Saturday, March 28, 2015

Financial Planning: Weekend Update - March 28

This week was pretty dismal: 3 solidly down days, a flat Thursday and an anemic Friday. But income investors don’t get too worked up about ordinary volatility. Q1 earnings season is beginning with plenty of warnings, many apparently due to the strong dollar’s impact in international trade. That might be of concern, but even if a few positions get hit over the next month or so they'll still keep paying dividends and any spare cash laying around can be used to average down on the hardest hot stocks.

INTC was the big excitement on Friday afternoon when rumors broke that it was buying Altera, a major manufacturer of FPGAs (Field Programmable Gate Arrays). Intel closed up $1.92 for a 6.38% gain and popped my position into the money. Altera (ALTR) shot up 28.39%.

The portfolio is in good shape however. Only half the positions are in the money - not surprising after a week like this. The one small net loss position isn't an issue either as long as the MO doesn’t fall too far past my cost basis of $51.39. At this point my worst case scenario will be to write a farther out call in April.

Even with the down week, there’s still a good chance a major portion of the portfolio will be assigned next month. This will give me an opportunity to re-allocate a little. My current thought is to re-purchase only one of the Electric Utilities (ETR) and one of the Oils (COP). The remaining funds will be allocated into INTC (I don't expect Friday's jump to hold), MO (maybe), and F reducing my cost basis in those stocks

If SNY is assigned I’m currently looking at MRK and ABBV as possible replacements.SNY has a great dividend and obviously has legs in terms of capital appreciation... BUT... it's an ADR and that means there's some currency risk and there are fees involved with the payment of dividends. So even though it still looks like a great pick, I think I want to eliminate those potential, complications from my portfolio.

I like KO and will re-purchase it should I be assigned. Next time I’ll write the calls a little more out of the money.

Friday, March 20, 2015

Financial Planning: Weekend Update - March 21

Positions on March 20, 2015 - Green Means "In The Money"

We've had a pretty volatile first week! Monday March 16 was a nice "up" day with the S&P 500 gaining about 1.25%. As a result, a few of my positions moved into "in the money" status, meaning that they are subject to being assigned.

Tuesday was pretty much flat, down 0.3% in anticipation of Wednesday's Federal Reserve policy statement.


Most of today's trading was dominated by fear - no one wanted to be caught too long if the Fed announced tightening. It wasn't too scary; the S&P fell 11.61 points from the open, bottoming out at 2061.23. The news from the Fed at 2:00 was exactly as expected: they deleted the word "patience" from the policy statement and the market took off gaining 38.27 points from the low. This resulted in eight of my twelve positions becoming "in the money". The laggards are Intel, Ford, Altria, and Diebold. Even so, every underlying except MO was up on the day. Had today been expiration I would have a net gain $11,127.20 or 3.41% and the pleasant task of re-allocating the bulk of my portfolio. But we've got 4 weeks and 2 days left until the real expiration...


A nothing day. Friday is options expiration.


Whee! more or less 1% gain in all the indices. As you can see from the positions chart above, 9 of my 12 positions are in the money. There wasn't really any news to fire off today's action.

Where We Stand

After Week 1 the portfolio is up 3.5% counting capital gains, option premiums, and dividends. This is a pretty remarkable result and will almost certainly not be sustained through April expiration.  With this many positions in the money there isn't much more room for gains.

I'm keeping an eye on six new companies. Emerson Electric (EMR) which has a 3.38% dividend and an active options market, Texas Instruments (TXN) with a 2.35% dividend and great options, Philip Morris (PM) a beaten down tobacco stock with a 5.14% dividend and excellent options. The last two are Con Ed (ED) with a 4.19% dividend and Nucor (NUE) with a 3.02% dividend and very active options. Last is SAFT, an insuramce company with a 4.72% yield but rather low options volume.

My thought is that I'm over exposed to oil and electric utilities. Depending on what gets assigned in April I may drop COP, PPL, and ETR and replace them with ED and NUE. The techs, INTC and DBD might get swapped for TXN and the insurance company SAFT.

This portfolio is not meant to be traded, but as long as it's just paper I can make mistakes, adapt, and diversify.

Monday, March 16, 2015

Financial Planning: The Income Portfolio

SYMBOL Position Cost Current Annual Div Value Div Tot
INTC 500 $30.93 $30.93 $0.96 $15,465.00 $480.00
SNY 700 $47.07 $47.07 $1.91 $32,949.00 $1,337.00
KO 700 $39.91 $39.91 $1.22 $27,937.00 $854.00
PG 400 $81.83 $81.83 $2.57 $32,732.00 $1,028.00
DBD 600 $33.34 $33.34 $1.15 $20,004.00 $690.00
CVX 300 $101.62 $101.62 $4.28 $30,486.00 $1,284.00
ETR 500 $74.65 $74.65 $2.60 $37,325.00 $1,300.00
GE 1000 $25.04 $25.04 $0.92 $25,040.00 $920.00
COP 500 $61.64 $61.64 $2.92 $30,820.00 $1,460.00
PPL 1000 $31.80 $31.80 $1.49 $31,800.00 $1,490.00
F 1000 $16.20 $16.20 $0.60 $16,200.00 $600.00
MO 500 $51.39 $51.39 $2.08 $25,695.00 $1,040.00

$326,453.00 $12,483.00

For the next nine months I’ll be paper trading the portfolio you see above. The total value is what I'm currently projecting for the roll-over IRA I'll start in January 2016. All dollar amounts shown in this post are "last price" as shown on March 15, 2015 (which would include any after market movement on March 13).

