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Dr. Terry Allen
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Publisher of options newsletter TerrysTips.com since 2001.. Thirty years experience trading options virtually every day. including stint as seat holder and market maker on the C.B.O.E. MBA from Harvard Business School and DBA from Univ. of Virginia Darden School. Author of Making 36%: Duffer's... More
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  • Why 401(K) Plans Have Been Called Frauds, Scams, Hoaxes, Ponzi Schemes Or Outright Failures.

    What kinds of people might refer to America's favorite way of saving for retirement with such words a frauds, scams, hoaxes, Ponzi schemes, or failures? You might be surprised.

    William Wolman, former senior editor and chief economist for Business Week magazine, wrote a book about it - called The Great 401(k) Hoax.

    Michael Lewis, author of Flash Boys, the popular expose on high frequency trading (as well as many other financial books such as Moneyball and Boomerang, perhaps the best explanation of global melt-downs) said, "Wall Street, with its army of brokers, analysts, and advisers funneling trillions of dollars into mutual funds, hedge funds, and private equity funds, is an elaborate fraud."

    Robert J. Shiller, Nobel Laureate and Yale University economist, said "The 401(k) plan is a naturally occurring Ponzi process."

    Teresa Ghilarducci, professor of economics at the New School for Social Research and director of the Schwartz Center for Economic Policy called it a "failed experiment." Writing in the New York Times, she said, "The (401(k)) do-it-yourself pension system has failed. It has failed because it expects individuals without investment expertise to reap the same results as professional investors and money managers. What results would you expect if you were asked to pull your own teeth or do your own electrical wiring?"

    Alicia Munnell, the Peter F. Drucker Professor of Management Sciences at Boston College, wrote an entire book about the 401(k) problem. She called it Coming Up Short.

    Rachel Maddow, MSNBC host, called the 401(k) retirement plans "a scam" on her television show.

    Why have these apparently intelligent and knowledgeable people condemned America's favorite way of providing for their retirement? The reasons are multiple and extensive:

    1. Tax implications. While you get a tax deferral in year one, you pay ordinary income tax rates on a much higher dollar amount when you take it out, and tax rates will surely be higher in future years (how else can the government pay for social security and the mounting interest on the federal debt)?
    2. Unrealistic stock market return expectations. The Wall Street media machine has convinced the world that stock market goes up 6% - 10% a year over the long run, while in reality it has gone up much less than that. Warren Buffett calculated that it had gone up an annualized 5.3% for the past 100 years but he expected future returns to be much less. For the first 13 years of this century, the market has gone up an average of about 3% a year, barely above the rate of inflation.
    3. Excessive mutual fund fees. The only fee that needs to be conveyed to 401(k) participants is the management fee (expense ratio), but in most cases, that is only the tip of the iceberg. Trading costs, cash drag fees (assessed on spare cash in the mutual fund portfolio), loads (back or front-end), and Rule 12(b)(1) fees can add up to several times the expense ratio. These fees can be greater than the stock market has gone up (in my book, Coffee Can Investing, I demonstrate that a mutual fund portfolio that kept up with the market for the first 13 years of this century (inside a 401(k)) would end up, after taxes, with far less money than if it had been stashed in a coffee can and hidden under the mattress.
    4. Poor choice of funds. Unsophisticated investors invariable choose actively-managed equity funds that are great for Wall Street but awful for themselves. In particular, target-date funds. According to ICI, the mutual fund industry trade association, 41% of 401(k) investments are in target-date funds, and this number is projected to reach 50% by 2020. While these funds are intuitively attractive, they dramatically underperform low-cost broad-based market index funds. Over the last five years, target-date funds underperformed index funds by 22% - 47%. Those are astounding numbers. Since these funds have bonds as part of their portfolios, they do better than the markets when the markets have down years. However, there is not a single 5-year period when target date funds have kept up with market index funds.
    5. Attempts to time the market. When markets crash, individuals often switch out of stocks and into cash (and they plow more into the market when markets have soared). Their timing is dependably wrong almost every time. The highly-regarded Boston financial tracking firm, Dalbar, has calculated that over the past 20 years, mutual fund owners have fared 3.96% worse than the mutual funds themselves through their consistent inability to time the market.
    6. High frequency trading. This is an insidious and hidden cost that impacts anyone who buys and sells stocks or mutual funds. Literally millions of dollars are skimmed off every day that the market is open, and no one has any idea that they have been fleeced. The biggest losers are most likely owners of actively-traded mutual funds, since they typically trade in large volumes (and often).

