General guidelines

When buying a stock, I put no more than 5% of my portfolio into that position. If the investment grows beyond that percentage, I won't rebalance, but my initial commitment is limited to 5%.

The same goes for writing puts. If the put is exercised, I'll be buying the shares, so I limit the number of contracts I write on any stock to a 5% position. I calculate this by the amount of cash used to secure the put, since that's the cash that would be buying the stock.

When writing put contracts, I aim for a 1% return per month. I write puts only on stocks I would like to buy at that strike price.

Sold KCI puts

Sold 4 $35 strike March KCI puts for $1.20 per share.

Closed MDT puts

I closed ("buy to close") my January MDT puts for $0.05 per share.

Sold NS RIG puts

NB: NS trades are not for beginners. Sit down with pencil and paper to work these out, or you can make an expensive mistake.

* * *

I sold 2 contracts of Jan $80 RIG puts for $17.05. The unusually large option premium (21%!) is because this is a non-standard (NS) option. An event occurred which resulted in these shares trading in an unusual package. Usually, one contract is a promise to buy or sell a package of 100 shares at the strike price. In this case, the package is "$2314.38 cash in lieu of shares, 47 shares of RIG." Non-standard options are indicated by NS in the Option Chain screen.

The discussion below uses just one contract as an example, for the sake of simplicity.

I have still put up $80 * 100 = $8000 per contract to secure the puts. The possible outcomes are:

a) RIG is trading above $80 on the January 2010 expiration date. I keep the $17.05 premium, and get the cash securing my put back, for a 21% gain in approximately a month.

b) RIG is trading at or below $80 on the expiration date. I purchase 47 shares of RIG at $80 a share, and "purchase" $2314.38 cash. That would mean I was trading $8000 for $6074; uh-oh.

However, the net picture is better than it appears for b).

Remember the option premium. I'm paid $17.05 per share or $1705 total for writing this put. The total value of the property I end up with varies depending on the value of the stock at expiration. I consider RIG to be one of my core holdings--I already have 2.5% of my portfolio in it, and plan to make that 5%. These two contracts, each conveying 47 shares of RIG, will do that if exercised.

The total value of b) is $1705 + (47 * RIG) + $2314.38. I'm paying $8000 for this package, so $1705 + (47 * RIG) + $2314.38 = $8000. Solve for x (in this case, RIG, the market value of the stock). I will break even on b) when RIG is trading for $84.69 or above.

Naturally, if RIG tanks, or even stagnates for a significant period of time, I'll stay in the red on possibility b). That's why this NS option is trading for such a high premium, but it's also the reward that makes this risk worth taking.

Sold GSK puts, December options expirations

I sold 3 GSK Feb 42.50 puts for $2.15.

December options contracts I wrote on LNN, KCI, and MOS expired unexercised.

My portfolio is currently 73% in stocks, 20% in investable cash, and 7% in cash securing puts.

Bought ORCL

I bought more ORCL at $22.50, completing my 5% targeted allocation in this stock.

November 2009 options expirations

My OI shares were called away in November. I was also put SH (S&P Short) shares, which I sold.

Closed puts written on ANF

I paid $0.40 per share to close the Feb 27 ANF puts I sold in October for $2.16 per share. My original hypothesis--that ANF is badly overvalued, and will drop below $30 by February--may not play out. The stock is healthy, even if the company is not. I'm pleased to make a little money by closing the sold puts early. Ignoring the puts I bought, I've made $1.76 per share or 6.5% of the $27 share price in forty days. Including the puts I bought, however, I'm still at a loss my ANF position.

Bought EBIX, closed WAT puts

I bought more EBIX at $56, completing my 6% target allocation in this stock.

I closed my OTM Nov $50 puts on WAT for $0.10/share; I also have a long position in this stock.

Bought RIG, Synthetic Long on SH

Yesterday I bought two Nov $57 calls for $1.15. Today I sold two Nov $56 puts for $1.10, completing the synthetic long. SH is the ProShares Short S&P fund, so my calls will increase in value if the S&P drops, and decrease if it rises. This is strictly a short-term hedge.

Today I put 3% of my portfolio into Transocean (RIG) at $85. RIG reported lower revenues and earnings before the market open. I still like the company's position and balance sheet, so I bought it on the dip.

I also like ATW, a smaller company in the same business. I may put another 2% into that company (it reports on Nov 23rd) or buy more RIG, or put that in NE (Noble). There are many great companies in this segment, and they're at great prices right now.

Sold MSFT

Previously I had 6.5% of my portfolio in MSFT; I sold most of that today at $28. I still have a 1% position.

Sold UMH, PCP, SPLS

Sold UMH at $7.75, PCP at $95.85, and SPLS at $21.84.

