to the
> CBOE, between 55% and 60% of options contracts are
> closed out prior to expiration.
So here’s the rub: did the CME data showing 75% of all options held to expiration expired worthless mean 75% of all options expire worthless? Not necessarily. We would need a breakdown of options held to expiration vs. options closed out before expiration.
Continuing on:
> So if 10% of options contracts end up being exercised,
> and 55-60% get closed out before expiration, that leaves
> only 30-35% of contracts that actually expire worthless.
30-35% vs. 75% is a big difference and that, evidently, is what makes this such a big option myth.
Here is another post on the subject:
> It comes in several flavours, sometimes stated as 80%,
> 90%, or whatever. It is the maxim that most options
> expire worthless. It is repeated so often out there
> in the marketplace, it is taken as a given and used as
> a justification to be a nett [sic] seller of options and/or
> promote option selling @education”. It is repeated,
> as a mantra, by some of the most well known folks in
> optionland. There is only one problem, it’s bullshit.
Love it! It’s a compelling argument, too. I found a forum post from 2008 that read:
> Summa is a proponent of selling options, so at the
> very least he has a vested interest in putting forth
> the conclusions of this study which has lent
> credence to his book for years.
So if it is indeed “bullshit” then now we have an underlying motive for his writing it in the first place…
Categories: optionScam.com | | Permalink