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Options Strategy - Puts & Calls - Sound Logic?
#1
As I was working on re-balancing my portfolio recently (see the portfolio thread), I decided to use some options to juice my yields.

I've had good results selling cash-secured puts over the last few years either collecting some relatively huge premiums when volatility was high or getting better prices on assigned stocks than buying them outright. Typically it's been close or below the market low price in the purchase time frame.

However, the only covered call I sold, EMR, was called away during a big market move even though I thought the stock was at the high end of its valuation at the time. Because of this, I've been leery of selling covered calls for fear I'd miss out on a big run up when they were called away.

I'm not an options expert and most of the terms options traders use to discuss evaluating options are foreign to me. For me, it's always been about getting some free money on a wishful bet or into a position I wanted with a slightly lower cost basis.

I usually don't go much past a 60 day strike date since, for cash-secured puts, I don't like my money tied up for much longer. You never know when a bargain someplace else appears. Likewise, if a stock with a covered call starts a steady climb upward, I don't want it called away prematurely.

That being said, these are the trades I made and my reasoning. Wondering what others think. Is my strategy sound?

I've owned a lot of INTC since 2010 with an average cost basis a hair under 20 with all the reinvested dividends. I've already trimmed it twice near the highs at the time but I still need to get rid of 100 shares to bring it where I want it for now. I sold 1 call at $25 a month ago (about 2 months out) for $69. I think it won't get much above that without a catalyst. If it expires, I'll net $58.22 in premium which should work out to a 2.3% gain ($58.22/$2500) over 2 months which annualizes to around around 12%. Am I thinking correctly here? In which case, I turn around and do it again if the premium is sufficient. If it is called, net proceeds will be $25.37 or a gain on those 100 shares of 27% using the average cost basis.

I've owned ABBV since 2011 when it was still part of ABT and kept it after the split. It's still yielding about 3.3% and has good prospects in the pipeline but it will be 2-3 years before any of their major new products come to market. In the meantime, it's relying on Humira and the rest of the off-patent stable to keep the cash flowing. I only really need to get rid of 10-20 shares to bring it in balance with the rest of the portfolio but thought I'd try my hand at some extra income first. With a trailing P/E around 20 and it trading near the highs over the last year, I don't think it's going to jump up much in a month. I sold a call at $52.50 for net proceeds of $109.22 which should yield 2% ($109.22/$5250) in just over a month or about 11-12% annualized. If it's called, the capital gains would be in the 80% range and then I'd go back and sell some puts to put it back in the portfolio. It's a position that I want to hold for the longer term.

Lastly, my gambling itch. Sold a 60 day put on MAT for $36 with net proceeds of $124.22. The balance sheet is pretty good with debt to cash of $1.6B/$1.04B, debt/equity of around 50%, current ratio of around 3.3. Income statement is not bad y-o-y, they were just slammed with Barbie being out of favor over Christmas. They are yielding around 4% with a 55% payout ratio. I wouldn't mind holding it for a value play and then selling for some gains. Their dividend track record hasn't been as good as HAS but the company has been around for a loooooong time and is probably experiencing a temporary setback that they'll figure a way out of. If it expires, I'm expecting to gain 3.5% ($124.22/$3600) over 2 months or around 20% annualized. If exercised, I'll have 100 shares with a net cost basis of $34.96 that I can either sell immediately for a gain of 6% net of commissions or start selling covered calls for more premium. In the meantime, I can collect the 4% dividend while I wait for it to leave the portfolio.

So, is my logic reasonable?
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#2
Are you doing all of this in a tax-deferred account?

With respect to one's main portfolio, I am comfortable with the cash-secured puts on stock that you want to purchase, but want a better price. And I am comfortable with selling the covered calls as a way to juice returns on something you want to get rid of. The only play that I have not personally made my peace with is selling covered calls on something that you want to hold long term.

I'm also cool with using options to scratch the gambling itch, so long as it is only play money. I'm still sitting on some F calls myself!
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#3
Yup, all in the IRA.

I'm totally comfortable with the INTC trade. I'll use that to do some more re-balancing if it's assigned.

The logic of the ABBV is, if it's called, I can buy it right back with a small dip and I'll still be where I'm at. If it takes off, I'll again be wishing I had it back but will find something else in the meantime. It's not like the DGR since the split has been on a rocket. The capital gains don't mean anything since, being in an IRA, it will eventually be taxed as regular income when withdrawn someday.