Sold RSG, bought FPL and AAPL

I sold my remaining RSG stock at $26.17. I bought 1% FPL at $54.65 and 3.5% AAPL at $204.96.

I'm currently 33% in cash, but 20% is securing puts which expire between now and February 2010--so, about 10% investable cash. I have both covered calls and secured puts expiring next month, and I plan to increase my cash position.

Bought LNN, EBIX, Wrote MDT puts

I put 3% of my portfolio in LNN at $32, and another 3% in EBIX at $61.64. Sold 2 Jan $36 puts on MDT for $1.70.

October 19, 2009 Options expirations.

The $30 covered calls I sold on AVY expired ITM, so my shares were called away. The stock was trading at $38 today, so someone made money.

The $36 puts I wrote on MDT expired unexercised; I still want the stock, but I'll look to write more puts or buy on dips.

Bought more ANF puts

ANF has been up since October 8th on better-than-expected same store sales. SSS dropped by 18%; analysts were expecting -20.4%.

Share price increased over 5% on the news. Since the $34 puts are now in-the-money, the cost decreased sharply. I paid $3.70/share for 3 more $34 ANF Feb2010 puts, which slightly changes my profit/loss picture.

I used the spread between the $27 puts I sold and the $34 puts I bought to bring my net cost down. Net, I paid $3.44 for the right to sell ANF at $34.
I have the right to sell at $34, but must buy at $27. I make a profit starting when ANF is ($34 - $3.44) = $30.56, and the profit increases until ANF is at $27. This limits caps my maximum profit to ($30.56 - $27) = $3.56 per share.

I have now paid an additional $3.70 for the right to sell an additional 300 shares of ANF for $34. Since I sold no puts to pay for this, my profit potential is different. I make a profit starting when ANF is ($34 - $3.70) = $30.30. My profit increases until ANF reaches (theoretically) $0, for a maximum profit of $30.30 per share. I don't think this is likely to happen, but it's nice to dream.

ANF spread

I bought 3 Feb 2010 $34 puts on ANF for $5.60 and sold 3 Feb 2010 $27 puts on the same stock for $2.16.

This means I paid $5.60 for the right to sell ANF at $34 any time between now and February of next year. I also was paid $2.16 for my promise to buy ANF for $27 in the same time frame. The stock was trading at around $31 when I made the trade. This is a more complicated option trade, and has several possible outcomes.

If, in Feb 2010, ANF is trading above $34 a share, the puts I purchased are worthless. Why would I sell it at $34 when it's on the open market for $35?

Loss: $5.60 - $2.16 = $3.44 per share, or a loss of $1,032 for my three contracts.

If ANF is trading at or below $27, I will be obligated to buy the stock at $27. I will also have the right to sell it at $34. I will buy the stock at $27 and sell it at $34.

Gain: $34 - $27 - $5.60 + $2.16 = $3.56 per share, or a gain of $1,068.

The complicated part comes if ANF is between these two strike prices; that is, if it's trading between my $34 sell price and my $27 buy price.

If it's trading at $33, I still have the right to sell it at $34--and I would do so. However, because of the $3.44 I paid to buy the put, that would not give me a profit on the position. The loss would be:

Loss: $34 - $33 - $5.60 + $2.16 = $2.44 per share, or $732 on the whole position.

So you can see, the lower the share price, the smaller my loss. This ticks over into profit if the share price is below $30.56 ($34 - $3.44):

Break-even: $34 - x - $5.60 + $2.16 = $0 (and solve for x. 4th grade algebra has been more useful than my math minor).

So if ANF is below $30.56 by the February expiration date, I make a profit on the position, which increases the lower the price goes. The limit to my profit comes when I reach my lower strike price of $27. At that point, profit stays constant at $3.56 per share. The limit to my loss comes at my higher strike price of $34. At that point, my loss is $3.44 per share. If the price is somewhere in between, my profit/loss varies between those two limits.

Okay, on to the hypotheticals. I do not need to wait until expiration to change this situation. As the price of the underlying stock decreases, the puts I bought will become more valuable; it's more attractive to sell a stock for $10 over market price than for $5 over asking price. ANF has dropped by $1 per share since I made this trade, so the same puts I bought for $5.60 are now trading for $6.00. You can sell options just like you can sell stocks. Right now, I could sell the option I bought for more than I paid for it (but not enough more to make it worth the trade). Likewise, the puts I sold have decreased in value; it is less attractive to buy a stock for $5 below market price than for $10 below market.

Both options will decrease in value as they approach expiration; options are hedges against uncertainty, and the future 6 months from now is more uncertain than next month. So, I may close one or both of these positions early if I can do so profitably.

