Trojan Investing Newsletter

April 7, 2009 Issue 3 - Volume 2

Welcome Trojan Investors! Inside This Issue

We would like to thank our contributors and those
who have invested their time and effort to make the Trojan Trend Analysis
Investing Newsletter all that it can be. If you are interested The Hong Kong Housing Market:
in contributing or editing, please contact us at Opportunity in the Bear Market?..............p.2
trojan.investing.newsletter@gmail.com. For those of
you who are new to the TIN, read on to find out how you
can benefit from joining our readership. Investment Analysis
Through issues distributed at the beginning of The Gold Mirage..................................... p.4
each month, the Trojan Investing Newsletter hopes to
bring ideas together that stimulate new ways of thinking
to benefit you as an investor. Through critically analyzing Learning Center
economic and sector/industry trends as well as individual Stock Twits.............................................. p.6
securities, we hope to provide you with new insight into Covered Calls as a Trading Strategy......... p.7
how to view the world as a place to invest.
We are affiliated with the Trojan Investing Society,
the premier finance and investing club at USC. The weekly
TIS meetings are a great place to come to express your Market Performance Snapshot
opinions on the articles written; and where the contributors
2 - Jan 6 - Apr Return
of those articles will have a chance to answer any questions
you have. Being allowed access to a variety of investing Dow Jones 9034.69 7975.85 -9.12%
ideas through this forum provides our issues depth and S&P 500 931.80 835.48 -7.5%
breadth that we would otherwise be unable to afford our NASDAQ 1632.21 1606.71 1.88%
readership. We sincerely hope that you find our newsletter Russell 2000 499.51 447.56 -10.4%
to be interesting, informative and most of all, enjoyable. 10-Year T-Bill 2.217 2.93 -32.16%

“The whole financial structure of Wall Street seems to rise

or fall on the mere fact that the Federal Reserve Bank raises Contributors:
or lowers the amount of interest. Any business that can’t Joshua Inouye, Richard Graham, Alexander Muhr
survive a one percent change must be skating on thin ice.
Why even the poor farmer took a raise of another ten per- Co-Editor-In-Chiefs:
cent just to get a loan from the bank, and nobody from
Richard Graham
the government paid any attention. But you let Wall Street
have a nightmare and the whole country has to help to get Matthew Riley
them back into bed again.”
-Will Rogers, 1929
Disclaimer: Views expressed in this newsletter are not those of the University of Southern Cali-
fornia or any of TIN’s affiliated groups, but the author’s own. Recommendations are made by
students, not financial professionals. Readers should not rely on information from the following
-Trojan Investing Newsletter Staff articles or the recommendations therein for trading or investing. The purpose of this newsletter is
to facilitate discussion and broaden students’ awareness of current market issues.

This newsletter may contain references or links to websites that are created and maintained by
other organizations. TIN does not necessarily endorse the views expressed on these websites, nor
does it guarantee the accuracy or completeness of any information presented therein.
The Hong Kong Housing Market: Opportunity in the Bear Market
By Richard Graham

