Luck Is The Residue of Good Design: Reserve Bank Transfers to the Treasury For 2013

"The Federal Reserve Board on Friday announced preliminary unaudited results indicating that the Reserve Banks provided for payments of approximately $77.7 billion of their estimated 2013 net income to the U.S. Treasury."
Src: Fed Press Release, January 10, 2014

One has to wonder how much of the national debt the federal reserve should buy up. Since operating costs are fixed, essentially if The Fed bought 100% of Treasury debt it would essentially be an interest free loan since the "surplus" of all that debt payment would just go back to the Treasury.

If that statement isn't intuitive, here's the math:

• Pretend "total cost of servicing the U.S. Treasury debt" was $453.3 billion.
• Pretend 100% of that debt servicing payments went to The Fed.
• Pretend The Fed needs "$20 billion for operations" (see the press release difference between what they recently earned and what they just returned)

If they owned all the debt, the cost of servicing the national debt would be 20 billion, not 453.3.

• 453.3 - 20 = 433.3
• "total cost of servicing the U.S. Treasury debt" minus "$20 billion for operations" = "surplus to return to the treasury"
• 453.3 - 433.3 = 20
• "total cost of servicing the U.S. Treasury debt" minus "surplus returned to the treasury" = "the net cost of servicing the national debt paid out from tax revenues"

Here's a common everyday scenario of how that works.

Son: Dad, this car must be worth a million bucks! It's a classic!
Dad: No son, no one will believe you unless you could get someone to pay you that much.
Son to his rich Uncle: Will you buy this for me for $1 million if I pay you a kickback? I need to recover my 10 grand I put into it.
Uncle: Sure, here's $1 million.
Son to Uncle: Thanks here's your receipt for $1 million.
Son to Dad: Look dad, I sold it for $1 million!
Dad: Wow, that's awesome. Sorry I doubted you.
Son to Uncle: Here's $999,990,000 back. I really only needed $10,000.

Test question: What was the 'true' cost of the car the uncle bought?

So the argument against fear that China will dump all our Treasuries is silly. In a crisis, The Fed simply agrees to buy it and store it for safekeeping until such time as a market buyer can be found to pay a reasonable price. That's exactly what they did in the bank run. When the world was about to come to an end (circa 2008) everyone (virtually, not literally) sucked up Treasury debt in a panic as the asset of last resort on earth. Naturally, most of those people calm down and eventually decide to go buy something better like stocks, bonds at rates above 2%, houses, etc., etc. Meanwhile, the Federal government started dumping new Treasuries on the market to cover the cost of all the unemployed.

Net Result: Massive flood of Treasuries coming to a market near you!

Reaction: The Fed simply agrees to buy it and store it for safekeeping until such time as a market buyer can be found to pay a reasonable price. We now know, also, that this safekeeping time frame is about 5-6 years. Like a storm water retention pool, they open the door and "collect" the "flood waters" in a safe storage facility until such time as they can trickle it out into the streams without washing away all the neighborhood homes and cars (pun intended).

One might argue, with a flood of new money to China (i.e. printing press operations to buy it all up) the value of the dollar would collapse.

Fantastic! Two great things to come out of that:

1. All the friggin' money Microsoft, Apple, Intel, and whomever that is locked up offshore because they don't want to pay tax on it would be going down the toilet unless they cash it in and bring it back home. The risk management dealers in their internal Treasuries would quickly do the math and realize paying tax is cheaper than loosing purchasing power. Not only that, making products offshore would price them out of the domestic market bringing those products back to America's friggin' huge economy. Bringing back the money instead would allow them to build factories to build domestically for less money.
2. The prices of American goods and services (and labor) would become "dirt cheap" just like China. So all the companies in all the nations on the planet would suddenly be looking for ways to hire Americans to produce their goods and services. And American businesses who are paying dirt-cheap labor in China and India would be paying through the nose because of their more expensive currencies. Those televisions, iPods, phones, clothes, etc., etc., would be cheaper to make here than there. American cars would be a fraction of the cost of foreign cars, and the auto industry is a HUGE part of our economy.

China knows this. China knows they can barely care for their billions of humans even in a weak global economy with America on the edge. China knows their political systems would collapse if their unemployment rates started climbing like America's from Americans shutting down manufacturing in China. China knows a population addicted to government stability would never support their totalitarian regime if they were starving. China doesn't have America over a barrel, America has them over a barrel. Or maybe the better analogy is the good-guy bad-guy movie scene where each is pointing a Glock 37 at the other's face. It's left as an exercise for the reader to assign good and bad labels on the player's in this scenario.

