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Yesterday, the Euro closed below $1.30 – the lowest level all year. And the yield on the 10-year Italian bonds closed above 7%. The last eurozone countries who’s bonds closed at 7% were Greece, Ireland and Portugal.

The market considers these countries to be credit risks. If you have bad credit, you’d pay 30% or more on your credit card. But a sovereign nation has the ability to tax it’s citizens. So the chance for a total loss is remote – which is why it’ll pay a comparatively lower rate.

But even at a low 7%, Italy can’t pay the interest on it’s bonds. At this rate, as more of the debt rolls over at a higher interest rate,  it will eventually have to default on its debts.

The European Central Bank will make some half-hearted effort to bail out Italy and save the Euro. But in the end, the Federal Reserve will have to step in to save Europe. And it will.

The Federal Reserve will print money to buy up Eurozone bonds. This monetizing of debt will eventually result in massive inflation,

Regular readers know I’ve been talking about inflation for a while.

I’ve been moving my assets in to gold coins, silver, and globally-diversified undervalued large cap stocks like Walmart (WMT), Microsoft (MSFT), Cisco (CSCO), Johnson and Johnson (JNJ) and Berkshire Hathaway (BRK-B).

So what else is going to benefit from looming inflation?

Credit card companies like Visa and Mastercard.

These companies provide transaction-processing services. Unlike the banks that issue these credit cards, they bear no risk if the credit card holders default. They’re more like a toll booth on a bridge that collects a fee each time someone drives through.

But unlike the toll booths, which charge a fixed dollar amount, these companies charge a percentage of the transaction amount.

As the amount of money in circulation increases – and the prices of things goes up – they’ll collect more money for doing the same thing. Unlike other service companies, they don’t have to even explicitly increase their fees. Since it’s a percentage, it will automatically adjust upwards.

And if the Euro actually does collapse, travelers to Europe are more likely to use their credit cards for purchases. This is more convenient than exchanging currency at every border.

I looked at four stocks in this sector: Visa (V), Mastercard (MA), Discover Financial Services (DFS) and American Express (AXP).

Visa and Mastercards have significantly greater global appeal and penetration.

And between these two, I liked Mastercard more.

Over the past five years, it’s revenue and free cash flow has been steadily increasing. It’s currently selling for a P/E of 20 and a Price/FCF of 18.27.

As Warren Buffet demonstrated with his purchase of Lubrizol this year, paying 20 times free cash flow is a fair price to pay for a domainant company.

But unlike Lubrizol, Mastercard isn’t the market leader.  It’s second-place to Visa. But Visa’s cashflows have been somewhat erratic, and it’s stock is a bit too pricey.

So Mastercard is little expensive for my taste. I prefer to buy stocks at a discount. It’s on my watchlist – I’ll pick it up if it trades below 15 times FCF.

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Since then, I’m up nearly 44% on my purchase price (including dividends). Vodafone currently yields nearly 7.5%.

Recently, Barrons had a good article on why investors should still consider investing in Vodafone.

Its ADRs, which trade on Nasdaq and each represent 10 ordinary U.K.-listed shares, could rise more than 20%, to $35-$38, over the next two years. Including dividends, the total return could top 35%, with significantly less volatility than the average stock, given Vodafone’s relatively stable business. (Vodafone ordinary shares closed in London Friday at 180 pence. The ADRs finished near $29.)

There were also several quotes from fund managers:

“Vodafone’s stock is significantly undervalued,” avers Bruno Lippens, a portfolio manager with Pictet Asset Management, “essentially because the market still doesn’t appreciate Verizon Wireless” and the way the dividend will translate into reliable future cash. While there’s no formal annual commitment, Verizon Wireless has little net debt and produces about $1 billion monthly in Ebitda. “Absent massive investment needs, I don’t see an alternative” to paying out a regular annual dividend, adds Lippens, who sees some 40% upside in Vodafone.

The author of the article also thinks that a liquidation of Verizon Wireless could occur within five years, which could be as high as 50% of VODs current market cap.

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It turns out that it’s probably a better buy than anyone expected.

Buffett just announced that he’s spent $10.7 billion buying IBM stock, as well as a few billion dollars on CVS and VISA.

I currently own BRK-B, and I’d like to increase my exposure to it. But I’m strapped for cash.

So how do I make money from being LONG BRK when I’m short on cash?

Time to look at option strategies.

When most investors are bullish on a stock, they buy CALL options on it. They fork over some money (called a premium) and have an option to buy that stock at a specific price (called a strike price) at a future date. If the stock price exceeds your strike price, then you’ve made money.

