Income Portfolio – Year End (Almost) Review

8 months already! 

We initiated our virtual income Portfolio way back on April 9th, after dealing with my Father’s death and speaking to many of my Mom’s friends in Florida got me to thinking there must be a way to structure a portfolio that will hold up through thick and thin and throw off a nice monthly income – using a combination of dividends and option sales.  Our goal was to put $500,000 to work and generate at least $4,000 a month in income without reducing the principal.  

As you can see from the chart on the left, this is not exactly a radical strategy but, strangely, it’s also not one that retirees seem to be aware of.  Clearly, since 1990, the difference between dividend paying stocks and non-dividend paying stocks has made quite a difference.  These days, with most stocks moving in very high correlation – that is truer than ever because – if they are all going to go the same way, then any dividends you collect are a bonus, right?  

Of course, we try to outperform the S&P a bit as well and again, it’s a no-brainer to use put option sales to improve your entries because, clearly, if you only enter a stock with a 15-20% discount, then again you are likely to outperform the rest of the index.   The final trick up our sleeve is, of course, Fundamentals – we try to pick good stocks that will do better than the rest of the S&P.

And we HEDGE!  We hedge because, EVEN THOUGH we picked a good stock and we will collect our dividends and even though we gave ourselves a discounted entry – WE STILL MIGHT BE WRONG!  We might be wrong or the market may collapse (as it did on us just 3 years ago) in such a way that nothing is safe – so we hedge.  This virtual portfolio is very different from our more aggressive White Christmas Portfolio or the $25,000 Portfolio we closed out earlier in the year as our primary concern here is Warren Buffett’s Rule # 1 of investing:  Don’t Lose Money!  With that in mind, let’s look at our winners AND losers and see who’s going to be a keeper in 2012.

For the third month in a row, we did almost nothing in the Portfolio.  We set up our positions over the first four months – found a good balance and, aside from a few minor adjustments – let things play out.  That was our intention with this portfolio – it’s meant to be as low-touch as possible and, despite the fact that the S&P has ranged from 1,074 at the beginning of October to 1,292 at the end of that month and back down to 1,158 a few weeks ago and now back to 1,250 – our balance has allowed us to leave things alone – spending more time playing golf and less time watching the market silliness every day. 

In our last update on November 16th, we had recorded $72,089 of realized virtual gains against $28,375 of unrealized net losses from open positions.  We had a big down and up move since then but, as of Friday’s close, we’re in more or less the same place this month – so let’s see how our positions did.  

The following positions were closed (all passively):  

• 3,000 shares of FTR paid a 0.188 dividend on 12/7 – up $564
• 5,000 shares of SVU paid a 0.088 dividend on 11/29 – up $440
• 500 shares of MT paid a 0.188 dividend on 11/18 – up $94
• 3,000 shares of ACI paid a 0.11 dividend on 11/29 – up $330
• 10 TBT Nov $18 puts sold for .90, expired worthless – up $860
• 10 BA Nov $50 puts sold for $1.52, expired worthless – up $1,520 

Don’t you just love dividends?  Keep in mind our goal is to keep buying more and more dividend-paying stocks until, in few years – we really don’t have to do a thing except wait for those dividend dates to get out checks.  At the moment though, we are a little more aggressive, working our way into positions in stocks that either pay us good dividends down the road or have nice option premiums to sell every month.  This month, without taking any portfolio action at all, we picked up $3,808 – just $200 shy of our monthly goal.  

We still have the following open puts and we’re not closing any yet but I’m going to color them green for ones I intend to stick with (rolling if still in the money) and red for ones I think we’ll give up on (black is undecided):

• 10 KFT Jan $30 puts sold for $1.60 ($1,600), now .08 (up $1,520)
• 10 EXC Jan $37.50 puts sold for $2.20 ($2,200), now .01 (up $2,190)
• 10 HCBK Jan $10 puts sold for $1.50 ($1,500), now $4.10 (down $2,600)
• 10 HCBK Jan $7.50 puts sold for net $0, now $1.60 (down $1,600)
• 10 GE 2013 $17.50 puts sold for $2.10 ($4,200), now $2.83 (down $730)
• 10 HPQ Jan $35 puts sold for $2.90 ($2,900), now $6.90 (down $4,000)
• 10 CCJ Jan $25 puts sold for net $1.25 ($1,250), now $6.60 (down $5,350)
• 5 RIMM Jan $35 puts sold for net $1.65 ($825),now $18.50 (down $8,425)
• 10 RIMM Jan $27.50 puts, sold for $4 ($4,000), now $11.15 (down $7,150)
• 10 IMAX Jan $25 puts sold for $2.40 ($2,400), now $4.20 (down $1,800)
• 10 IMAX 2013 $22.50 puts for $4.90 ($4,900), now $5.50 (down $600)
• 30 FTR 2013 $7.50 puts sold for $1.30 ($3,900), now $3.10 (down $5,400)
• 20 GLW 2013 $17.50 puts sold for $2.40 (4,800), now $5 (down $5,200)
• 30 NLY 2013 15 puts sold for net $2.43 ($7,290), now $2.40 (up $90)
• 20 VLO Jan $20 puts sold for $3.05 ($6,100), now .65 (up $4,800)
• 10 TITN March $22.50 puts sold for $4.50 ($4,500), now $2.20 (up $2,300)