I also didn't need to do a one-for-one sale or purchase of these options. I could have bought just one put, for a net cost of $560, and still sold three puts, for a net gain of $648. Then, the cost of the puts I bought would be completely covered by the income from the puts I sold. This would change my profit/loss outlook.

That is, if ANF is trading above $34, the puts I'd bought expire worthless. However, I still made (300 * $2.16) - (100 * $5.60) = $648 - $560 = $88 on the trade.

If ANF is at or below $27, I'm obligated to buy 300 shares at $27, but can sell only 100 shares for $34. So, I would have paid $8100 for all three hundred shares. I'd be able to sell 100 shares for a total of $3400. I would be left with two hundred shares at a net cost to me of $4700; that's $23.50 per share. If ANF is trading at $23.50, I can sell the shares for a profit/loss of zero. If it's trading above $23.50 I can sell them for a profit. If it's trading below $23.50, I could sell at a loss.

So you can see how you can mix and match options to suit your purposes. This can get very complicated, and it's easy to overlook something and open yourself up to risks you weren't expecting. I like writing out the outcomes of each possibility ("if p happens, the effect on my trade is q"), especially when I'm learning a new option strategy

Proof that you can be very smart and still do very stupid things

I bought more OMTR in the last five minutes of trading yesterday. I think that's the worst investment mistake I've made since I bought GE at $32 back in May 2008.

Since OMTR will be bought out by ADBE for $21.50 share in a mere 21 days, and I bought at $21.41, my maximum profit is $0.09 a share on this purchase. What was I thinking?

RSG called away early

EDIT: RSG was called away a day earlier than I thought; the sale posted to my account on the 29th, but was executed on the 28th. Since the shares were called before the ex-dividend date, the dividend went with them.

In June, I sold 5 $25 October calls on my RSG stock; the stock is now trading at $26 and change, so imagine my surprise when the shares were called away yesterday on no news! They were called away on the ex-dividend date, so the buyer chose to call the shares on the very first day they wouldn't get the dividend. I'm baffled, but I'm happy to keep the dividend; it's a nice 2.87% yield at the current price of $26.50. I bought the shares at $19.11, so my yield is higher.

The dividend is $0.76 per share. The yield is the dividend divided by the current share price; this is the money you get in dividends for every dollar you spend.

$0.76/$26.50 = 2.87%

So for every hundred dollars I spend on RSG, I'll get $2.87 back this year.

However, I bought RSG at a lower price. My shares increased in value, but I'm paid the same dividend as all the other common shareholders.

My dividend yield is:

$0.76/$19.11 = 3.98%

For every hundred dollars of my original investment, I'm getting $3.98 per year.

This is why I like dividend bearing stocks, and why I keep a close eye on them.

Helpful links on dividends:
the SEC: http://www.sec.gov/answers/dividen.htm
Investopedia: http://www.investopedia.com/articles/02/110802.asp

Sold SSCJQ, MCK

I sold the rest of my McKesson stock at $57.86 (the majority was called away last month at $45 strike + $2.10 premium).

I also sold the remains of my Smurfitt-Stone preferred stock at $7.00, my first (and, hopefully, the last) OTC trade. Smurfitt-Stone was bought at $20.50, declared bankruptcy in January of this year, and even the preferred stock has dropped as low as $0.10 a share. The common shareholders have fared far worse. Now that the position has increased to a mere 65.8% loss, I'm selling.

Smurfitt-Stone's bankruptcy was the final factor in my decision to manage my own portfolio. Before, I'd managed about 10% myself, and left the rest in the care of my (expensive) Merrill Lynch advisor. The bankruptcy filing made me realize that no matter how much I paid my advisor, no one would care as much about my portfolio as I do. I now manage my portfolio myself.

Closed OTM puts

Today I closed October puts on FLS and TUP which were way out of the money, for $0.10 a share. All other things being equal, I'd let the puts go until expiration. With the current market drop, I want the cash ready to reinvest in discounted stocks.

Bought WAT

I bought a partial position (4%) in WAT today; I also have Nov $50 puts outstanding. WAT has been moving steadily upward since I opened my options position, and I am not sanguine about having the shares put to me. If WAT drops to my $50 strike price or below, it will be 5.3% of my portfolio (including the shares I just bought outright). If it stays above $50, at least I'll have my 4% and can later write more puts to hopefully fill the 5% target at a better price.

Bought ORCL

Today I put 3% of my portfolio in ORCL @ $21.50; I plan to add another 2% later, hopefully at a lower price.

A bunch of puts expired unexercised over the weekend;

4 $20 KCI, $2.20 premium
6 $15 JKHY, $0.65 premium
1100 $10 GTI, $1.60 premium
1 $65 PCP, $3.10 premium

for a total of $3,340 in income. I still want all these stocks, so I plan to write puts again to buy at a more desirable price. The exception is PCP; my targeted position in this stock is already partially filled, and it has increased dramatically in price since my initial purchase and I am reluctant to buy more at these prices.