    In the old days before the government (with considerable encouragement and financial support from corporations and Wall Street) brought the IRA and 401(k) on to the scene, companies were responsible for their employees' retirement years through their defined benefit plans. When employees retired, they could count on a fixed amount each year for as long as they lived (the amount determined by how much they earned while they worked and how long they were employed). No longer. Now, the individual is responsible for his own retirement, and he or she has to figure out how to parcel out a fixed amount (dependent on how well the stock market does) over those years of retirement.

    Retirement income has shifted from a certain known amount for as long as you live to an uncertain fixed amount dependent on the stock market.

    Defined benefit plans were largely funded by insurance plans. As retirees died, their life insurance policies were used to fund the retirement years of those still living. When defined contribution plans came into being, most of the money ended up in the pockets of Wall Street, and billions are extracted each year from the participants, regardless of how poorly the chosen stocks perform. Great work if you can get it, and Wall Street surely has figured out how to get it.

    401(k)s are great for the companies and great for Wall Street, but just awful for the poor workers who are trying to salt money away for their retirement. The worst part of the shift to defined contribution plans is that the conversation about what is best for workers is centered around what the best offerings from Wall Street might be. Other concepts (such as whole life insurance) do not even make it to the table for consideration.

    I always thought that life insurance was one of the worst possible investments. "Buy term insurance and invest the difference" was the mantra I bought into. But over 95% of term insurance policies never collect anything. That seems like a pretty good deal for the life insurance companies but not such a great deal for the people who bought those policies.

    When I read that Warren Buffett was offering more than the cash value of fully-paid policies because the tax-free guaranteed pay-offs were substantial, I reconsidered my early prejudices against whole life policies.

    With a fully-paid whole life insurance policy, you can get all the money back, in cash, that you put in, tax free (just like in the coffee can), and you still have more than that in the face value of the policy. You can borrow on your home equity and know that you will not be leaving your children with a liability because the insurance policy will cover your loan, and all proceeds from the insurance policy is free of taxes.

    Surely, guaranteed tax-free money should be one of the possible places that we would like to have some of our money. All your money in a 401(k) or IRA is non-guaranteed and also taxable at the highest rates when you take it out. Alternative investments should be part of the conversation. As long as people believe the Wall Street media hype, those alternatives will never be discussed.

    I am not in the insurance business. In fact, I am an active investor in the market (I happen to prefer stock options). But in my opinion, it is a shame that most 401(k) participants who are not otherwise active investors do not even get the opportunity to consider whole life insurance in their company retirement programs. There is something heart-warming about the words "guaranteed" and "tax-free," but those are things that they will never enjoy.

    Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

    Tags: retirement
    Aug 15 6:37 AM | Link | 2 Comments
  • How To Play The Lululemon Athletica Earnings Announcement

    This quarter's earnings season is winding down. Only one company with weekly options available, Lululemon Athletica (NASDAQ:LULU) is due to report next week. (I restrict my analysis to companies with weekly options because they are the most actively-traded and popular, and I often employ the weekly options in my trading.) LULU reports on Monday, June 10 after the closing bell.

    LULU is a high-end retailer of fitness apparel including fitness pants, shorts, tops, and jackets for healthy lifestyle activities, such as yoga, running, and general fitness. Based in Vancouver, British Columbia, LULU has 135 stores in the United States and 51 stores in Canada, and also has extensive wholesale business through health and fitness clubs.

    Not only are its clothes high-end, so is its p/e ratio, 42.47, which compares to Nike's (NYSE:NKE) 24.11. This lofty evaluation is the likely reason for the large number of shares sold short (19.8% of the float).

    Looking forward to next week's earnings announcement, let's check out what has happened over the past four quarters, with the stock price change from the close on the day before the announcement until the closing price on Friday (when the weekly options expire):

    (click to enlarge)

    LULU has not done very well after earnings announcements considering they beat estimates every time. In half the quarters the stock fell after they topped estimates. The stock has tended to move considerably after an announcement (an average of 7%). Next week's option prices are priced for a 7% move, exactly the average change for the last four quarters.