As a result of the global macroeconomic decline, tight credit mar- cause buyers become very limited. As a result, prospects for
kets, and falling real estate prices, the real estate and prop- real estate growth are limited until credit markets unfreeze.
erty development industry in Hong Kong and (as a corollary)
China is undergoing a period of limited growth and falling Opportunities in the Bear Market
profits. While the current environment is certainly hostile to
the real estate industry in these areas, low prices and cash- While the Hong Kong and Chinese real estate market is chal-
strapped companies provide strong property developers op- lenging at the moment, well positioned companies can take
portunities for long-term growth and profits. advantage of the poor market and position themselves for
success in the future. Firms with large amounts of cash on
Housing Woes hand and large credit facilities can purchase real estate at fire
sale prices from other struggling developers and wait for
The world wide macroeconomic decline has resulted in large prices to improve to sell. By buying when the market is low,
amounts of layoffs and poor consumer sentiment in Hong firms can position themselves to profit off of the eventual
Kong, two factors which hurt prospects for real estate indus- market recovery.
try growth. Because of the global economic downturn and
worldwide financial crisis, large financial services firms, banks Two firms that are in this advantageous position are Hang
like HSBC Holding PLC, retail, and tourism companies are Lung Properties (HK.0101) and Cheung Kong Holdings
initiating layoffs. As unemployment increases, individuals will (HK.0001). Both firms have weathered the current down-
be unable to afford their current rental and lease payments, town better than their peers. Hang Lung successfully called
which threatens revenue for real estate developers. If the the real estate market. They refrained from purchasing land
worldwide recession continues to deepen and layoffs contin- during the boom, now sit on a large cash reserve, and have
ue, the current market could get much worse. Moreover, low no debt. Cheung Kong diversified their company portfolio
real estate consumer sentiment is hurting demand for real during the housing boom, investing in a wide array of real es-
estate. Worldwide stock market declines have substantially tate and other companies, like biotech. They also sit on large
decreased individual wealth, which has decreased the number cash reserves. They also control a large market share in the
of buyers in the Hong Kong real estate market and forced Hong Kong market. These firms can aggressively buy in the
prices lower. Another indicator of poor consumer sentiment depressed market at below normal prices and build up prop-
is the Hang Seng Property Index, the capitalization weighted erties to be sold when the market recovers.
index of all property stocks traded on the Hang Seng Index
of the Hong Kong Stock Exchange. Since its high of 33492 Both of these firms will remain competitive in the Hong
in May of 2008, the index has fallen 52% to 16046 in mid- Kong housing market in the coming months, even though
February, an indicator of poor investor confidence in the real the market will remain depressed. In the short run, these
estate industry. As a result of poor consumer sentiment, real firms should exploit their advantageous capital structure as
estate prices are predicted to fall an additional 35% in the the market falls and reaches bottom by purchasing land and
current year and expected to begin to rebound in the second developing it for low prices. In the long run, prices will re-
half of 2010 . Additionally, as worldwide business begins to cover, and these firms will stand to make substantive profit.
slow, demand for commercial real estate will decrease. This This bullish outlook should be treated with skepticism, how-
will slow new property development and hinder growth. ever, because when the economy will recover remains to be
seen. And until it does, the Hong Kong real estate market will
Moreover, tight credit markets are having a negative effect remain depressed.
on the Hong Kong real estate industry. Tight credit markets
hurt both developers and consumers. Developers are unable
to get capital to fund new projects, and consumers are unable
to take out loans to buy, lease, and rent property. This effect
creates an impasse in the real estate market where buyers and
sellers are unable to do business. This forces down prices be
The Gold Mirage
By Richard Graham
Once again gold is a topic of discussion amongst numerous Gold was worth over $2000 in 1980 if we look at it using
financial “talking heads” and market participants. In the face 2009 dollars. Because the current recession is on pace to ei-
of the current economic downturn, the increased demand ther be as worse or worse than the 1980s’ recession, those ex-
and increase in gold’s price should be obvious: investors’ ap- tremely bullish on gold (sometimes referred to as gold bugs),
petite for risk has decreased due to large equity and derivative are quick to point out that gold has a lot of room to grow
volatility, and investors fear that government spending will (see figure 1).
erode the value of the US dollar. Investor flight to safety and
fear may point to a short-term run-up in the price of gold, Figure 1
though gold will be unable to sustain those gains in the long There are, however, numer-
run. ous flaws with this outlook
for gold. In the long run,
Gold, which has been a precious commodity for thousands the price of gold is highly
of years, is considered an investment to hedge market contingent upon jewelry de-
uncertainty and inflation. It is considered a precious com- mand, which has dropped
modity because of its rarity and probably in some part do to due to the recession. If the
its shiny and attractive nature. It is 18x rarer than silver and recession continues, it will
has significantly fewer industrial uses—meaning only that be difficult for investors,
the supply of gold circulating as bullion, jewelry or stored in Source: Economist who are still a minority con-
giant secure vaults is relatively stable. Output from mining sumer of gold, to fill the
operations remains relatively stable as large holes the jewelry business leaves (see Figure 2), allow-
well. There have been no new ing prices to fall. The Economist forecasts that in 2009, to-
major discoveries of gold veins or tal gold consumption will fall 6.5% even though investment
gold in copper veins and so there Figure 2 demand is increasing
is no major output increase in the 10%. Even though sup-
foreseeable future. Although gold ply will contract, excess
has been traded for centuries, in supply is projected to
more recent times it has not really increase by 21%. While
been though of as an investment the 10% increase in in-
instrument for the masses. The vestor demand in 2009
creation of large gold funds like seems enticing to po-
the SPDR Gold Shares ETF tential gold investors,
(GLD), makes gold accessible to other economic factors
the broader public and changes clearly need to be con-
gold trading in a significant way. sidered.