While we prefer sound money over fiat money, we have to say, the QE policy by the fed not only was a shrewd solution to a global run on the bank, it was a shrewd political statement to China (whether intentional or by unintended consequence) that the U.S. will do anything it takes to secure the value of U.S. Treasury debt.

Just another fantastic real-world example of the Navy SEAL's training motto:

“Luck is the residue of good design."

Risk, Risk, Everywhere

We try to avoid sending our readers to anything that smacks as an advertisement to sell newsletters, but sometimes the questions are relevant enough to justify addressing them head on, even if there is a sales pitch in there. Fortunately John Mauldin not only has a good pulse on the global investment community, but any sales pitch in his material is minimal compared to the content.

So with that, we point out some serious questions and concerns he addressed in a recent email which we happen to agree with. One might ask, how can you not agree with observations from the real world? Right, well, some do, so we just want to point that out.

From John's survey of readers, he concludes:

When everything is manipulated... you don't know the TRUE value of anything, right?

The Fed-driven fixed interest rates are breaking the backs of retirees (or near retirees), who find their nest eggs dwindling unless they take larger investment risks.

And the growing federal debt and the resulting "true" inflation is eating away at investors' capital.

They see interest rate risk, inflation risk, central bank and currency debasement risk, confiscatory tax rates... and bonds on life support, running out of air.

src: How to Find REAL in a World Full of FAKE

Stocks, Bonds, and Currencies doesn't agree with everything said or implied by John Mauldin or Grant Williams, but they have a long-standing reputation that justifies considering some of what they say. If you take a look at the video, come on back and tell us what you think.

Why You Don't Want Government Controlling Social Security

First, they promise to take care of you and your future financial welfare:

The National Pensions Reserve Fund was established in April 2001 to meet as much as possible of the costs of Ireland's social welfare and public service pensions from 2025 onwards, when these costs are projected to increase dramatically due to the ageing of the population. The Fund is controlled and managed by the National Pensions Reserve Fund Commission. The Commission's functions include the determination and implementation of the Fund's investment strategy in accordance with its statutory investment policy. This policy requires that the Fund be invested so as to secure the optimal total financial return provided the level of risk is acceptable to the Commission.

(source: NPRF Home Page)

Then after they make a mess out of protecting your current financial welfare, they threaten your future welfare to compensate for their screw-ups.

In the first six months of 2011, the Government liquidated €10bn worth of National Pension Reserve Fund assets in order to contribute money to the EU/IMF bailout package.

Including this €10bn set aside for the support programme, the total fund size at the end of June was €20.8bn. This also comprises of the discretionary fund and directed portfolio, as well as bank investments of €5.5bn.

The discretionary fund has now been reduced in size to €5.3bn as a result of the liquidation of assets, according to the quarterly portfolio and performance update published today.

Including shares held in Bank of Ireland and AIB, the directed portfolio is worth €15.5bn.

(source: Business Leadership News)

If you're thinking, "That's ridiculous, that would never happen here" you must be twelve years old.

Hindenburg Omen - Not!

It would be hard to find someone or group that can beat the quality of data that comes out of Bespoke Group. Today they made an astute observation that trumps the low quality blogosphere hype about the Hindenburg Omen. In typical fashion, Zero Hedge made another biased emotional appeal:

"Today, we just had another (unconfirmed) Hindenburg Omen."

As Bespoke Group points out, the facts of the matter refute the present perceptions.

"Call us crazy, but an indicator that measures the internals of the equity market should probably avoid using fixed income securities in its analysis."

The problem we see all too often in the internet world of truth is few people bother to actually take the time to understand the basis for these long-standing fundamental or technical indicators, nor take the next step to actually vet the information to see if in fact the data is in conformance with the statistical presumptions, requirements, a priori, and other critical factors.

We think one can take solace in knowing the low-quality data monitors who perpetually cry "the sky is falling" can be ignored more often than not. Notice Bespoke confirms the 2008 instance of the Omen, while Zero Hedge gets it wrong when they say the last Omen occurred during 2009. Not only is it statistically wrong, you can see from a chart if it had occurred it would have undermined it's reliability.