Damn, I was sure that I would at least be able to get rid of RIMM but I can’t.  They are too cheap.  However, our targets are clearly unrealistic and not doing us any good so it’s time to get off the couch and re-commit to our worst position.  We have a $15,575 loss to date on the short puts and we can roll these 15 puts to 30 of the 2013 $17.50 puts at $4.55 ($13,650) which obligates us to buy 3,000 shares of RIMM for $17.50 ($52,500), which is just about our size limit for a single position.  When we first began buying RIMM in the $30s, we would have been thrilled to get 3,000 shares for $17.50 – now we’re not so sure but, as long as RIMM holds $15, we know we can make that work.   

Since our ultimate goal is to hold RIMM forever and sell calls and since we’re obligating ourselves to own 3,000 shares anyway – there’s no sense in not selling 15 Jan $19 calls for .72 ($1,080).  A few of those sales will go a long way towards digging us out of our hole.  

I still like the FTR puts because, even though they are down $5,400 – it’s still a net entry at $6.20 with FTR now at $5.16 and paying us a $2,256 annual dividend on the 3,000 shares we already own at net $6.29.  So, we end up with 6,000 shares at $6.25 ($37,500) that will pay us $4,512 in dividends each year (12%).  Do we really care what the PRICE of the stock is when we get that kind of VALUE from our investment?  

Overall, our net on the puts has decayed a bit, to an unrealized loss of $31,955.  We were down $28,375 last month (RIMM got worse and GLW tanked too) so that pretty wipes out this month’s gains but think about that from a long-term perspective.  We net zero for the month but, in the end, we get the above stocks at those low entries with little or no damage – even if we keep treading water like this.  As I noted with FTR, our goal was to have 6,000 shares that pay a 0.188 quarterly dividend of $1,128.  Whether FTR is at $5 or $15 – we just want our dividends!  Any increase in the stock price is simply a bonus.  

Like Buffett says in the video in the comment section of our "Build a Berkshire Workshop" project – the guy who bought KO at the IPO for $40 might have given up and sold when it dropped to $20 the next year but then they’d be missing out on $5M today – from that single share!  We’re not deluding ourselves that RIMM, for example, is going to be any KO but the market cap at $16.50 is down to $8.5Bn and for that $8.5Bn you buy RIMM for, they had $20Bn in sales and $3.4Bn in profits in their last full year and they had a 10% miss last Q (still earning .88 per share for the Q) because they committed the grave sin of spending money on R&D as well as record unfavorable currency exchanges on the weak dollar.

The bottom line is, would you like to own a $8.5Bn company that returns $3.4Bn a year?  Duh, right?  How about $1,7Bn?  That’s still 20% on your money (p/e of 5) if their earnings drop 50% (and the company is guiding closer to $4Bn next year) how about $850M?  1/4 of RIMM’s last year earnings are still a 10% return on your purchase.  Of course, if earnings are dropping that quickly, we would lose interest but RIMM is down on speculation and extrapolation based on one bad quarter, not on any actual numbers.  Is any of this a reason to bail out of the stock?

If you are a long-term investor, over the years your stocks will go up and down in PRICE – it’s your job to determine the VALUE.  AAPL was at $200 in November of 2008 and then at $82 in November of 2009 – a hopeless cause right?  Never coming back?  It was down from October ’08 through April of ’09 and I put up the same kind of charts and said BUYBUYBUYBUYBUY until I was blue in the face – the PRICE didn’t matter, because the VALUE was there.

Generally, in our stock portfolio, 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 most of these are solid companies we bought when they were cheap.  Some got cheaper and some have gone up considerably.  We’re not interested in buying more of the ones that went up but the ones that got cheaper are where we’re likely to put more cash:

• 3,000 NLY at net $15.76, now $16.12 – .62 dividend expected 12/30 ($1,860)
• 2,000 AGNC at net $27.65, now $28.90 – $1.40 dividend expected 12/30 ($2,800).
• 3,000 FTR at net 6.29, now $5.16 – .19 dividend expected 3/7 ($570)
• 20 GLW Jan $16 calls at net $2.55 ($5,100), now .12 (down $4,860)
• 1,000 CSCO 2013 $17.50 buy/write at net $11.92/14.71, now $18.88 – .06 dividend expected 1/4 ($60)
• 1,000 HCBK at net $6.83, now $5.93 – .08 dividend expected 2/2 ($80)
• 5,000 SVU 2013 $5 buy/write at net $2.99/4, now $7.48 – 0.088 dividend expected 2/30 ($440)
• 1,000 RRD 2012 $12.50 buy/write at net $8.83/10.67, now $14.58 – 0.26 dividend expected 2/3 ($260)
• 1,500 NYB 2013 $10 buy/write at net $8.30/9.15, now $12.03 – 0.25 dividend expected 2/3 ($375)
• 2,000 SKX Jan $14 buy/write at net $9.75/11.88, now $12.73
• 5,000 WFR 2013 $7.50 buy/write at net $3.85/5.67, now $4.42
• 2,000 SONC March $10/$12.50 buy/write at $6.95/9.72, now 7.17
• 3,000 HOLI Jan $7.50/5 buy/write at net $2.90/3.95, now $8.19
• 1,500 HOV 2013 $1 buy/writes at net .18/.59, now $1.58
• 500 MT 2013 $15 buy/write at net $7.50/11.25, now $18.81  - 0.188 dividend expected 2/19 ($94)
• 4,000 AA 2013 $7.50 buy/write at net $5.43/6.47, now $9.64 – 0.03 dividend expected 2/3 ($120)
• 2,000 F 2013 $10 buy/write at net $7.30/8.65, now $11.03 – .05 dividend expected 1/31 ($100) 
• 3,000 ACI 2013 $12.50 buy/write at net $7.50/10, now $15.54 – .11 dividend expected 2/28 ($330)
• 5 OIH 2013 $110/130 bull call spreads at $10, now $11.50 (up $750)
• 5 OIH 2013 $100 puts sold for $11.50 ($5,750), now $6 (up $2,750)
• 10 BRK.B 2013 $70/82.50 bull call spreads at $4.70 ($4,700), now $7.30 (up $2,600)
• 10 BRK.B 2013 $50 puts sold for $4.40 ($4,400), now $2.30 (up $2,100)
• 5 CAT 2013 $80/95 bull call spreads at $6 ($3,000), now $8.60 (up $1,300)
• 5 CAT 2013 $55 puts sold for $5.55 ($2,775), now $3.55 (up $1,000)
• 10 ANR 2013 $30/40 bull call spreads at $2.85 ($2,850), now $2.25 (down $600)
• 5 ANR 2013 $25 puts sold for $6 ($3,000), now $8 (down $1,000)
• 10 TM 2013 $62.50 calls bought for $6.50 ($6,500), now $10.50 (up $4,000) 
• 10 TM 2013 $55 puts sold for $5 ($5,000), now $3.20 (up $1,800) 

We don’t care about the P&L on our buy/writes, they are simply on or off track. Meanwhile, they are paying us $7,089 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 8 months!). On the other positions, we are ahead net $9,840, paring 1/3 of the unrealized losses on our short put set.   

The main idea here is to establish inexpensive entries for future call selling and dividends. Meanwhile, we hope we have adequate protection from our long-term hedges to see us through things – just in case we fail again.

• 50 DIA March 2012 $110 puts at $4.15 ($20,750), now $2.80 (down $6,750)
• 50 SDS March $19 calls at net $4.30 ($21,500), now $2.40 (down $9,500)
• 50 SDS Jan 30 calls sold at net $0 ($0), now .65 (down $3,250)

Down $19,500 on our protection is much worse than last month as we’re still guarding for a big drop that hasn’t come.  Of course, if it doesn’t come, then we should get our $28,000 back on the short puts AND we have A LOT of money to collect on our buy/writes.  

Last month, we had $72,089 of realized gains and we added $3,808 from our closed positions above for a total of $75,897 less the $28,375 unrealized loss on our puts, the $9,840 unrealized gain on our open positions and the $19,500 unrealized loss on our hedges leaves us with a net of $37,862 – not bad as our goal was to make $4,000 a month and this is just the beginning of our 8th month.

Keep in mind, the real money comes when our long-term buy/writes mature next year (the gains we’re not counting).  If CSCO holds $17.50, the 1,000 shares we bought for net $11.92 gain $5,580.  5,000 shares of SVU at net $2.99 make $10,050 if SVU just holds $5, etc.  On the whole, we’re looking at about $75,000 in expected gains that we’re protecting with our hedges.

Next month is going to be busy, with plenty of adjustments to make after the holidays.  It would be nice to have a Santa Clause rally but, obviously, we’re not counting on it.  We’ve still got less than 1/2 of our $1M buying power in use (ordinary margin) but we’re certainly at the point where we’re not looking to add many new trades until we take others off the table.  No matter what the market does, we’re going to want those hedges over the holidays but then we’ll see how things shake out in January.  

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This entry was posted on Saturday, December 10th, 2011 at 8:22 am and is filed under Uncategorized, Virtual Portfolio Review. You can leave a response, or trackback from your own site.