Sold more MOS puts

Today I sold 3 MOS $50 puts for $3.80/share. My previous $45 MOS puts expired un-exercised last month. I still want MOS, since I like the company and I no longer have an agriculture position since I sold Agrium also last month). I compared MOS and AGU as long term investments.

AGU:
P/E ratio | 10.22
revenue / employee | $ 1.18 million
dividend yield | 0.21%
price / tangible book | 1.996
price / sales | 0.8293
price / free cash flow | 15.46
return on equity | 19%
return on assets | 16.89%
leverage | 2.166
current ratio | 1.953
debt / capital | 0.2679
net profit margin | 9.05%
Annualized 5Y revenue growth | 31%
YOY Revenue growth | 90%
Gross margin | 26%
EBITA margin | 9.5%
cash/share 2.29


MOS:
P/E ratio | 10.98
revenue / employee | $ 1.428 million
dividend yield | 0.28%
price / tangible book | 3.032
price / sales | 1.946
price / free cash flow | 19.05
return on equity | 30.87%
return on assets | 19.19%
leverage | 1.493
current ratio | 3.273
debt / capital | 0.1289
net profit margin | 9.22%
Annualized 5Y revenue growth | 34%
YOY Revenue growth | 4.9%
Gross margin |30%
EBITA margin | 28.3%
Cash/Share | 6.08

The two companies have very similar numbers, and either would make a good investment. For me, the deciding factor was the cash reserves held by MOS. MOS has a better current ratio, more cash per share, and is less leveraged. This cash hoard gives MOS more flexibility in its response to changing market conditions; it can afford to expand, buy a distressed rival, or hunker down in lean times.

In the ag space, I also really like Terra Nitrogen. However, I'm still trying wrap my head around their M.C. Escher business model Terra is both TRA (selling nitrogen products) and TNH (which owns a nitrogen manufacturing facility). Here's an excerpt from their website which attempts to clarify the relationship:

"[TRA]directly or indirectly holds approximately 75% of the outstanding common units of [TNH], which are traded on the New York Stock Exchange, and the remaining 25% of [TNH]’s units are held by the public. In addition to operating the [TNH] manufacturing facility in Verdigris, [TRA] also owns and operates five other North American manufacturing facilities, and has a 50% interest in an ammonia facility in Trinidad and 50% interest in GrowHow UK Ltd., a United Kingdom joint venture. [TRA] also has a deep-water terminal in Donaldsonville, Louisiana, and 50% interest in Houston Ammonia Terminal near Pasadena, Texas. "

TRA and TNH both have great management; ROE is 38% and 152% (!) respectively. However, while I can keep an eye on them, what about these little private companies? If GrowHow UK Ltd. accidentally vents ammonia gas, TRA will also be sued, whether or not they're actually responsible. Are these shipping arrangements in LA and TX bringing in income or are they just an expense? What if TRA decides to raise capital by selling it's 75% stake in TNH?

Bought ADBE

Adobe, a fabulous company, is trying to buy Omniture, another fabulous company which I already own. I still believe in OMTR, and the ADBE offer is for straight-up cash (not a cash + shares deal), so I put 3% of my portfolio in ADBE, which has dropped 6% on the news. If/when the offer is finalized in November, I plan to put the cash from the purchase into ADBE, which should complete my targeted 5% stake in ADBE.

I'm buying ADBE now due to the dip from news of the OMTR deal. The P/E is high, but justified by the company's other numbers:

Current ratio: 5.0
ROE: 19%
Total Debt/Equity: 0.1
Gross Margin: 95%
Net Margin: 18%
EBITDA(Earnings Before Interest, Taxes, Depreciation, and Amortization: 26%
Revenue/Employee: $455,600
Revenue Growth, annualized over 5 years: 18%
YOY Revenue Growth: 13%

Much of this information comes from WolframAlpha, a free data search engine which I use and recommend.

Sold KCI puts

Sold 4 Dec $35 puts on KCI for $1.85. That's a 5.3% gain in 3.2 months, 1.7% per month, 20% annualized. I've already written $20 puts on KCI, which will expire this month.