The combined dividend yield of 3.82% is about as good as you can get without venturing into things like MLPs or REITS. There’s nothing wrong with those types of securities as such, but I’m not comfortable with having them in my retirement portfolio. Preferred stocks are another high yield class of securities I’ve avoided for one important reason: this portfolio is designed to provide a steady income that can be supplemented by selling covered calls.

The methodology is relatively simple:

1.              Purchase quality stocks that have solid dividend performance
2.              Allow dividends to accumulate in cash
3.              Each month sell covered calls at the lowest “out of the money” strike
4.              At expiration re-evaluate any called positions and re-purchase or re-allocate
5.              Use the remaining proceeds and dividends, if any, to increase positions.

Purchase quality stocks that have solid dividend performance

This is actually pretty easy to accomplish. I started with the list of companies called "Dividend Aristocrats" - companies that have paid and raised dividends for at least 25 years.  I filtered that list by using my broker's research and rating system and then added other companies that were well rated and had excellent dividend yields. I have a cumulative yield of 3.82% - pretty good given that I haven't ventured into REITs, MLPs, or even preferred stocks.
Allow premiums and dividends to accumulate in cash

The usual approach to investing is to re-invest dividends. That makes perfect sense if you’re investing for the long term. But I’m investing for current income. All dividends and option premiums get swept into each month’s pile o’ cash. We won't need the money for normal expenses as long as my wife is still working so for at least a few years most of the dividends and option premiums will be re-invested - the following month. Because all this is happening in an IRA, there are no immediate tax consequences (all "short sale" transactions are classified as short term gains) unless I need to take a distribution for some reason - then the normal IRA distribution rules come into play.

Each month sell covered calls at the lowest “out of the money” strike price


INTC April 31.00 $0.82 $410.00
SNY April 48.00 $0.65 $455.00
KO April 40.00 $0.84 $588.00
PG April 82.50 $1.10 $440.00
DBD April 35.00 $0.35 $210.00
CVX April 105.00 $1.30 $390.00
ETR April 75.00 $1.85 $925.00
GE April 25.00 $0.60 $600.00
COP April 62.50 $1.72 $860.00
PPL April 32.00 $0.60 $600.00
F April 24 16.50 $0.32 $320.00
MO April 52.50 $0.78 $390.00

Premiums $6,188.00

Dividends $1393.20


This is where the fun starts. By writing out of the money calls I get current income and I get at least some of the profit if the share price increases beyond my strike price.  If a stock’s price drops below my purchase price I have to be careful to remember my cost basis and not write a call that would cause me to sell at a loss if the call were to be exercised.

Because I started this account with a rather substantial roll over, I'll get about two years worth of trading "on the house". After that I'll be paying whatever the normal commission is at that time.

Violating my "out of the money" rule is this month's GE call - it's $0.04 in the money. I decided to go ahead because the amount is very small in comparison with the option premium. Should the position be assigned I'll still clear $560.00 on the trade. This is almost certainly a tactical error but GE has been in the doldrums for several years and there's a very good possibility it will close below $25 in April.

Finally, notice the Ford call expiration is on April 24. There wasn't an out of the money call with any kind of premium value on the regular expiration date of April 17 but Ford's option market is very active and there are weekly options at more strike prices.

At expiration re-evaluate any called positions

On the weekend following the third Friday of each month I’ll know which positions have been assigned. If I still like the company I’ll place an order for the next trading day to replenish my position. If not, I’ll go back to the “Dividend Aristocrats” list and repeat my research.

Very occasionally something called "early exercise" can occur. This most commonly happens when the underlying is about to distribute a dividend and the value of the dividend is greater than the remaining time value in the option.

Use the remaining proceeds and dividends, if any, to increase positions

This phase is particularly important because it’s where I can reduce my cost basis.  Since I’m not re-investing dividends automatically, I have to make this decision each month.  The only rule is to purchase only in lots of 100 shares so I don’t have any assets that can’t have calls written against them. For example, if Ford drops to $15.20 I could buy 400 shares with my pile o' cash, reducing my cost basis to approximately $15.91. I might have to skip a month to get decent premium for a $16 strike price but that's the way this whole thing works: time is money. So...

For this first month I have $7581.20 in cash available (in March, only KO, PPL and MO pay dividends). Assuming I didn’t use some of it for another purpose I could increase my position in anything other than PG, CVX, or ETR. I could also hang onto it for another month if I wanted to increase my position in one of the higher priced stocks. If any positions are assigned I may also use some or all of the pile o' cash to re-purchase the underlying. We'll see on April 20 (and 27th).

EDIT 2015/03/17: I stupidly had all the dividends in my master spreadsheet paying on their ex dates rather than the pay dates. I've adjusted the amount of dividends received in the above charts.