That is pretty much what we did with our virtual Income Portfolio since our last major update on August 13th. Of course we made some adjustments in Member Chat – taking advantage of the top and bottom of our range but, on the whole, we ignored the 1,300-point up and down moves in the Dow because this portfolio is well-hedged for a 20% drop – so there’s nothing about a 10% drop that’s going to make us panic.
We did have a 20% drop in late July to Aug but (and see our last update) again – as we were Cashy and Cautious – all that did was make it a fine time to buy MORE stocks that were on sale – picking up stocks like WFR, SONC, IMAX, VLO, OIH, TBT and HOLI at 20% discounts to their already low prices. The volatility was expected and as I said at the time:
We stuck to our guns this week and had a lot of fun playing the wild gyrations with our short-term betting but the Income Portfolio is an exercise in managing a "low-touch" portfolio – one that does not require us to make daily adjustments. I am aware that can be frustrating for people who stare at the markets every day but that is what our short-term trade ideas are for in Member Chat. That goes for people who are retired or semi-retired too. You don’t HAVE to play every day – or any day for that matter but you do need to work one week a month and that would be this week – the week of options expirations, when we do our update (this post) and then next week we make our adjustments (if any).
I know it’s hard to take the long view of the markets, especially if you are also a short-term trader – as it can be very difficult to switch gears as you go back and forth between portfolios but you MUST learn to take that other view. On Dave’s daily chart above, we see our range was clearly broken in early October and we spent almost 48 hours below that major support level but OUR major support level was at 10,431 (10% below our must hold line) and that held quite nicely and, like Warren Buffett – we took the opportunity to "Be greedy when others are fearful" and did a bit more bottom fishing – because that’s what you do when you are a long-term investor – you take the LONG view, and the long view looks more like this:
See – that doesn’t look too bad at all, does it? It’s the same market – just shot from a couple of steps further back to put things into a long-term perspective – where we’re having a slight pullback of 25% after a 2.5-year, 100% move up. I guess it would be nicer if the markets just went up and up and up and up and never-ever pulled back but that’s not the planet we invest on so we have to deal with the fact that even a bull market has pullbacks and learn to deal with them.
In our last update, we had dumped out of all of our short-term short puts as we were too choppy to comfortably ride out the market gyrations with short-term positions in our long-term portfolio. Fortunately, we were way ahead of goal with $33,134 taken off the table in our first 4 months, over 100% ahead of our goal of having $4,000 a month to live on without touching our principle. Knowing we had another round of dividends coming to us in September (the joy of owning dividend stocks!) meant we had no urgent need to do anything as we had already accomplished our year’s goal ($48,000 profits projected to be withdawn by year’s end) in month 4 with only 35% of our cash and margin put to work.
As we, like Buffett, had our cash ready, willing AND able on the sidelines – we were happy to take advantage of a few opportunities along the way – putting our sideline cash to work at what we HOPE (not a valid investing strategy) is a bottom. First we’ll review our open short-put positions – the ones we really, Really, REALLY want to own for the net strikes (even IMAX):
We have a net loss of $31,335 if we stay this low though January 2012 and January 2013 expiration dates. That’s $1,770 worse than two months ago. Not so bad with the market dropping 20% on us and the VIX blowing up. Also, as with any of our portfolios – these are the LOSING ends of spreads – don’t forget we’ve already cashed in $33,084 and we have plenty of calls to sell and dividends to collect. At the moment, there’s really no point to even adjusting these positions. I had mentioned, in the past, that we do need to stop out short puts with a 30% loss and, from now on that is going to be a rule but, since it seems many people have not done that, I’m going to play this set through as it’s more educational to follow it over time anyway but PLEASE look over this list and consider how sensible stops could have saved a huge amount of our virtual cash!
And, of course, that’s what hedges are for and we took advantage of the dip in IYR to cash out our major hedge with a profit that almost entirely covers the losses on our short puts – leaving the cash we’ve taken off the table free and clear. Remember, it’s the same concept as the $25KP but on a longer time-frame – as long as we have faith, we ride out our losing positions while cashing in our winners to reduce the remaining basis:
That’s $54,414 cashed out in two months – not bad at all! Notice we didn’t touch our positions, we didn’t roll or double down or – well, anything. We have a balanced portfolio and we let our hedges do their job. We took off the IYRs and added the SDS hedge (changing to a fresh horse). Remember – it’s not a profit until you cash it in! In general we don’t really want to be up or down, we just want to collect our premiums and our dividends – which brings us to our Dividend Positions and Spreads:
Notice we don’t care about the P&L on our buy/writes, they are simply on or off track. Meanwhile, they are paying us $6,539 in quarterly dividends while we whittle away our basis over time (and that time isn’t all that long as we’ve only been doing this for 5 months!). On the other positions, we are ahead net $5,075 and, as you can see, we’ve taken on a little more short-term risk as we can certainly afford it being way ahead this year already.
The main idea here is to establish inexpensive entries for future call selling and dividends. We broke up some of our buy/writes and that pushed the losing puts into the earlier section and there are many thousands of call contracts to be sold when the market comes back. Meanwhile, we hope we have adequate protection from our long-term hedges to see us through things – just in case we fail again.
A nice net $9,500 on our protection, which is not bad considering we’re at the top of our range. Even if we dip, the DIA Oct $111 puts will either expire worthless or get stopped out and that will leave us well protected on the way down (those DIA March puts were up $19,000 when the Dow was at the bottom of the channel).
All in all that leaves us in month 5 with $54,414 in realized gains from which we are using $4,000 a month to pay our bills off this $500,000 retirement account. Our unrealized positions are down net $16,760 so plus $37,654 is just right and we still have only about 1/2 our cash and margin deployed. Keep in mind our goal for the year is $48,000 in profits and we still have 7 months to go. Obviously, getting ahead is fantastic as it allows us to build our portfolio down the road.
Next month, we’ll be taking a hard look at all of our positions to determine if any of our horses are looking tired.