One problem with this approach is that the recent volatility in the market has increased the premiums on options.

Another problem with this approach is that usually,  investors lose money on options. Most commonly, the options expire worthless because the stock price didn’t hit your strike price. And sometimes investors paid too much premium, so that despite exceeding the strike price, they still end up losing money overall.

Let’s look at an example.

Consider the BRK-B, Jan 2013 $75 CALL option. It’s currently selling for $10.50, which means on each contract (1 contract is 100 shares), you’d pay $1,050.

So, in January 2013, unless BRK-B is trading for more than $85.50, you’ve lost a thousand dollars!

A better way is to use PUT options.

When you buy a PUT option, you’re paying a premium and you have the right to sell a stock to someone at a specific price at a future date. You make money if the stock price declines below the strike price. You would enter this contract if you were bearish on the stock.

However, if you SELL a PUT option, you receive a premium. In return, you must buy the stock if it declines below a certain price. If the stock goes up in value, then you get to pocket the premium. So you would only enter this contract if you were bullish on the stock.

Being bullish on BRK-B, and short of cash, I’ve taken a short PUT position.

As I outlined in my previous post, I think BRK-B is worth $112 and has a floor below $72.

I sold the Jan 2013 $60 PUT for $4.50. This means I collected $450 per contract.

If BRK-B drops below $60 per share, I will be forced to buy the stock.

However, based on the premium I collected up front, my purchase price will be $55.50 or 50% of what I think is the intrinsic value.

Mostly likely, the option will expire worthless and I’ll get to keep the premium.

This also how you can turn around the high premiums to work in your favor.

If I didn’t already own BRK-B, I would go for a higher strike price. Most likely, I would sell the Jan 2013 $80 PUT for $11. This would allow me to collect $1,100 per contract.

Of course, the risk that I would be assigned the stock would also be much higher. But I would be comfortable owning this stock at an effective price of $69 per share ($80 strike price – $11 premium = $69).

Option trading is not without risk.

It’s easy to over-leverage and wipe out your portfolio. I use this strategy with great caution and with a lot of forethought.

You also need the highest level of option trading and a margin account in order to sell puts.

A trade like this one usually has a 20% margin requirement. Which means, I need at least $1,200 in margin. Based on that margin a $450 premium would represent a 37.5% gain in 14 months. Not too shabby.

If you’d like to learn more about option trading, I strongly recommend The Bible of Options Strategies: The Definitive Guide for Practical Trading Strategies. It’s a excellent primer on various option strategies.

Disclosure: If it wasn’t already obvious, I’m long BRK-B. Both the stock and by selling puts.

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In the middle of July Cisco (CSCO) was trading at $15.66.  From a fundamental perspective, Cisco was cheap – selling at less than 10 times free cash flow, and had just started paying a 1.5% dividend. However, the market was discounting the stock price  because they didn’t believe the CEO, John Chambers, could revitalize the aging tech giant.

But regardless of the management, based on just the numbers, the stock was too cheap too pass up.

And numbers don’t lie.

Yesterday, Cisco announced stellar results. It seems that growth is picking up.

Since that last post, shares of Cisco are up almost 20%, at $18.61.

Cisco isn’t the only company doing well this economic environment.

Large cap blue-chip companies like Intel (INTC), Microsoft (MSFT), Walmart (WMT), Johnson &  Johnson (JNJ) are also doing well.  Even my old favorite Vodafone (VOD) which I bought over a year ago is doing well. The share price, currently at $28.39, is up nearly 23% from my purchase, and it currently yields 6.75%.

So what stock is worth buying today?

Believe it or not, it’s Warren Buffet’s Berkshire Hathaway (BRK-A or BRK-B).

Buffett recently announced that Berkshire would buy back shares below 1.1 times the book value. The world’s best value investor definitely recognizes value in his company stock price and has effectively put a floor underneath the stock.

Currently trading at a Price/Book  of 1.15,  the stock is close to that floor.

Let’s look at the B shares, or the baby Berkshires (BRK-B), which currently trade at $76.

Buffett’s 1.1x of book value puts the stock price floor at $72.69. But how much is the stock actually worth?

This is actually very simple to calculate.

The value of the publicly-traded securities owned by Berkshire is $63.66. The rest of the companies made $4.8 in earnings. These companies are worth about 10 times the earnings or another $48.

Add the $48 to the $63.66 and we get $111.66.

So buying Berkshire today means we have a floor at 5% below today’s price, and an upside of 31%.

Disclosure: I’m Long CSCO, BRK-B, MSFT, INTC, WMT and JNJ

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