$100,000 Hedged Portflio Update

We didn't do a wrap-up last week as I instead wrote a long, Members Only post (only Part 1 too) on "Setting Up A $100,000 Hedged Virtual Portfolio" concentrating on a virtual $20,000 allocation in the financials for our first sector.

We're going to do more of these on the weekends as people find them useful and also because, although they are very popular, I do get tired of just reviewing what we did for the past 5 trading days every week.  So maybe a little of both today but I aim to keep this short (as I usually do, but it never works out) so we can do another post on earnings plays tomorrow.

How is our new sample virtual portfolio looking after a week?  Well let's see: 

• 500 UYG at $3.48, selling 5 May $3 calls for .72 and 5 May $3 puts for .28, net $2.48/2.74
  • UYG now $3.79, May put and call combo now $1.12 = net $2.67 ($95 profit on $1,240 = 7.7%)
• Selling 2 FAS $7.50 puts for .45 naked
  • FAS closed at $9.40 so 100% profit of $90
• 500 C at $3.04, selling May $3 puts and calls for $1.11, net $1.93/2.47
  • C now $3.65, May $3 put and call combo is $1.19 = net $2.46 ($265 profit on $965 = 27.5%)
• Selling 2 IYF May $36 puts for $2 naked
  • IYF closed at $40.26, May $36 puts $1.20 ($160 profit on $400 =40%)
• Selling 2 JPM May $29 puts for $1.95 naked
  • JPM closed at $33.26, May $29 puts $1.17 ($156 profit on $390 = 40%)
• Selling 7 FAZ May $10 puts for $2.40 naked (adjusted to reflect Monday's gap down open)
  • May $10 puts are now $2.67 so a loss of $189 (-11.3%).  Both our July and Oct escape rolls are still intact so no worries here anyway (this is a hedge to the others)
• 5 FAZ Oct $12.50 calls for $4 (adjusted), selling 5 May $21s for $1.05, net $2.95.
  • The Oct $12.50s are now $3.29, May $21s are now .45 so net $2.85, a loss of $50 (3.4%)

So far so good!  The FAZ hedges are holding up nicely while all of our upside plays were winners.  Our 3 April put sales are expired $90 in profits so risk off the table and cash put back to work and May Put sales look safe enough at the moment, up $316, while the May option plays are up $360 against a $239 loss on the hedges.  Overall, we put less than $1,500 of capital to work (there were, of course, some margin requirements – see original post) to make $527 in a week.  While this may not seem to thrilling as it was part of a $100,000 porfolio – this sector was "just" a $20,000 net allocation and $527 a week is $27,404 a year.  Again, I urge all members to watch the video "The Man Who Planted Trees" so they can understand this investment philosophy.

I am not going to do this every week and certainly not going to do it for 5 sectors of $20,000 allocations – this is why we have a Hedge Fund!  But always feel free to ask about adjustments etc in chat, all we are doing here is weekly adjustments for the more casual investor who doesn't have time to watch things dance around during the week. 

Now that a few of our positions stopped out, we need to take a look at what's left.  Actually, the stops worked out perfectly because we wanted to flip a little bearish after April expirations and having 1 bullish put sale cash out on us and 2 more looking fairly safe at 40% up already is just the ticket.  Do not be impatient – our conservative goal for May 15th was to make $1,375 and we already made $527 which is, as I pointed out, a good return even on the whole $100K (don't expect this all the time of course!).

Investment capital should not be burning a hole in your pocket.  Warren Buffett sat on $40Bn for 3 years and barely made a move until the October crash where he suddenly gave GE and GS $5Bn each along with some other moves and he placed a $5Bn bet that the S&P was done going down by essentially selling puts against that possibility.  If you have cash, you can take advantage of opportunity – if you have positions then opportunities can pass you by very quickly.  We kept 98% of our cash on the side BECAUSE we didn't need to adjust any of our trades.  The adjustments are opportunities to by a position we believe in cheaper than where we started (because it went against us) we're certainly not going to cry because everything went our way and we didn't need any more money to be on target! 