Our conclusion is that Bespoke is right and that Zero Hedge isn't filtering out fixed incomes, and therefore wrongly attributes an instance of the Omen to a point at which it never actually occurred. This is a good thing as it suggests the Hindenburg Omen is still a reliable indicator, if one can first learns how to read data and understand the meaning and abstractions of the words that make up the theory.

Banks Are Not Intended to be Safe Place To Keep Money

We've been seeing rules like this lately with the phrase "prohibits branches of banks … from operating primarily for the purpose of deposit production."

Let that sink in for a minute --- if you want to run a bank, you can do X, Y, and Z, and many other things, but if you have a primary purpose of attracting deposits, it's a no-no -- slap you on the wrist, bad boy!!

Now put on your consumer hat. Why do you put your money in a bank? Isn't the primary purpose to ensure your wealth is in a safe place so you don't have to stash a bunch of money in a steel, tamper-proof, fire-proof, locked-down safe, and then carry wads of cash around where thieves can separate you from your wealth when you go buy something? From your point of view, a bank's primary purpose is to be a safe place to keep your money.

But the bank is prohibited from primarily attracting your interest in their safekeeping services.

We can't speak for you, but that explains a lot.

Declining GDP Can Be Good

The following is an open letter to John Mauldin in response to Thoughts from the Frontline Weekly Newsletter, Six Impossible Things. It ties in with another story at telegraph.co.uk about the rapid decline in money supply.

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Good essay, as usual, Mr. Mauldin. Hey, ask a trusted scientist about dimensional analysis. Your delta force equation is slightly incorrect; it should be multiplicative, not additive. Conceptually it's right, but the formula is formed wrong and the implications may be very different when you use the correct dimensions and mathematical operations. You might characterize this with the label "Busy Boys ... Better Boys", from the 3-cent stamp I discuss at the end, where I reveal another time in American history that produced sustainable healthy economic output. In short, declining GDP might not be bad if we think about it a little deeper than our illustrious leaders who seem to be acting out of habit, not knowledge.

First Fixing the Formula
For your delta force equation the definition of productivity has to be "dollars per person", since "population" is clearly "sum of persons". Therefore, the plus sign is wrong; it must be "multiplied by". Think about it this way in dimensional analysis: if you get 10 miles per gallon and have 20 gallons of gas, how many miles can you travel? The formula is "M traveled = 20G x 10 MPG". Take away the numbers and just use dimensions: M = G x MPG.

The "per" in math means"divided by", and so the Gs cancel each other out:
G x (M / G) [in our case, 20G x 10M / G)]

Canceling out the Gs...
20 x 10M = 200M

You can't do that with addition: 20G + 10MPG = M is an invalid formula.

So look again at your delta formula. What you're saying is correct, but addition is the wrong operation and the implications are different when you properly put them into the correct mathematical dimension.

In dimensions, your delta force would be "Dollars" = "People" x "dollars per person" [D = P x D/P]. But there is still something missing. Some dollars per person are zero. My 5 year old productivity is zero because he isn't working. Likewise for the unemployed. Those have to be clarified as "working people" x "average dollar per working person".

Implications
It is not enough to "grow one's population", one must grow the population of people "that contribute to monetary productive efforts". If population grows, but the output of the new people are smaller than existing labor, it may not produce a rising GDP. To the extent new population produces less per person than existing population, GDP may decline if workers leaving the work force were more productive.

The corporation I work for is making this mistake. In the latest economic downturn, they got rid of highly-skilled labor because their wages and benefits were high, resting on imported immigrants with lower wages. The consequence now is that what they produce requires much higher labor input, because the inexperienced immigrants repeat many of the old mistakes the experienced laborers learned how to avoid. I'm not against immigrant labor, I'm just pointing out that low-wage immigrant labor may do more harm than good, even though low wage costs can increase productivity metrics. Wage-based productivity metrics can't tell you how much output was sacrificed.

There is a component of output, momentum, that doesn't manifest itself instantly with the replacement of high wages with low wages. Decay exists in everything. Poorly maintained plant and equipment break down more often. Poorly engineered products don't last as long. Poor quality of service and product diminishes customer willingness to return for more or refer others when needs arise.

If our economic stimulus programs don't produce another artificial credit-induced wave of consumer spending to make up for the diminishing sales of the old customers, the diminished momentum from displaced experienced labor is going to become evident when the consequences of the inexperienced low wage worker is reflected in declining output, increasing costs, or declining sales.