Article: Ghost Ships of the Recession

Shipping is a leading indicator of economic activity; BDI (Baltic Dry shipping Index) has become a buzzword of the current recession. The excerpts below are from a Daily Mail article published Sept 13 2009.

http://www.dailymail.co.uk/home/moslive/article-1212013/Revealed-The-ghost-fleet-recession.html

"The biggest and most secretive gathering of ships in maritime history lies at anchor east of Singapore. Never before photographed, it is bigger than the U.S. and British navies combined but has no crew, no cargo and no destination - and is why your Christmas stocking may be on the light side this year.
... the hulls gather rust and seaweed at what should be their busiest time of year.
Local fisherman Ah Wat, 42, who for more than 20 years has made a living fishing for prawns from his home in Sungai Rengit, says: 'Before, there was nothing out there - just sea. Then the big ships just suddenly came one day, and every day there are more of them.
'Some of them stay for a few weeks and then go away. But most of them just stay. You used to look Christmas from here straight over to Indonesia and see nothing but a few passing boats. Now you can no longer see the horizon.'
...750ft-long merchant vessel is standing absurdly high in the water. The low waves don't even bother the lowest mark on its Plimsoll line. It's the same with all the ships parked here, and there are a lot of them. Close to 500. An armada of freighters with no cargo, no crew, and without a destination between them.
...This time last year, an Aframax tanker capable of carrying 80,000 tons of cargo would cost £31,000 a day ($50,000). Now it is about £3,400 ($5,500).
...This is why the chilliest financial winds anywhere in the City of London are to be found blowing through its 400-plus shipping brokers.
Between them, they manage about half of the world's chartering business. The bonuses are long gone. The last to feel the tail of the economic whiplash, they - and their insurers and lawyers - await a wave of redundancies and business failures in the next six months. Commerce is contracting, fleets rust away - yet new ship-builds ordered years ago are still coming on stream.
...These empty ships should be carrying Christmas over to the West. All retailers will have already ordered their stock for the festive season long ago. With more than 92 per cent of all goods coming into the UK by sea, much of it should be on its way here if it is going to make it to the shelves before Christmas. But retailers are running on very low stock levels, not only because they expect consumer spending to be down, but also because they simply do not have the same levels of credit that they had in the past and so are unable to keep big stockpiles."


There's quite a bit more, mostly industry-specific. I encourage you to read the entire article.

Article: Boring Fair Value

This is an interesting article from which compares the current rally to the 1930 "hope" rally which presaged a long decline in US stocks.

Haven't We Been to this Show Before?

Caveat; I am suspicious of anyone who uses phrases like "muse wondrously" in an otherwise serious article. PJ O'Rourke can get away with it; this guy can't. Also, the author is a banker, not a historian. His degree is in public policy, not economic history.

This article by Jeremy Grantham has a more cogent view of the current market environment:

Free subscription required

If you aren't already a subscriber, go to www.gmo.com/America/MyHome/, register, then access the article "Boring Fair Value" in the site Library. Published July 2009, but still relevant.

Let your winners run

I posted the following on one of my favorite boards, on the topic of taking profits on multi-baggers or letting your money ride. This is true only from an investment perspective, when you've done significant research on your position. Speculators probably do something different. I'm not being catty; I don't understand the spec mindset.

Personally, I prefer to let my winners run, but when I keep a big gainer I also use a stop-loss order to bolster my selling discipline.

It's easy to overlook a "slow leak" in a position; I've been surprised by sales from a stop-loss order I'd placed and forgotten.

It's possible your order will trigger, and then the stock will reverse its losses. Stop-loss orders are useful when you've picked a sales price you'll be happy with, but are not concerned with selling at the absolute highest price you can get. You can also set the order to sell all or part of your position.

I'm doing exactly this with a big winner, Helmerich & Payne, HP. Bought at $7.89, it's now a 350%+ gain; the old saying "pigs get slaughtered" is echoing in my head. However, I still love the stock.

Instead of selling, I have a stop-loss order in place to sell PART of my shares if the stock drops to $31. That's a large enough gap that the order won't be triggered by ordinary market fluctuations. I'd be selling about a third of my position, which would recover my original investment, plus a little extra profit. Two-thirds of my HP position would remain invested; I'd sell that portion only if the reasons behind my original investment hypothesis changed.

This allows you both to preserve your profits in the face of irrational market pricing changes, and to capture the out-performance of stocks which have already proven themselves to be winners.

Sold WAT puts

Today I wrote 3 $50 November puts on WAT for $2.24 each. Waters makes basic (and very expensive) lab instrumentation, and provides service contracts for their instrumentation. I believe Waters will benefit from future economic recovery; these instruments are useful in quality control for many industries. In the meantime, WAT will earn more through service agreements, as companies make more frequent and more expensive service calls to help their old equipment limp along until they're able to replace it.

MDT, PCL

Today I put 5% of my portfolio into PCL (Plum Creek Lumber) at $30/share. I chose to buy now because Plum Creek has not participated in the current rally; it's above it's March lows, but is currently trading near its April stock prices. The stock has a 5% yield and I believe lumber and mineral rights are an excellent hedge against inflation.

