I am a risk taker

I’ll admit it. I am a risk taker. But I also think of everything in terms of risk/reward. What is my downside compared to my upside – is losing the money I worked for worth the potential reward? Note that I care more about the downside, before looking at the upside. To me, the risk/reward profile could not have been better over the past few months. Let me explain.

I am young and can take more risks

I have my whole life ahead of me. I am extremely fortunate to have had a job since I was 14 – started off life guarding, working as a golf course attendant, then a Domino’s driver in college, and during the summers in college working at a Wall Street bank and then a big four accounting firm. I am thankful my parents supported me in going to college, and helped pay for over half of my expenses. When I graduated in May from Virginia Tech, I still had about $25k in debt from my student loans,  car loans, and Switzerland study abroad trip loans. I was a little worried how long it would take me to pay down the debt (I was estimating it would take me about 1 1/2 years, if I was somewhat frugal). But I was worried I would spend all the money I earned. So I planned to live with my parents to save some money, instead of paying outrageous rents in DC (sometimes up to $1,600/month). Thanks, again, Mom and Dad! Living at home greatly increased my cash flow. This reduced my risk.

Cash flow is everything, better your odds

I agreed I would pay a certain amount of my paycheck to my loans each month. This was absolutely reasonable. So I kept to my payment schedule, but soon realized I was not spending as much as I thought I would. Most of my expenses came from riding the Metro (about $7 a day) and going out to eat at food trucks in DC ($10 a day). Then I spent maybe $50 a week (movies, gas, eating out, etc. with friends).  On a $3k monthly paycheck, I had a lot of extra cash, especially since I wasn’t paying rent (although I did help pay for utilities/groceries).

Invest your extra cash to get ahead

So what did I do with the extra cash I was accumulating? Well, being a finance major, I knew I could either spend it, save it, or invest it. I knew most of my friends save their money, worried they could potentially lose their jobs if something went wrong. But I felt comfortable at my job, especially since I had just started. I didn’t really have anything I needed to buy, so I didn’t spend it. So, I invested nearly half of paychecks. Of course, this was an alternate to paying down my student loans (at 3.4% and 6.8% interest), but my grace period was not over yet since I had just graduated.

What do I invest in?

I traded options in college and thought I would give it another try. I knew the volatility of options, which is why I wanted to invest in them. So I bought long call options (very long, like 2-years out) on companies/stocks that I thought were fundamentally undervalued, or at the bottom of their business cycles. One such stock was a US mining company that mined and sold coal and iron ore.

long call optionCoal and mining in general got destroyed during the 2008 financial crisis because of the global growth slowdown. In fact, there are still stockpiles of iron ore in China today. Coal was also getting hit in the US with additional regulations. These concerns caused coal and iron ore stocks to plummet in value. The one company I invested in had cut its dividends by over 60%, reduced production, and decided to wait out the storm. It replaced management, too, bringing in experts that would be more fiscally responsible than previous management.

I decided the stock was ready to invest in. It had dropped from $86 to $15 over the past 5 years. Meanwhile, other companies in the industry were going out of business, but this company was changing the way it worked to survive. I got in right before earnings, and bought long 2-year call options. The reason I bought 2-year options is because the stock is very volatile and has a high beta. But the stock always seemed to jump up and down during the year, quite dramatically. If I invested at a bad time, I would still have 2-years for the company to perform well. Also, while looking at the chart, it looked like the stock was just hitting the bottom of its yearly cycle. I got in right before earnings – I knew the quarterly report would be a market moving event. Earnings were expected to be modest, so there was a lot of room for upside surprise.

I took the plunge and it paid off

Earnings came out the stock jumped nearly 6% and drifted higher over the next few days. I gained nearly 140% on my investment. After a week or so, I felt the stock was priced closer to fair value, so I cashed out, and used the gains to pay down my debt.

What I learned

I was lucky that everything came together on this investment move. I have cash flow because I live with my parents. I started my job and earned cash flow to invest right when this stock was hitting the bottom of its cycle. I made the large investment right before its earnings, which were better than expected.

But although I had luck, I also minimized risk. I bought a 2-year call option, instead of a short-term option. I did my research, and have actually been following the company I invested in for nearly 4 years now. I could also afford to lose the money without severe consequences since I was living with my parents. I was already putting aside money to pay for expenses and to pay down my debt. I sold out when I thought the stock was fairly valued, I did not speculate more than I needed to.

Overall, the risk/return profile was favorable. I minimized risk through understanding my financial needs and knowing the company and industry I invested in, and it got me ahead of schedule.

What Now?

I am now working on saving up my cash for another investment in the near future. By cutting down my debt from $25k in July to $11k in November, I have more room to invest, while continuing to pay down my debt on a monthly basis. But right now, the market is fairly valued. I will jump in again when I see mispriced assets. For many stocks at this point in time, I don’t believe the risk/return profile is favorable.

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