Busy Boys ... Better Boys
I think this single-minded focus on dollar metrics by economists, business managers, and policy planners is insufficient for solving the real problems facing the global economy. I have a 3-cent US postage stamp I found in my Mom's estate. It has no date on it, but others appear to be from the 1950s. This little 3-cent stamp speaks volumes about the decline in American culture, and it's impact on GDP when we consider the abstractions evident in the Delta Force equation.

It's a picture of newspaper boy on the left walking through a neighborhood. A bag rests over his shoulder with the motto, "Busy Boys ... Better Boys". On the right is a hand holding a torch with the motto, "Free Enterprise". Between them is a statement, "In recognition of the important service rendered their communities and their nation by America's newspaper boys."

We used to call that "work ethic"; it used to be a virtue. I don't recall seeing any government program honoring and extolling the virtues of work ethic like that 1950s postage stamp. Instead the focus is on entitlement, equality, and rights. It's evident, too, when you shop for products and services. Finding anyone with a work ethic that values one's contribution to others is rare, especially in the young. The predominant theme is one's right to income, or making a sale (getting one's money) at the cost of integrity and future product loyalty.

It isn't enough to just get more people earning wages, or keeping wages high to prop up tax revenues. The culture needs to re-discover the value of contributing to the success of others, which is the essence of the old work ethic. The idea that one's existence earns them a fair wage without consideration of their contribution is the essence of the decline in American industry and economic health.

Bad Can Be Good
Declining GDP or contraction of money supply are not problems in and of themselves. They are symptoms of something more fundamental. Whether they are good or bad depends on the essence of the underlying fundamental. A family that lives within it's means is a financially healthy family. If that family had a growing GDP (lots of economic activity based on new debt) they would be creating new money (increasing money supply) as they take on new debt and buy more products and services.

If they change their wayward ways, stop incurring new debt, reduce spending to conform to current income, they will flatten their contribution to GDP and contribute to a reduction in money supply. This is good for the family and the community, because there comes a point when economic activity shifts from debt service payment to new product and service output, but at sustainable levels. This was what characterized the decades following the great depression, an age where people understood the good things of life come from hard work, not easy credit.

If the old GDP reflected this old over-spending habit of the community at large (an addiction to "more stuff" now!), a declining GDP may be indicative of a more sustainable and healthy future. Furthermore, to the extent business learns to evaluate their output based on making product more desirable to the consumer, not only on price, it means a higher satisfaction (standard of living) and a more sustainable business model for business.

Money Multiplier and Velocity

Can you have GDP growth without debt growth? Is debt contraction (monetary deflation) a sure sign of economic contraction? Apparently the common perception is no and yes: without debt expansion we are doomed. While we believe at SBC that these events can exist for a period of time, we don't believe they are forgone conclusions of some necessity borne out of some fundamental economic equation.

John Mauldin has produced for us some excellent analysis on this topic. We don't like predicting the future, but we conclude from his recent work that GDP growth does not have to be negative nor small.

First let's look at some conclusions from The Multiplication of Money. We believe it's a mistake to conclude a nation can't have economic growth without credit growth. If we understand the money multiplier correctly, it measures growth of debt; how much M0 money (reserves) gets converted into M1 money (via loan origination). It doesn't measure how many times the dollar from wages and income changes hands. In fact, if we pay cash for something and the business we trade with pays cash, and that business pays cash, and their business, and on and on down the line, all kinds of GDP is being created without any debt growth, either in M1 or M2. Economic activity without debt growth is very possible. It's how the world operated before fractional reserve banking was invented.

What we've described there is money velocity. Mauldin has another excellent description of that in the recent weekly newsletter titled The Implications of Velocity. In it he presents an example of one kind of GDP growth.

"Having learned from their parents, they immediately become successful and start doing $100,000 a month themselves. GDP rises to $14,000,000."

Wait, how did they get their hands on the money to conduct trade? If mom and dad gave them the money, mom and dad had to give up spending it themselves. If the bank loaned them the money from fractional reserves, the velocity doesn't have to change for everyone to stay at the same level of income, since everyone still has all their money to spend and the new kid on the block has newly created money from fractional reserves. For sure, this is how economies have grown in modern times, giving someone future money to spend today.