Fear Vs. Fundamental Supply and Demand Source: The Wall Street Journal

Recently, gold prices have increased and have even broken
through the long-standing $1000 mar, making the bull case
for gold very convincing. The current economic downturn
is on pace to rank among those of the 1980s and 1930s. In
these uncertain times, gold is an easy investment to turn to.
Its value, in contrast to that of equities and corporate debt,
is not contingent upon strong company performance, but is
rather based off of demand for its safe nature.
Future Inflation?
Even in the face of falling demand and excess supply, gold
investors argue that gold prices will increase because of
gold’s role as a hedge against inflation and currency deprecia-
tion (which go hand in hand). While the price of gold has
historically dropped when the economy begins to recover,
many believe that due to large fiscal stimulus packages, lax
monetary policy, and quantitative easing, economic recovery
will be coupled with high inflation rates. default--all macroeconomic factors that depreciate a cur-
rency. These countries have also implemented large stimulus
People point to US fiscal and monetary policy as the main and budget packages on the same level as the United States’.
stimuli for high inflation. On the fiscal side, the US Treasury Because currencies are traded in pairs, currency traders are
market is being flooded with trillions of dollars in T-Bills to left with a choice: buy dollars, which are historically a safe
fund the current deficit. This poses a two-pronged problem currency, or invest in any other, unproven foreign currency
(which is a boon for gold investors). First, high deficits and and their economy. The answer is obvious, buy dollars. In
debt erode the value of the US dollar. Second, large T-Bill comparison to other economies, the US economy is far more
sales (in addition to the already outstanding national debt) stable and diversified. The economic crisis has revealed major
in the current economic climate threaten to literally collapse flaws in export driven reserve currency economies like China
the market for T-Bills because their security and worth come and Japan. The current appreciation of the dollar proves this
into question. On the monetary side, they point to Federal claim and it is safe to say that this trend will continue.
Reserve’s policies during this recession. The FED has sub-
stantially grown its balance sheet (to record levels) through The kicker argument in this debate involves gold exchange
programs like TALF and has recently engaged in quantitative traded funds. Because the average investor is either unable or
easing. unwilling to hold actual gold, they invest in exchange traded
funds to invest in gold. High demand for exchange-traded
Such aggressive monetary policy creates likely prospects for funds means that these ETFs need to purchase gold in or-
inflation. der to maintain themselves. ETFs like the SPDR Gold Trust,
which holds 1,024 tons of gold—this makes them the sixth
Inflation, however, may not be as likely. Central banks world- largest holder of gold in the world, holding more gold than
wide have slashed interest rates to ultra-low levels. In the China, Japan, and the European Central Bank—are now play-
event of inflation, they could easily raise interest rates to ers in the worldwide gold market. The problem, though, lies
contract the money supply. Setting an explicit inflation tar- in how these funds operate. When people buy shares, these
get is back in vogue, which calms markets, wage growth, and ETFs have to buy gold, when people sell shares, these ETFs
consumers alike. Inflation also naturally erodes the value of have to sell gold. If the economy heats up or investors’ appe-
the money supply, slowing down price growth. Also, most of tite for risk increases, investors will begin to pull their money
the FED’s expansive monetary policies have targeted bank out of gold ETFs. The ETFs, as a result, will have to sell their
balance sheets. As a result, most of this new money will stay gold, flooding the market. This will collapse the price of gold
in the financial system and not even enter the consumer’s by creating a large amount of excess supply. If this scenario