    Over the last several months, I have been testing the proposition that the level of expectations prior to an earnings announcement is a better indicator of what the stock price will do than the actual earnings themselves. I call it the Expectation Model. Basically, I examine recent stock price activity, estimates vs. whisper numbers, past post-earnings price changes vs. results, current RSI levels, and come up with a measure of whether expectations are unusually high or low.

    If expectations are usually high, there is an excellent chance that the stock will be flat or fall after the announcement, regardless of how much the company might surpass estimates, and conversely, the stock is more likely to move higher when expectations are low, even if estimates are merely met. (Unusually low expectations are generally less predictive of higher post-announcement prices, however - unusually high expectations more reliably predict lower prices after the announcement).

    I have had some serious success with this model, including 12 consecutive winning pre-earnings calls (average gain about 18%) without a loss - see results and update. Over half of the earnings plays were published in Seeking Alpha articles published before the announcement - see some examples here and here.

    A bullish case for the company cited getting its yoga pant line back after recalling it for being too transparent - Lululemon Poised To Pop After Ironing Out Pants Issue. A more balanced analysis was made by Bill Maurer - Will Lululemon Decline After Earnings? I strongly encourage you to read this article as he reported just about exactly what I would have said so there is no reason for me to repeat it all here.

    The only thing I would add to Bill Maurer's article is my concern of the level of recent insider and institutional sales of stock. While Yahoo reports that insiders sold 579,758 (4.2% of their holdings) over the past six months, if you add up the individual sales reported that number becomes more than double that amount. Furthermore, in the last quarter, institutions disposed of over 7 million shares (4.9%) of their holdings.

    So how does LULU stack up with the Expectation Model? Bottom line, expectations seems to be a little high leading up to next week's announcement. The stock has had a huge run-up recently, rising about 25% over the past 10 weeks and hitting a new high of $82.48 last week before backing off about $4 since then. Whisper numbers are higher ($.32) than estimates ($.30).

    Recent institutional sales or purchases are part of the model and have been a fairly reliable indicator as to how the price might move after the announcement. We can expect that a great deal of research and analysis went into their decision (in this case, to sell shares) and it is usually a good idea to follow along with them rather than guess they are wrong.

    High expectations, a record of lower stock prices after earnings, and what I believe is a currently-expensive stock price, all lead me to believe that there is an excellent chance that LULU will trade lower next week and that anyone who is thinking of buying shares should wait until after the announcement and most likely get a better price at that time. This is just what I said about Costco (NASDAQ:COST) two weeks ago (a company I love and am long), and even though it bested estimates, it is trading about $5 lower after announcing.

    I don't feel as strongly that LULU will drop after the announcement as I did with COST, however (mostly due to the stock falling $4 in the last week), so I will hedge my bet. With LULU trading at $79, I will buy 10 July-13 80 calls and sell 10 Jun2-13 78.5 calls (incurring a maintenance requirement of $2500) for about even money, and buy 5 July-13 - Jun2-13 82.5 call calendar spreads for about $1.25 (just in case I am wrong and the stock moves higher). My total investment will be about $3200.

    Here is the risk profile graph for those positions assuming that IV of the July option will fall from 40 to 30 after the announcement:

    (click to enlarge)

    These positions could make an average gain of about 20% if the stock does not fluctuate too much. It looks like a gain of some sort should come about if the stock fluctuates by less than 5% on the upside or about 7% on the downside. This is an investment you should only make with money that you can truly afford to lose. I plan to do it, and expect it to be my 13th consecutive winning earnings trade.

    Disclosure: I am long COST. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Additional disclosure: I plan to place the neutral-bearish options trades mentioned in the article in the next 72 hours.

    Tags: COST, LULU, earnings
    Jun 06 1:05 PM | Link | 3 Comments
  • Why Betting On Apple Next Week Could Be One Great Wager

    This is the second article covering companies who report earnings during the week starting April 22, 2013. The first article - 3 Earnings-Related Plays For Next Week - included the companies which report before Wednesday, April 24th, and today the rest of the companies are covered.

    For several months I have been studying ways to predict stock price action after an earnings announcement using four measures:

    1. Whisper numbers vs. analyst expectations
    2. Stock market action leading up to the announcement
    3. The percentage change predicted by option prices vs. historical post-announcement changes
    4. The implied volatility (IV) advantage of the Weekly options over the next-month out options (this is also a good indicator of how much the further-out options will implode in value after the announcement).

