Investing 102 For Millennials

If you haven’t read Investing 101 yet, we recommend you do that first before reading Investing 102 for Millennials.

Alright.. time for the advanced topics. The good news is, you don’t need these products to make a lot of money in the market, but we figured it would be good to know.

Disclaimer: I have been investing for 13 years and have never shorted a stock, bought an option, or purchased on margin, and have still made a lot of money the old school boring way. If that is all gibberish to you, great, we’ll be covering those topics and more below and why you should be careful when purchasing any of these securities.

Forex:

You’ve most likely heard of this, or you’ve at least seen someone on Instagram advertising their Forex program, which is guaranteed to make you rich! Ha. I forgot to mention this in Investing 101, but there are no guarantees to getting rich in the market.

What is Forex? The Foreign Exchange Market (FX) is a way to trade currencies on an Over The Counter market that is open 24 hours a day. You buy and sell currency pairs to make money hoping currency A increases to currency B. It is harder to take a buy and hold approach in Forex, there are a lot more outside factors (government involvement) that contribute to fluctuation in prices.

There has been a recent trend on the internet of people trying to teach other people how to make money in the Forex markets. They share their profits on their Instagram stories and always pitch “turn your phone into a money machine.” I am convinced those “influencers” make more money from selling the FX courses than they actually do in the FX market because if they really figured out the FX market, they’d keep it to themselves and make a ton of money.

I don’t invest in the FX market. I consider it more speculation than true value investing based on an underlying business. If things are too complicated to explain to a 5-year-old, then I try to avoid investing in it.

Options:

An option is exactly what it sounds like it is: It gives the contract holder the right (option), not an obligation to buy or sell an underlying asset (stocks for example) before a certain date.

There are 2 types of options: put and call options. People buy options to speculate or hedge their risk.

Let’s run through the basic mechanics of an option. Usually, an option contract represents 100 shares. There is a cost of buying an option, also known as the option premium. For example, if the option has a premium (cost) of $0.5 a share, the contract premium would be $50 ($0.5 x 100).

A key component of an option is the strike price. This is also known as the exercise price. This is the price you can sell or buy the underlying stock.

The last key component of an option is time (expiration). Strike price and expiration are key things to keep in mind when buying an option.

American options can be exercised before the expiration date, and European options can only be exercised on the expiration date. I always believe in long-term investing: options put a cap on your timing because of the expiration dates.

Call Options

If you anticipate a stock price to increase, you’d buy a call option. If you are wrong about the stock price increase, the option would protect you from a large loss. You would only lose out on the option premium (the cost per contract). It lets you hold a leveraged position at a lower cost than buying the shares.

For example, if a stock is currently trading at $10 and you anticipate this stock will be worth $20+ dollars in a year. You can buy an option with a strike price of $15 and an expiration in one year. Let’s assume this contract costs $1.00 per share. A contract usually means 100 shares, so your option premium will be $100 dollars. One year from now if you were right, and the stock is trading at $21 dollars, you would exercise your option, which would allow you to buy 100 shares at $15 dollars a share ($1,500) and you could turn around and sell them at the market price ($2,100). Your profit less the cost of the option would be $500. ($600-$100).

If you were wrong, you would only lose the $100.

The reason I don’t buy options:

• People can’t time the market. No matter how great a company is, the timing is a key factor in options. If another pandemic hits like coronavirus, your call option may not hit the strike price for more than a year. If you owned the stock, you’d be able to ride out any ups and downs, without being worried about an upcoming contract expiration.

Put Options

Put options are the same thing as call options, except they are used when you speculate that stock might drop in price.

Shorting

Shorting is an interesting concept. Have you watched the Big Short?

I won’t get into the actual definition of shorting because conceptually it might be confusing. Let’s just talk about what it is and how it works.

You short a stock if you anticipate it will decrease in price. How is this different from Put options? With a put option, your maximum loss is the option premium (contract price). With a short, your maximum loss is unlimited, because theoretically, a stock price could keep going up. A short is the opposite of buying a stock. You are borrowing the stocks from your brokerage, hoping the price decreases so that you can buy back the stocks at a cheaper price. Your profit would be the difference in those 2 prices. The inverse of buying a stock. Your maximum profit on a short without factoring in leverage is 100% return. A stock price can’t fall more than 100%.

The 2 reasons I do not short stocks:

• My risk exposure is unlimited, and my profit potential is capped at 100%.
• Margin calls: When you short, you need to have 150% of the short in your account. If the stock price continues to rise, your position will keep falling and since you need to maintain the 150% maintenance margin, you will either need to buy back the shares (closing your position) or add more money to your account.

Q&A

As always, if you have any questions on Investing 102 for Millennials or on any other topics, Just ask Baba below in the comments. Have a request? Ask Baba