I also wrote four October $36 puts on MDT, paying $0.85 per share. I had puts on MDT expire un exercised last month; if the stock dips in the next six weeks, I may get it at a desirable price. If not, I'll continue to write puts for it; I want the stock, but not enough to pay $38/share for it.

Aug 22 2009 Options expirations

I had several options positions expire over the weekend. Puts I wrote on PCL (Plum Creek Lumber) MDT (Medtronic) and MOS (Mosaic) all expired un-exercised. That capital is now free to be used in new trades. I plan to sit on it for a while until the market dips.

Shares of SLV were put to me; I immediately used these to write Jan2010 calls at a $17 strike price. I was paid $0.50 a share for these, for a total of $450 income on the 9 contracts. If un-exercised, my return will be 2.9% for the trade or 0.6% per month--negligible compared to puts, but acceptable for a covered call since the risk is significantly less. As detailed below, SLV is in my portfolio only to generate income via puts and calls.

I had written covered calls against VZ (Verizon) and MCK (McKesson). VZ was called away, fairly close to my $31 strike price. My MCK calls, however, had a strike of $45--when my shares were called away, I could have sold them on the open market for $56!

That's the risk of covered calls; you may not make as much money as you could have. My initial buy price on MCK was $23.70, so when it was at $44, I was happy to agree to sell it for $45. I never dreamed the price would increase so dramatically in less than two months.

Stop-loss orders triggered

Over the past week, my stop loss orders on GE, AAPL, and MRO (Marathon Oil) have triggered. These are all stocks I'd buy back when or if they drop 25--30% from their current levels.

LNN puts

I finally wrote puts on LNN. I wrote one contract December $35 puts, for $1.90/share. These puts will pay 5.4% [(1.90/35.00)*100 = 5.4]. I'd be happy to buy this stock at $33.10 ($35 - $1.90 = $33.10). It's currently trading around $43 after a recent price run up. This is a small cap (it's market cap is only around $525 million!) so it's price is extremely volatile. I think the market currently overvalues the stock, so I'm not willing to buy it outright.

A trade purely to generate income

One of my stop-loss orders triggered today. I used the proceeds to secure a new put position. I "sold to open" 9 contracts (900 shares) in SLV (iShares Silver Trust). These were $14 puts which I sold for just $0.25 each. They expire August 22, so this 1.78% return is generous for an 11 day commitment. The stock is trading at $14.09 now, so there's a good chance I'll get the shares. If I'm put the shares, I will immediately write covered calls on them. This is an income trade; I expect to make money by selling puts and calls on this stock, not capital gains from the stock itself.

The equivalent in real estate would be buying a house in a part of town where I don't expect property values to increase significantly. I would buy that house purely for rental income, not with plans to sell it later for a profit. If you aren't going to be writing covered calls on this stock, it isn't worth buying.

In addition, I'm making only $225 on the puts; a nice return for an eleven-day wait, but not huge (especially considering transaction costs). If I wasn't buying a large number of contracts, I would just buy the shares outright. For a smaller trade, it isn't worth the trouble or the wait.

When your chickens come home to roost, remember to collect the eggs.

I was put 100 shares of FLS from a put I wrote in May. The command was "sell to open 1 contract of FLSSN. Premium $5.90/share. Strike $70/share. Expiration July."

My income from this put was $590. The stock price was approximately $68/share when the contract expired, so I bought the shares at $70/share ($64.10/share including the premium, $70 - $5.90).

Naturally, I turned right around and wrote calls on my new FLS stock. I wrote 1 contract January 2010 FLS calls at a strike price of $80, for $4.20/share. The period of the call is about 6 months, which is about as long as I'm comfortable with. So, at this point I have bought FLS for $70/share, and I have earned $10.10 ($5.90 + $4.20) on my stock. That's a 14% return (I'm rounding down to keep it simple and account for transaction fees, which vary by which broker you choose). If my shares are called away in January, I will have made a 28.7% return ($80 strike - $70 purchase price = $10. $10 profit + $5.90 put income + $4.20 call income = $20.10 total income. $20.10/$ 70 = 0.287 ). If my shares aren't called away in January, I'll still have the premiums, plus my shares. Here I am not including the dividend, which is a 1.7% yield at current prices.

I have also written August $45 puts on Mosaic. At 36 days, this is a shorter term than I would usually consider (I like a term from two to six months). I chose this option because a)I would be content to buy MOS at $45 and b) this put offered an unusually good return relative to longer-termed options. I would consider $40 and $45 puts on this stock (currently trading at $48).

Compare the August, September, and December puts, at 33 days (1.1 months), 64 days (2.13 months) and 155 days (5.17 months) respectively.































