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Modern Investment Dilemmas

27 Dec 2011
Jim Cramer has his detractors, sometimes deservedly so (Jon Stewart), but he made a point on today's Mad Money show that is right on the money. But whether by design or by accident, he missed out on an implication that should set investors and would-be reform legislators thinking about the nature and future usage of America's stock markets.

His point was this: starting in the 1980s, hedge funds began creating derivative vehicles for investment because they were running out of equities to invest in. That's right! That had so much money to spend that they just plumb ran out of stocks to buy!

Well, almost but not quite. Cramer's caveat was that they could continue to invest in stocks, but they would have to actually buy the companies. Then they would have to do real work! That's not fair!

Instead they created indexes like the Standard & Poors 500 stock index. They created REITs and ETFs and futures where no commodities would change hands. Cramer's point is that this trend tends to make stocks move together with the market, rather than individually on their own merits. As a result it is increasingly difficult to pick good stock investments based on company fundamentals, which should be the only basis for picking stocks.

I wish Cramer had pursued that line of thinking. Why is there so much money available? Why doesn't it go elsewhere? Perhaps this is why Ted Turner has spent the last two decades becoming America's largest landowner. Perhaps he had no stomach for this trend, but wanted a sane, viable investment vehicle. So he bought land! I hear they aren't making it any more.

Why are second and third order derivatives allowed? Allowing them means that investors no longer have a stake in the success of companies they invest in. Instead, they have a stake in the overall market. This is a very different breed of horse.

The fundamental value of the stock market, which is to reward or punish the performance of companies with dollars and cents, is reduced and ultimately destroyed. When this happens, American capitalism is further weakened, potentially making it more of a threat than a benefit to economic society.

Writing as an individual investor, Cramer's comments strike a chord with my most successful recent investment strategy. I've found that I can make more money trading call and put options as the market trades up and down. Instead of buying shares in a blue chip stock, I trade options in blue chip stocks. Done correctly, this helps reduce the general risk of options trading. The key is to be intimately aware of the stocks' trading patterns, and then sculpt the buy and sell points to the cent and the second. The average investor with a day job cannot do this, at least not often, but it works, sometimes stunningly well. Other times it flops just as stunningly, such as when a stock moves to a new trading channel.

I follow this strategy, and make ridiculous profits, but I can make ridiculous losses, too. In the end it is not satisfying. I'm searching for, and finding, low-risk investment strategies that take advantage of Cramer's trend. Unfortunately, I'm afraid this is a situation where what is good for investors, is not good for the stock market or capitalism as a whole.

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