So, we are now left with the two naked puts and the UYG and C buy/write positions and both seem fine to leave in place.  Our current net on UYG is $2.67 and it pays to bear in mind that we CAN'T do better than $3 but we started at $2.48 as this was a very conservative play and is simply "on track."  C was a bit more aggressive (see original post for trade plans) and we are halfway to goal of $3 with a net $2.46 so we set a stop on this one at net $2.30 because they have been fairly erratic and we weren't too thrilled with the earnings.  That leaves us with 2 hedges with nothing really worrisome hedged against them.

Just because we are bearishly biased doesn't mean we HAVE to find bullish plays but we don't want to be 100% bearish and that's what we'll be if C stops out so let's try a couple more, bearing in mind we are bearish next week until earnings and/or breakout levels prove us wrong. 

One no-brainer of a play is selling some FAS puts again.  Since we already sold FAZ puts, it's VERY unlikely both the FAZ and FAS puts will burn us at the same time.  In fact, we had a play last week selling the May $9 puts on both at the same time that's working very well so far.  As we can still get a high premium and as we do still like the financials long-term, we can make a commitment to go long on FAS (if we have to):

Selling 10 FAS May $6 puts for .50 naked:

• Commitment -$500 ($2,500 in net margin)
• May profit goal $500
• Stop/Loss Target: Roll to July $4 puts (now .50) or Oct $2.50 puts (now .45) even.
• Downside coverage required: None (I’m willing to live with it)

GE's earnings were fine and we've always liked them as a long-term survivor.  The lower VIX is forcing us to move our timeframe out to June on the less volatile plays in order to get a good comfort zone but $2.89 for the GE June $11 puts and calls gives us a nice entry so:

200 GE at $12.39, selling June $11 puts and calls for $2.89, net $9.50/10.25

• Commitment $1,900/$4,100/$7,200 (same logic as UYG from 1st post)
• June profit goal $300
• Stop/Loss Target: 50 DMA is $10, action required if we break that.
• Downside coverage required: We won't mind buying more at $8 so $500 is plenty.

IYR worked well but URE has gotten interesting not that it's flying over the 200 DMA at $3.   There are a couple of interesting ways to play this but the simplest thing to do is just sell the June puts.  

Selling 10 URE June $3 puts for .50 naked:

• Commitment -$500 ($2,500 in net margin)
• May profit goal $500
• Stop/Loss Target: Roll to Sept $2 puts (now .35) even.
• Downside coverage required: None (I’m willing to live with it)

Last and most risky is PGF.  An ETF that invests in preferred securities of financial institutions AND pays a 15.88% dividend.  There is, of course a risk that we have another financial meltdown and these go back to $6 a share again but it does kind of make sense to buy more again if that happens.  As long as the dividend is there, we want to own a bunch of these but the spread

300 PGF at $11.59, selling May $11 calls ONLY for .90, net $10.69

• Commitment $3,177/$5,577
• May profit goal $123
• Stop/Loss Target:  Buying 200 more at $12.50 with $12 stop or selling 3 Jun $10 puts at $1.25+, now .40
• Downside coverage required: We are scaling in but will want $2,000 of protection if either event triggers.

Don't forget we're playing PGF for the dividends so it's our intention to hold about $6K worth long-term and collect $1,000 a year against them (maybe more).  Meanwhile, being called away on May 15th at $11 may not seem like much but it's 3.9% for one month which is 46% a year which is why dividend players who don't sell calls because they are "worried about missing the dividends" are very poor mathematicians.

That's plenty as our main goal is to wait for some really bad earnings and pick up someone who we feel is beaten down more than they deserve.  We have $1,240 tied up in UYG, $965 in C, a $1,680 credit from FAZ puts and $1,475 tied up in the FAZ spread plus the $90 we already pocketed on the puts we sold that expired worthless so only $1,120 cash committed out of $20,000 set aside for financials -before our new plays which are net $4,077 in cash so plenty of money left to make adjustments or grab new plays along the way.

