Q: Can you explain what "naked call" options are? – S.R., Mountain View, N.C.
A: Sure. There are two main kinds of options: calls and puts. Buying a call gives you the right to buy a certain number of shares at a particular "strike" price within a set period of time (often just a few months). Buying a put gives you the right to sell shares.
When you sell (or "write") a call, you're committing to deliver a set number of shares if the buyer exercises the call. If you don't own the underlying stock, that's a "naked call." It's risky because if the stock soars, you may have to buy it at the new high price, to deliver it to whomever bought the call you sold. You might lose a lot. Of course, if the stock stays below the strike price until the option expires, you pocket the price of the option. That's the appeal of this strategy.
"Covered calls" are safer, where you sell a call only if you own the underlying stock – and are willing to hand it over, if necessary. You won't lose any cash this way, but if you have to relinquish your shares, you'll miss out on profits you might have made if you'd kept the stock.
Many options strategies are risky. You can build wealth in stocks without ever using options.
Q: Why does the stock market's value rise or fall every day? – V.N., Tulsa, Okla.
A: The stock market is made up of thousands of companies' stocks, and each rises or falls according to what investors think of it, based on the latest news or developments. Promising news usually sends a stock's price up, and vice versa.
Stocks for your retirement: We often assume that as we approach retirement, we should sell many or all of our stocks and stick mostly with less volatile investments, such as bonds, certificates of deposit (CDs), money market accounts and cash.
That might be a mistake, though. It can be smart to keep a meaningful portion of your portfolio in stocks even when you're retired. After all, if you retire at age 62 and you live to age 92, those are 30 years in which your nest egg could keep growing, and stocks offer better growth rates than bonds over most long periods.
You can aim for growth with the portion of your portfolio that you keep in stocks, while relying on the portion in safer investments to preserve your assets. For context, know that the stock market has averaged close to 10% annual growth over many decades – though with great variability from year to year, and no guarantees.
One old rule of thumb is to take the number 100, subtract your age, and invest the remaining portion in stocks. So if you're 60, you'd park 40% of your portfolio in stocks, and 60% in bonds. With people living longer these days, some use a newer rule of thumb, subtracting their age from 110. That would put a 60-year-old 50% in stocks and 50% in bonds.
Another common rule simply suggests a 60-40 mix at any age, with 60% in stocks and 40% in bonds. But with interest rates having been very low for many years now, that hasn't served many retirees well.
It's best not to use any one-size-fits-all strategy for your portfolio, as everyone has different savings, incomes, risk tolerances, ages and expected longevity, among other factors. Take some time to try to determine your best allocation mix – one that will allow you to sleep well at night while still generating the income and portfolio growth required for the rest of your life. Don't be afraid to consult a financial planner, either; you can find some fee-only ones at NAPFA.org.
My dumbest investment
Black Monday blues: My dumbest investment was selling my shares of Microsoft on Black Monday in 1987. – S.F., online
The Fool responds: Ouch – this is an extra-painful story to hear, because Microsoft had just had its debut on the stock market – its initial public offering (IPO) – the year before. Had you bought 100 shares at the IPO and never sold, you'd be sitting on quite a bundle.
The stock started trading on March 13, 1986, at $25.50 per share, so 100 shares would have cost you $2,550, plus whatever commission your brokerage charged you. Microsoft has split its stock nine times since then, so those 100 original shares would have become 28,800 shares through splits. With the stock recently trading for about $215 per share, your 28,800 shares would be worth almost $6.5 million!
Of course, we're looking back now knowing what a success Microsoft has been. Back in 1987, it was still a fairly small company, and its future unclear.
"Black Monday" occurred on Oct. 19, 1987, when the Dow Jones Industrial Average plunged by 508 points, representing a 22.6% drop at the time. The market crash took most stocks down with it, to varying degrees, and Microsoft was no exception. Savvy and/or experienced investors at the time would have hung on to their shares – and bought more, if they could. Market crashes present great long-term buying opportunities.
Name That Company: I trace my roots back to Baltimore in 1889, when a 25-year-old fellow named Willoughby launched me in a basement and began selling spices and extracts door to door. Over the years, I've offered cream of tartar and food colorings; "blood purifier," castor oil, cold cream, liver pills, talcum powder, tooth powder and witch hazel; and ammonia, birdseed, flypaper and roach traps. Today, with a market value recently near $25 billion, I boast brands such as French's, Frank's RedHot, Stubb's, Old Bay, Lawry's, Zatarain's, Kohinoor, Club House, Aeroplane and my own name. Who am I?
Last week's trivia answer: I trace my roots back to 1937, when three men and two women founded me in Baltimore, aiming to invest money strategically and serve their clients with integrity. Today, I'm a major financial-services company, with $1.3 trillion recently under management. The bighorn sheep is my mascot. With more than 7,000 people – including over 700 investment professionals – serving clients and shareholders in 51 countries, I offer everything from mutual funds to college savings and retirement accounts. From August 2010 to August 2020, my stock roughly tripled. I've made multiple lists of best places to work and most admired companies. Who am I? (Answer: T. Rowe Price)
The Motley Fool Take
Banking toward profits: It's not a popular time to be buying bank stocks, with a pandemic going on. But it's also a perfect time to do so because prices are low. Shares of Bank of America (NYSE: BAC) were recently down 19% from their 52-week high, as low interest rates and a poor economic outlook are keeping investors away. So Bank of America has recently been trading at a forward-looking price-to-earnings (P/E) ratio of just 11 – below its book value. Investors who buy at such a level can get a lot of bang for their buck. Plus, while waiting for the stock to recover, they can collect a growing dividend that recently yielded 2.5%.
Aside from pandemic-related issues, Bank of America has been doing very well in recent years. It has emerged as a leader in mobile and online banking functionality, and that has helped improve its profitability.
Once COVID case numbers start falling, which should happen once vaccines are widely distributed, some bullishness will return to the economy; interest rates are likely to rise and unemployment rates to fall. All these factors could benefit financial stocks.
Bank of America is a solid and well-run institution that has dramatically improved its asset quality and business efficiency over the past decade. Its stock price could be higher or lower in a year, but over the long run, it should reward investors well.
Copyright 2020 The Motley Fool
Distributed by Andrews McMeel Syndication