Monday, June 29, 2009

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

Sunday, June 28, 2009

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,
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

Saturday, June 27, 2009

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.


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.