So let's take a look at the velocity equation. Notice P=MV does not have debt as part of the equation, except to the extent debt is a component of M. Since GDP transactions are conducted in real physical cash or checking deposits, the monetary metric to use is M1. The astute reader will notice immediately that one can conduct transactions with credit cards and bank loans. True, but since we are presuming an economy where debt is not growing, those don't count. They either get offset by someone paying down loans, or by the person paying off the loan (credit card) at the end of the month with cash or M1 money.

Furthermore, for those who spend cash on debt repayment (pay down car loans, mortgages, etc) we need to realize those payments are M1 asset transfers from debtor to creditor. They don't affect the M in the velocity equation, either.

In fact, Mauldin shows M2 is not growing as M1 has recently. Since M2 is not directly spendable money, it appears the nation is churning the money in demand deposits and cash (GDP is not zero) instead of loading it into savings vehicles (M2 is not growing with M1). Unwinding debt would do this. As pointed out above, debt pay-down is nothing more than an M1 asset transfer from debtor to creditor. If the creditor then uses it to pay down their own debt, it too is another asset transfer of M1 from debtor to creditor. This creditor to debtor pay-down cycle can go on for some time. It can happen any number of times, all the while reducing "total debt". Does that alter velocity or GDP? Not necessarily.

At some point a creditor is payed and decides not to reduce debt, either because they don't have any in the first place or they are comfortable with the debt they have. If they save it, the money appears as M2 growth. If they spend it, it appears as a contribution to velocity and GDP.

It seems apparent, then, that if M1 is growing and M2 is not, and GDP is not contracting, that M1 money is being used to buy things with cash or pay down debt (or bury the bills in a can in the back yard.) There really aren't any other things one can do with money but to spend it, save it, or pay off debt.

People don't spend M2. It might be a funding source for spending, as people cash in the CD or transfer money out of a money market. It may also form the basis of confidence for spending, since one can buy on credit and pay it off when the CD matures or when they chose to redeem Money Market funds. But M2 itself is not directly spendable. It only represents the confidence of spending what is available in M1 or new debt. One can think of it as a source of "respending". If one writes a check today and something else comes along to entice the person later, one always has that M2 savings to use for the purchase. Nevertheless, all commerce takes place with M1 money.

We conclude that it is not a forgone conclusion that we must have economic stagnation if we have debt contraction. It's not even certain that we will have weak economic growth. Whether we do or not really depends on the velocity of money. If those with money have confidence to spend it, and if they relearn how to live within their means, we could have very healthy GDP. The problem we have with the common public data is that they predominantly provide statistics representative of the Losers; those who've botched it; those who are financially illiterate. While we have no hard data to prove it, we believe those people make up the minority of the American public.

Isn't it interesting how many advocate that people live within their means and that the nation would be stronger if we didn't rely on debt for economic well being? Has anyone even provided a picture of what that transition would look like? We don't want to sound too proud or arrogant, but maybe we just did.

Now what fiscal policy can do to this aspect is another matter. We'll have to look for evidence to that effect somewhere else.

Before you scoff at our conclusion, take another clue from chaos theory. Mauldin points out a very useful lesson from the book Ubiquity: Why Catastrophes Happen. The conclusion is that stress points are built into the fabric of human existence. The implication is that it almost doesn't matter how one responds to a crisis. The long term consequence is that complacency and comfort will set in, preparing the way for the next build up of critical mass to produce another crisis. Now if you can't tell when you are there at the precipice, how can you tell what the fundamental change is that is setting up the next generation for a fall? If you knew when the fundamental change was taking place, one presumably could prepare a plan for the consequences of the complacency that follows. But in fact these things are never clear until they become hindsight.

The Fed's Report Card, by The Fed

The federal reserve put out their assessment of Ben Bernanke's helicopter ride in a report titled Large-Scale Asset Purchases by the Federal Reserve: Did They Work?

Presumably it isn't surprising they conclude what one expects when demand rushes in like a flood:

We present evidence that the purchases led to economically meaningful and long-lasting reductions in longer-term interest rates on a range of securities, including securities that were not included in the purchase programs. These reductions in interest rates primarily reflect lower risk premiums, including term premiums, rather than lower expectations of future short-term interest rates.

Well of course! When demand for security jumps, so does the price. For a bond, rates fall when prices fall. And given the money to fund the purchase was created out of thin air, there was no decrease in demand for competitive instruments. The money that may have purchased those bonds was free to purchase others.