Keep in mind this is a virtual portfolio and we are ignoring the many great addtions we made this week during member chat and making no adjustments to our positions other than whatever looks good on the weekend.  The idea is for people who have actual jobs and can't trade every day to get a good idea of how to build, allocate and manage a hedged virtual portfolio. 

I had intended to add another sector this week but I am concerned we are a little overbought and we don't have enough earnings data to form a good premise for allocating another $20,000.  Since these are humming along quite nicely, I don't see any real reason to jump the gun but there are two put sales we can enter that I think are reasonable to establish.  DBC is the commodity basket that includes oil and it has underperformed the DBA as petroleum products and precious metals have underperformed in this "recovery" – just another reason we think the whole thing is BS but that's another post… 

So even if we are crashing, we like DBC LONG-term in any virtual portfolio and the 2011 $15 calls are $6.90, a $1.70 premium.  We have 20 months to make up that $1.70 so our goal is to collect .10 per month in premiums.  Of course we also want to mitigate some of our downside risk as DBC was as low at $18 in early March.  It would cost us .65 to roll down to the Jan 10 $13s, now $7.55 so that would "cover" us against a $2 pullback in DBC and the Jan $13s have just .35 in premium so they will lose value faster than we will to the downside (delta is near 100) meaning our escape roll will get CHEAPER as DBC goes down.  That means selling 1/2 the July $21s for $1.18 accomplishes most of our goal by itself as it gives us .59 per long contract, which either pays for most of a roll that eliminates our premium or, on the way up, eliminates 1/3 of our premium.  That is what we call a nice spread!

10 DBC 2011 $15 calls for $6.90, selling 5 July May $21s for $1.18, net $6.31.

• Commitment $6,310
• July profit goal – $590 (the price of the puts we sold but  staying even and working off premium would be fine)
• Stop/Loss Target: Will roll down to Jan $13s, now $7.55 if DBC drops below $19 and will fully cover with July $19s, now 2.17, for another $1+.
• Downside coverage required: None  (I’m willing to live with it)

My other "must have" before it gets away is UNG.   A much riskier play but potentially very rewarding.  I'm counting on the new EPA warnings on CO2 etc. to make natural gas a little more attractive or at least get talked up at some point off these lows.   I've been telling members to stay away from nat gas from $6 to $3.50 but now this ETF is finally starting to make sense at $15.05, 75% off it's highs of last summer.  We are going to go with a pure scale-in here with no cover unless we break $14.

5 UNG Oct $10 calls for $5.55.

• Commitment $5,550/$11,550
• June profit goal – $500 (expecting to be near 50 DMA at $16)
• Scaling in Downside Targets: Will roll down to Oct $8s for $1.40, now $1.75 and to Oct $6s for the same at which point we would want to add 5 more Oct $6s and sell 1/2 July calls that pay $1.50 or better (offsetting 1/2 cost of rolls).
• Downside coverage required: None  (I’m willing to live with it)

That kind of play is a little tricky to follow down the road but we'd be looking at getting into the Oct $6 calls, now $9.05, for $5.55 + $1.40 + $1.40 or $8.35.  Of course, by the time we got those rolls we can assume they'd be down to $6 and we double down at $6 and have a net entry of $7.18 on 10 contracts where we turn around and sell 5 July calls (probably $11s) for $1.50, dropping our net basis to $6.43, which is why we're willing to live with it as we have very little premium and would still have good position against the calls we sell. That is, of course, our downside plan.  If things go well, we just make money and have a good time.

Look at that, suddenly we're big spenders committing another $11,860 of our $94,803 in cash!  I know it's tedious, which is why the average investor doesn't do it but, again, watch the video and think about it…

So much for keeping it short – I'll still try to get a weekend wrap-up going though as I'm not as enthusiastic as I was about earnings plays (see Steve's comment end of Friday's post) – it's still very scary out there and we should make sure they can take out our breakout levels before we make too many upside bets.  Obviously, if the markets head south on Monday, it's no time to be jumping into the last two plays – just like it wasn't even possible to pay as much for FAZ on Monday as they closed for the Friday before – you do need to use your head and always feel free to check with me in chat if you're not sure if a play still makes sense.

Have a great weekend,

– Phil