The MAT trade was the easiest. My biggest worry is I get assigned and it drops quite a bit. It's not a long-term hold for me but I'll be patient collecting the 4% yield until I can at least break even either selling calls or selling outright.

The IRA is in TDA and their option commissions are higher than some places so I try to limit the commission to less than 30% of the premium. During the Great Recession, I was regularly making $200-$400 on cash secured put premiums so today I'm not so enthralled with the premiums being offered.
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#4
(03-16-2014, 09:19 AM)Dividend Watcher Wrote: The IRA is in TDA and their option commissions are higher than some places so I try to limit the commission to less than 30% of the premium. During the Great Recession, I was regularly making $200-$400 on cash secured put premiums so today I'm not so enthralled with the premiums being offered.

You seem to have a substantial enough of an account to warrant a call to TD and try to get your ticket charge waived.

The commission percentage you've mentioned would make me blow my mind.
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#5
If you call and complain, TDA should drop your commissions to as low as $7. That is what they charge me for all trades including options. Just complain that they are too high compared to the competition and that you will move your growing account if they don't drop the fees.
Alex
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#6
I think it's best to use a separate account for this sort of activity. This does two things.

1) Commissions are lower. This is because you can open an account just for this sort of activity. You can trade options contracts and stocks for $1.00 or less at certain large discount brokers.

2) It forces you to separate your investments from your trading activity. This has really helped me buckle down and not sell my long term investments over the years. I will never go back to mixing speculation and investment in the same account, ever. I just can't do itSmile

The downside to this is that you need money for the trading account. Most of the discount brokerages I'm thinking of have higher than normal minimum requirements. This can be a big hurdle if you are just starting out.

Maybe it's something worth trying.


I probably should add that this idea of separation forces you to really think about what you are buying. If you know you are buying to hold for the long term you tend to really think about what you are getting into. You also tend to pay less attention to your investments(which is a good thing IMO) because you have your trading account to keep you busy. I think I got a little off topic hereSmile
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#7
Well, the waiting has ended as all the options have expired today.

INTC got assigned at $25.00. After commissions, the proceeds were $2538. Not as much as INTC is worth today due to it's recent run up but a 27% gain over my purchase price. In the meantime, I collected a bunch of extra shares reinvesting those dividends. My position is now at the size I wanted it in the portfolio and will keep reinvesting. I still think Intel is a long term hold. The dividend is adequate at a current rate of 3.3%, the company is changing structurally and focusing on the weaker areas, the new CEO has had some interesting comments on where he wants to go and they still have plenty of cash with which to execute and maintain the dividend.

With a few days of trepidation, ABBV finished much lower than the strike price thanks to the biotech selloff. They bounced around the 52-week high which I didn't think they'd go much above for now at these levels but then came back down. I don't think there's much upside right now but they do have over 20 compounds in various trial stages with many expecting to either be approved or coming to market in 2-3 years. The premium was $109.22 after commissions so that was a nice add to my cash in a little over a month.

MAT didn't trade either. It had a little run up close to 40 and then fell back with the latest earnings release. MAT was my speculative trade since I think it may take a year or so for them to either get the doll business back on track or to add to/change their product line. They've bought the MEGA brand (a competitor to Lego) and are working off their inventory glut. The financials look pretty good to me and I may still take a small position with a 4% yield. Both MAT and HAS will need to diversify more into either video or technology-based toys in the future. I think it's a sad trend but we'll watch what they do over time. After commissions, I made $124.22 for a little over 2 months.

I now get the use of the cash covering the MAT put plus the premiums. I've been shopping but nothing is really striking me as dirt cheap so I'll just sit on it for now. Thinking of adding a little to OHI since they, again, have boosted the dividend. Utes have had a sustained uptrend for the last couple months so I'd rather look elsewhere. Doing nothing strikes me as an intelligent move right now. N'est pas?
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#8
Lots of cash got freed up with call assignments this month. For now, probably through June will likely be happy to let cash accumulate, about $45k at this point. This activity is just inside the trading account. The long term account only sells when a security disappoints to such an extent to be a deal breaker. Soon the long term account will equal about 35% overall portfolio.
Alex
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#9
(03-16-2014, 04:57 PM)hendi_alex Wrote: If you call and complain, TDA should drop your commissions to as low as $7. That is what they charge me for all trades including options. Just complain that they are too high compared to the competition and that you will move your growing account if they don't drop the fees.

If you have a large enough balance, you can it get down to $5/trade.
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