pockets. When the economy begins recovering—the time occurs when the economy is heating back up, the ETFs will
when inflation prospects are highest—this money will have have to sell their large quantities at fire sale prices, depressing
to be paid back to the FED, which will act as a stabilizer and the price of gold more.
decreases the money supply.
Even if the price of gold increases in the short term, the
Additionally, those in the bond markets (for whom it can be upside potential is not worth the downside risk. Gold has
argued are able to more accurately predict inflation) indicate consistently been unable to piece the $1000 mark and has
a low long-term inflation trend. A quick survey of the index- traded within the $900 range throughout the economic crisis.
linked government bond market shows that investors are The downside risk is great. Gold has not fallen like its other
not forecasting large amounts of inflation over the next ten commodity counterparts have, and could fall quickly if mar-
years. ket conditions change. Over the long run, especially as the
economy recovers, we can expect to see the price of gold
Because gold is traded in dollars and seen as a hedge against decrease as investors move out of gold and into more risky
a depreciating dollar, dollar appreciation poses a threat to the investments and as the dollar appreciates. For these reasons
price of gold. American national debt may be approaching and others, it is important to stay away from gold, its price is
record levels, but the US is still the largest economy in the merely a mirage.
world. The US is the only country currently large, stable and
diversified enough to support a global currency. Other coun-
tries like those in Eastern Europe, Latin America, Europe,
Russia, China, and Japan are facing far greater problems, rang-
ing from collapsing tax revenues due to crashing commodity
prices to collapsing export markets to bank failure and loan
Stock Twits
By Alexander Muhr
If you pay any attention to the Internet, as virtually any
college student does, then you’ve likely heard of a service
called Twitter. Although by Internet standards the company
is not that old—it has already been open for more than one
year--the media has picked up on the phenomenon as well
– as you might have seen on the ubiquitous 24-hour news
channel.
To be honest, the first time I signed up for twitter I though
it was cool, but could not see any benefit: my account was
pretty much nonexistent for the past year until I found out
about StockTwits. This quirky name might turn some off,
but it really does describe the incredible new power and
depth that StockTwits gives to the individual investor (and
arguably the professional money manager).
What is StockTwits?
“StockTwits is an open,
community-powered in-
vestment idea and informa-
tion service. You can think
of it as Bloomberg for the
little guy and gal. Eavesdrop
on what traders and investors are talking about RIGHT
NOW or contribute to the conversation and build your
reputation and following as a savvy market wizard.”
who – according to his website – focuses on energy topics.
During the hour people field questions about Oil, Natural
Gas, etc. and a discussion evolves that sometimes leads to
talk ranging from US Treasuries, to the consumer, to much
more. This is just a small example of what is talked about
on StockTwits.
For me, the main benefit is to filter out noise from the news
media and be able to “hear” different opinions on various
stocks and markets. I accomplish this by filtering my feed to
just stocks or markets that I an interested in, even though
most users are happy to have conversations about any topic.
If you sign up, you’re most likely going to be “talking” to an
experienced player that is willing to express their views on
the market, which is virtually impossible outside of Stock-
Twits unless you call them up directly. Using StockTwits in
essence opens the door to the minds and conversations that
market players have every day with themselves or with oth-
ers.
And if you sign up, be sure to follow me – I’d be happy
to give some pointers on usage and who else to follow: @
amuhr.