As you can see in the screen cap, the percentage return per month (premium / share price = percentage return. Percentage / time period (in months) = percentage return per month) is unusually attractive for one option; the August $45 put.

Even though the dollar value for the December $45 puts is the highest, the August $45 puts offer the best value. Since I also would be pleased to purchase this stock at that price, I wrote that put. If I wasn't willing to pay $45 for the stock, I wouldn't consider it no matter how nice the return looked.

FLS: When your chickens come home to roost, remember to collect the eggs. When you get income from puts, and then the shares are put to you at your strike price, consider adding to that income by writing calls. Be sure you would be willing to sell at your call's strike price.

MOS: It's your percentage return, not the dollar amount of the premium, that should draw your attention to the stock. No put has value to me if I'm unwilling to buy at the put's strike price.

For both: Write calls only on stocks you'd be happy to sell at that strike price. Write puts only on stocks you'd be happy to buy at that strike price. I write options as a way to generate income within my overall investment strategy, not as speculation.

LNN price movements

The puts on LNN I wrote that original e-mail about are paying well again. The stock price was $32 and December puts were paying $4.70 at that time. The stock price shot up to $36 when LNN released earnings; the puts no longer paid well. Now that the price has dropped, the puts are moving back to the $4.60--4.70. I, personally, will wait in hopes of LNN moving even lower. I may write puts at $25 at that time.

And now... we wait.

With the whole market downtrending, and having written all the covered calls I find attractive, I'm now waiting until prices are decreasing at a slower rate before making more trades. At that point, I'll begin writing more secured puts with the aim of getting securities at more desirable prices.

I have a bunch of secured puts expiring in August and September; the capital securing those puts will then be ready to redeploy in future months.

Watchlist

Panhandle Oil & Gas (PHX) This is a royalty trust, not a core holding.
Adobe Systems (ADBE)
Dolby Laboratories (DLB)

Writing puts

Today I wrote the following puts:

Medtronics (MDT): 3 contracts at $1.55/share, strike price of $34, expiring in August (51 days)
Precision Castparts (PCP): 1 contract at $3.10/share, strike price of $65, expiring in September (79 days)

Income from MDT: 300 shares * $1.55/share = $465
Return from MDT: ($1.55/$34)*100 = 4.5% over 51 days.

Income from PCP: 100 shares * $3.10/share = $3.10
Return from PCP: ($3.10/$65)*100 = 4.8% over 51 days.

These percentage returns are about what I aim for for shorter term puts (two to three months until expiration).

For longer term puts (four to six months) I aim for at least 7% returns.

Covered calls

I've written covered calls on the following positions:

McKesson MCK: 2 August $45, paying $2.10 per share
Quest Diagnostics: DGX: 2 August $60, paying $0.65 per share
Republic Services: RSG: 5 October $25, paying $1.15 per share
Avery-Dennison: AVY: 4 October $30, paying $0.40 per share
Verizon: VZ: 4 August $31, paying $0.90 per share

Stop-Loss for AAPL

Two (trading) days before Steve Jobs is expected to return from his self-directed medical leave, I've placed my AAPL shares under a stop-loss order at $135. Just in case he decides to ditch the company and go study at the Shaolin Temple or something. Then, I'll buy the shares back more cheaply.

Naturally, I'd like to write puts to buy those lower priced shares, but the premiums offered for puts on this high-profile stock are unattractive.

Batten down the hatches

I anticipate another broad market correction during the next six months. Because of this, I'm currently writing covered calls against several long positions in my portfolio. These calls are written against stocks for which I do not anticipate a significant price increase in the next six months or a year, and which I do not wish to sell because I like their long-term prospects.

I'm choosing calls with expiration dates in August, September, and October.

Writing covered calls will increase my cash position (currently 36% of my portfolio) so I can buy more stock during the downturn. In addition, the premium paid on calls at a given strike price is linked to the current share price. Consider;
Example A: The stock is selling for $34, and the option's strike price is $35,
or,
Example B: The stock is selling for $30, and the option's strike price is $35.

Writing a call is a promise to sell my stock at that strike price on or by the expiration date. I can expect to be paid more for that promise when the share price is only slightly below the strike price.

Since I anticipate share prices will decrease in the short term for each of these stocks, I'm writing the calls now to take advantage of the current, higher share price.

There are other stocks in my portfolio upon which I could profitably write calls, but have chosen not to do so. In each case, there is a special situation with the stock which makes using options undesirable. In one case, the company (AGU) is in the middle of widely publicized take-over negotiations. In another case (UMH) the company is too small to have open options interest. A third (HP; that's Helmerich-Payne, not Hewlett-Packard) is such a valued part of my portfolio that I won't risk it being called away.