    The basic premise is that if expectations are unusually high, there is a very good chance the stock will fall after the announcement, regardless of how much the company beats analyst expectations on earnings, revenue, margins, and guidance. There seems to be a large group of investors who "sell on the news" and at least temporarily depress the stock when expectations are particularly high going into the announcement date.

    If expectations are unusually low, the reverse is true. The stock may well move higher even if the company fails to meet analyst projections.

    Last week, these expectation measures suggested that SanDisk (NASDAQ:SNDK) had extremely high expectations and would likely fall after the announcement, regardless of what the numbers were. The bearish option spread I recommended in How To Play The First Week Of The April Earnings Season ended up gaining 68% after commissions - see details.

    As high as SNDK's expectations seemed to be, Google (NASDAQ:GOOG) had equally low expectations. In one of our portfolios at Terry's Tips, with GOOG trading about $770, we bought May - April calendar spreads at the 780 and 790 strike prices, paying $4.60 and $4.75. In the morning after the announcement, we sold these spreads for $11.52 and $11.80, more than doubling our money. Once again, our measure of expectations correctly predicted the direction the stock price moved after the announcement.

    Apple (NASDAQ:AAPL) seems to have as low expectation levels as GOOG did a week ago. This would suggest the outright buy of AAPL in advance of Tuesday's after-hours announcement, or May - Apr4 calendar spreads at higher strikes than the $390.53 current price (e.g., at the 400 and/or 410 strike prices) where calendars can be bought for less than $4. These spreads could easily be worth double those amounts if the stock moves moderately higher next week after the announcement.

    Here are the numbers for the remaining companies (trading over $20) with Weekly options that announce next week:

    (click to enlarge)

    While you may use this information to support or refute ideas you may have about these companies, there does not seem to be a strong indication for any of these companies that expectations are particularly high or low. That is a real shame since I spent many hours calculating these figures.

    Occidental Petroleum (NYSE:OXY) and Qualcomm (NASDAQ:QCOM) have whisper numbers which are higher than analyst expectations by the largest margins of any of the other reporting companies, but both companies have traded much lower over the past week and month, suggesting that expectations are not unusually high in spite of the elevated whisper numbers.

    Of the nine companies reporting, Starbucks (NASDAQ:SBUX) might be the one with the highest expectations (and might be most likely to trade lower after the announcement). Whisper numbers are slightly higher than analyst expectations, the stock has moved higher over the last month, and it fell only 0.1% last week while the S&P 500 fell by 2.1%. However, unless you have other reasons to believe that SBUX is due for some weakness, this level of expectations is not sufficiently strong to suggest a short sale, at least compared to the high levels we saw in SanDisk last week and low levels displayed in AAPL and GOOG.

    One interesting note is that many companies, notably Baidu (NASDAQ:BIDU), F5 Networks (NASDAQ:FFIV), and Amazon (NASDAQ:AMZN) have option prices which are quite low compared to the average historical change in the stock price after the announcement (according to EarningsWhispers.com). You could buy a straddle for the percentage of the stock price (Option Volatility column) and make a gain no matter which way the stock price moves just as long as the percentage change is the same as the historical average.

    Another way of playing this would be to use the information that option prices for these companies seems to be lower than they should be to pick a direction if you like or dislike a particular company's prospects, and buy either a put or a call. For example, I think AMZN is having difficulties right now, and selling the stock short or the outright purchase of a put might be in order. Even with that inclination, I would be more comfortable buying a calendar spread at a lower strike price because I don't really feel that strongly about the stock moving lower at this particular earnings announcement.

    I continue to believe that checking out the level of expectations prior to an earnings announcement is a great way to predict the direction the stock price might take after the announcement (regardless of how good or bad those numbers might be). In order to get a handle on the level of expectations, you have to go through the process of measuring the variables as I have done in the above table.

    There is surely some value in concluding that there is not a clear edge to be had in either direction based on these calculations (as we have discovered in the above table), and as long as there is interest from Seeking Alpha readers, I will continue to make these calculations and pass them along to you.

    Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Tags: SBUX, AAPL, earnings
    Apr 21 10:38 AM | Link | 1 Comment
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