Most of the information I get is through news websites

(WSJ.com, etc.) or my Google Reader (for blogs and compa-
ny filings I subscribe to), but no service gives me real-time
access to the minds of investors. StockTwits does that, tak-
ing the Twitter infrastructure and tailoring it to the needs of
the trader or investor. Since many news services also have
accounts on Twitter, most news is forwarded instantly to
your account, so there is no need to keep checking back to a
website. Impressively this does not only save time, but also
creates instant conversation about news stories or particular
trading ideas that crop up from the minds of “the crowd” –
except with StockTwits there is a track record.

Right now the site has about 30,000 users since it was
launched in October of last year, and has a very diverse mix
of traders, bloggers, journalists, venture capitalists, hedge
fund managers and many more. One particular event that
has evolved from the community is the “MacroTwits” hour
every Sunday night. This event is lead by GregorMcDonald
Covered Calls as a Trading Strategy
By Joshua Inouye
Covered calls are often mentioned on the news or when strike price of 84, which corresponds to the location of the
discussing options strategies, simply because they are the kink, and the price at the time of this writing was 4.70. Due
most commonly used strategy, especially by retail investors, to this price, the maximum profit that can be realized from
due to their simplicity. A covered call refers to a call option this strategy is 4.70 (per share, which is a gain of 5.6%--a
that is sold, but covered by the ownership of the underly- very nice gain if the stock was at 84 or above at expiration,
ing security. Ordinarily, a call option that is sold naked (not especially because this is over a period of 2 weeks). A key
covered) will be subject to the possibility of unlimited loss, point is that if SPY advances very far, the outright owner-
similar to shorting a security. However, owning the underly- ship of the stock will outperform the covered call strategy.
ing security in an appropriate ratio hedges against unlimited The point at which this occurs is where the 2 lines intersect,
loss, and drastically changes the profit/loss characteristics which is at 88.96. Therefore, the conclusion is as follows:
of selling calls. This is also known if SPY is above 88.96 at expiration,
Figure 1
as a buy-write strategy (i.e., you outright ownership will outper-
buy the underlying security and form the covered call strategy,
write—or sell—calls on it). and if it is anywhere below 88.96
at expiration, the covered call
strategy will outperform the SPY
outright ownership. Additionally,
Figure 1 shows the profit/loss the covered call strategy will still
graph of a covered call on SPY, turn a profit if the SPY drops
using recent (early April) prices slightly (provided it does not
of the call and SPY itself. There drop below 79.56—see graph).
are several aspects of this graph
to take note of. The outright It is also an important point that
ownership (dotted line) shows if the market moves sideways
your profit/loss if you simply and SPY is very near 84 at expi-
own SPY. The price of SPY ration, the outright ownership
was 84.26 at the time of this strategy will not gain anything
writing. The graph should make but the covered call strategy will
intuitive sense. If SPY is exactly still make about 5%. As an aside,
84.26, then the profit/loss will be 0. If SPY is at 95, then if you could employ this strategy the same way continuously
the profit would be 10.74 (since you could sell it at that throughout the year and if the market moved sideways, you
price for a profit of 10.74). Conversely, if it dropped to 75, would have a 355% gain after compounding. You would
you would have a loss of 9.26, as can be seen in the graph. have made nothing if you were simply long the stock and it
Ultimately, for SPY ownership, you make 1 dollar for every moved sideways for a year. However, these opportunities do
dollar the SPY moves up and vice-versa. The profit/loss not always present themselves due to the price and volatility
line is linear. fluctuations of SPY and its options. but The central theme
of this strategy still remains true: you can make money if
However, if you write a call (or calls, depending on the the stock do not move or even if it drops a certain amount.
number of shares you own—you would write one call for Unfortunately, you never get something for nothing in the
every 100 shares of SPY that you own to obtain the profit/ financial markets, and to obtain this benefit you must give
loss graph shown above), your profit/loss at option expira- up some upside potential. The nature of this strategy is in-
tion would be that indicated by the kinked solid line. Note trinsically less volatile, although the long-term performance
that option in this chart is an at-the-money option that of this strategy vs. outright ownership depends on the time
expires in April (2 weeks from the time of this writing), frame chosen. In general, it will outperform the underlying
which implies that it has the greatest time-value premium security if the security falls in price, stays the same, or even
of options with the same expiration. This option has a rises a little bit. But, it will generally underperform in a rag-
ing bull market since upside potential is given up.
Let us look at a few situations by examining the perfor-
mance of ^BXM, which is the Chicago Board Options
Exchange benchmark for covered call writing strategies on
the market as a whole vs. the performance of the S&P 500
(^GSPC). These charts were taken from finance.yahoo.com.
First Case: Falling Market
! that the divergence mainly comes from the sharp drops or
The covered call index (blue or top line) fell only 20% be-
tween September 19, 2008, and November 17, 2008, while
the S&P 500 fell about 28%. Note also that while the two
are fairly well correlated, the ^BXM has slightly less volatil-
ity.
Second Case: Sideways Market
! risk, when the market substantially gains, the strategy will
The covered call index (blue or top line) gained about 3.5%,
while the market was generally sideways overall in this time
period of July 11-October 3, 2005 and only gained 0.5%. It
can be noted that most of the relative gains of ^BXM over
^GSPC were when the ^GSPC fell relatively sharply.
Third Case: Sharply Rising Market
The ^GSPC (red or top line) gained about 25% from
March 9-April 3, 2009. This demonstrates the upside poten-
tial that is given up with the covered call writing strategy.
Fouth Case: Longer Term Performance Over The Past
Several Years
The ^BXM (blue or top line) lost only about 9% since 2005,
while the ^GSPC has lost about 30% to date. Again, note
pops in the ^GSPC; also there is slightly less volatility in the
^BXM. The amount of relative divergence on specific mar-
ket moves is based on the option implied volatility.
You can employ this strategy by writing calls on stock you
already own, or you can actually buy an ETF that employs
this strategy for you (e.g, BEP, BEO, MCN, etc.). These
ETFs employ the strategy on the whole market, but you
can utilize this strategy on any stock or ETF that has listed
options.
In conclusion, the strategy of writing covered calls, while
less risky than naked calls or outright ownership, will pro-
duces returns greater than the market in times of sideways
and downward market movement. However, due to this low
produce less than the market return.
This strategy could be applicable to today’s market. While
the market has rallied substantially in the past few weeks,
many market observers expect the market to fall or move
sideways during the upcoming earnings season. This strat-
egy could be used to provide extra returns if these observ-
ers are correct. However, regardless of what direction the
market moves in the coming months, one thing is certain:
the covered calls strategy is an effective low risk options
strategy that should be a part of any portfolio.