The reductions reflected lower risk premiums because it was made perfectly clear that there is no limit to the money available (since it doesn't come from finite pre-existing money) and hence no reason to expect lack of funding. It didn't reflect lower expectations of future short-term interest rates because it was also made clear it would end and the dilution effect was sure to increase the inflation premium in future markets.

One wonders if the authors actually expected any other conclusion. Imagine a rocket scientist being surprised that propelling an object at 200 MPH in an upward vector would make the object fly, but eventually fall to the earth as the applied acceleration source was stopped.

In spite of the humorous angle, it's a good piece of writing for one who wants to get a good look at how open market operations function.

Investing on The Edge of a Precipice

Today we highly recommend the March 8th weekly comment by John Hussman, The Rubber Hits the Road. Hussman makes some good points about history, comparing post-war economies with financial-crisis economies, relates that to this present period we face, and describes the human psychological factors that come to bear on security prices. The discussion of pending mortgage resets and how that may play out is particularly relevant.

It is interesting to see someone actually point out how and when we may rely on the irrational exuberance of speculators to make informed decisions of our own:

As we move through the coming months, resolving the "two data sets" issue will help us to determine which set of historical precedents is relevant. If the current economic environment produces fresh credit strains similar to previous periods of credit difficulty in the U.S., Japan and elsewhere, valuations and margin of safety will remain the most important consideration in determining investment positions. If the economic situation reveals itself to be more like typical post-war cycles, valuations will still be an important consideration, but we'll be better able to assume that speculation (provided sufficient evidence from market internals) will be reliable even in the absence of clear fundamental support from valuations.

If you are a Graham-Dodd fan, you'll particularly like how Hussman builds upon their foundation in presenting the expectations of investors in the current environment. Our conclusions is that with the infatuation Americans have with entertainment and personal emotions and opinions over facts and substance, we are unlikely to see any sound behavior by the general public with regard to investments.

The one thing he didn't mention in March 8th were the fundamental factors pointed out in a previous weekly comment, which contribute a third influence on the confluence of forces affecting the markets: the Fed quantitative easing policy coming coming to an end, just about the time we may begin to receive some clarity on his "two data sets". Add to that the potential for more debt issues out of Europe in the next few months, and the security markets may very well be resting on a weak precipice.

Sector Analysis and Business Cycles

Faheem Gill has a nice analysis of the business cycle and equity sectors that do well in each. He focuses on energy, but the charts would be good for one to copy and mark with one's own preferred investments at each stage.

The only thing lacking is a note to shift out of equities into bonds at the peak of the interest rate cycle.

Metals and Mining

Today we discovered Wildebeests, a web site devoted (in their own words) to the four M's: Minerals, Metals, the 'Merican economy, and Mathematica. They have some very good research and writing skills on the subject matter dear to our hearts, hard assets, and as such have earned a place in our investor links.

For some dialog between us, see the topic "Investing in Copper — What You Need to Know"

Velocity of Money

We're going to have to do some serious research on the Velocity of Money. This topic keeps coming up, but there doesn't appear to be a good discussion of the fact that Velocity can't be measured; it can only be calculated.

Furthermore, the fact that it exists (though some think it doesn't) doesn't mean it is the cause of inflation. Most posts appear to interpret it that we.

We at SBC believe velocity is a consequence of the psychology driven by theories expounded on by monetarism and Austrian economics. Until we get the in-depth analysis, we'll have to suffice for a few comments on the web.

See today's note on Seeking Alpha.
And another on Across the Curve.
And what appears to be one of the first arguments discussing Velocity and Monetarism. Mauldin has good analysis, but we don't think it discredits the view of V as a symptom rather than cause. Rather, it simply explains why there is a 12 to 18 month delay between monetary expansion and price expansion.

If you have more background and commentary, please put them into the comments so we can consider them in our analysis.

CBOE Answers Your Questions

The Chicago Board Option Exchange is a great place for both option market data as well as education. Today's Ask The Institute question was a common question many people ask (even some of those who know the option market well), namely, what happens to my puts if the company goes bankrupt? Can I still exercise the option if the stock stops trading?

Check out the answer at Ask The Institute. It might surprise you.

If you want to learn the basics of options, you can also get some nice video tutorials on basic option strategies at the CBOE Online Media Center. Click the "Strategy and Education" link under the Channel Guide on your left.

Finally, if you want to get the same e-mail alerts and news that brought this to our attention, go to the CBOE login page. The "benefits" promo links to the sign up screen to create your own personalized CBOE home page.