Reading List

The Richest Man in Babylon, George S. Clason
The Motley Fool Investment Guide, Tom and David Gardner
The Future for Investors, Jeremy Siegel
John Bogle on Investing: The First 50 Years, John C. Bogle and Paul A. Volcker
One Up on Wall Street, Peter Lynch and John Rothchild
A Mathematician Plays The Stock Market, John Allen Paulos

LNN discussion

The following is from a discussion I had about a new purchase; the other party is new to options. The stock was trading at $31--32 per share; it's currently at $34. The options trade I discuss has not, as of this writing, been accepted by a buyer. Since the stock price has increased, it is no longer as attractive (as valuable) to a buyer to ensure he can sell his stock for $30. This is a small cap stock and thinly traded; I'm keeping my order open in anticipation of LNN decreasing in price. If it continues to climb, I'll let it go; there's no profit in chasing diminishing returns.

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I think it would be a good idea to make some long stock picks before getting into options; without understanding how to buy a stock for long-term investment, it's tempting to use options to speculate, which is a bad idea. Just because an option pays a 10% premium doesn't mean it's a good buy! Anyway, here's information on the option order I put in today. This was a pick from Motley Fool Pro.

I've put in this trade, but it has not yet been accepted by a buyer. The stock is Lindsay Corporation (NYSE: LNN). The stock traded at about $32/ share today. I want this stock to end up as about 4% of my portfolio, which is currently about $225,000. So, 4% of $225,000 = a maximum of $9000 I can use to secure this put.

I would be happy buying this stock for $30 a share, but it wouldn't break my heart if I never owned shares, so I'm selling puts with a strike price of $30 a share. With my target allocation of $9000 in mind, that means I'm selling puts on 300 shares, which equals 3 contracts (each contract is for 100 shares, unless otherwise noted in the options chain. All orders are placed by contract rather than by share. I always double check to make sure I haven't accidently added an extra couple zeros!)

I write options in a time window of three-to-six months expiration time. That means today I'm looking at puts expiring in August, September, and December.

August $30 puts are currently paying $2.25 per share (that is, $225 per contract of 100 shares), September is at $2.95/ share, and
December is $4.70 per share.

That means the August puts will pay 7.5% ($2.25/$30),
September puts pay 9.8%, and
December puts pay 15.7%.

Puts have better payouts for longer expiration times; this is because you're "insuring" the stock for the buyer for a longer period of time. If something happens to the stock between now and, say, December, the buyer has limited his downside (he can sell at $30 a share no matter what) without limiting his upside (if the stock goes to $60, he reaps the benefits).

I've decided to write $30 puts expiring in December (the command is "sell to open"). I check to make sure I have enough cash in my account to secure the put, then click on the December $30 option (ticker +NRRXF ) in the option chain screen, which brings me to the screen for this option; it shows me the last buying and selling price for this option.

In this case, the last sale was at $4.80/ share on Thursday the 25th (today). It isn't unusual for no options to be traded for days on a small stock! The current bid for this option is $4.70/ share. The ask is $5.10/share; at least one person is willing to write this option for $5.10/share.

I place my own order; "sell to open three (3) contracts of +NRRXF, limit at $4.80/ share." That's $480 per contract, for a total return of $1440. Currently, that order is just sitting waiting for someone to accept it--like a stock order that has not yet reached your limit price.If someone accepts the contract, here's what will happen; my account will be immediately credited $1440. $9000 will be frozen, unavailable for withdrawal or stock purchases. However, it will remain in my money market account.

At the options expiration date, there are just two possibilities; either the stock will be selling at or above $30 in the open market, or it won't. If the stock is selling above $30/share, nothing happens; the option expires worthless to the buyer (except for the peace of mind it brought him) and I keep the options premium. If the stock is selling below $30, I still keep the premium, and the $9000 that was securing that put will be used to purchase 300 shares (3 contracts) of the stock. I don't have a choice there; if the stock has dropped to $5, I'm still obliged to buy it at $30.

The options premium can be considered as income, or as subsidizing the purchase of the stock. If the option expires, I'll pay $30 per share, but I was paid (hopefully) $4.80 per share; my net cost per share is $25.20 per share--compare this to purchasing out-right today for $32! The downside is the potential opportunity cost; if LNN jumps to $60 by December, I'll kick myself for not buying at $30. This is what I was talking about when I recommended using options with an investment mindset, rather than for speculation. It's important to know the company you're writing options on, so a significant change in share price won't be a surprise (barring a black swan event).

First post

This blog discusses trades made in my real money portfolio. I am an independent, non-professional investor. My strategy uses long stock positions, covered calls, and secured puts. I do most of my trading within a couple types of tax-sheltered accounts. All option positions are based on fundamental analysis of the underlying stock, not speculation about short-term price movements.