Tuesday, June 26, 2012

WHY I LIKE DITM INVESTING - LET ME COUNT THE WAYS!


The uglier the stock market gets, the more I like the Deep-In-The-Money Covered Call strategy. It has to be the #1 strategy for a FLAT or DOWN market.
Here are some reasons:

* When you buy a stock that pays a 4% dividend and at the same time (Buy/Write) sell a covered call 10% below the buy price, you are in a sense buying it at a discount! For example: Buy XYZ at $50 on July 1 and sell a call option to deliver the shares at $45 in January 2013. The call should be priced around $6 ($5 for the amount that you are losing by selling it lower - Intrinsic Value; plus $1 (Extrinsic Value) for allowing the call Buyer to take the stock at $45 no matter what the price of the stock is in January). XYZ pays a dividend of 4% per year, or $.50 each quarter, with the first ex--dividend date within a day or two of your purchase.
Since you, in essence, paid $45/share or $4500 for the stock, your dividend percentage is 4.44%, not 4%!

 * Much like a CD or Bond, you know pretty much what your return is going to be - with the stock's Appreciation no longer a factor - so it can go up to $55 or down to $46 and your return is the same. With all this tremendous volatility in the markets due to economic conditions and  High Frequency Trading by computers (70% of market Volume), the $45 is a Safety Net allowing you  to sleep at night while other owners worry what the next day will bring, and whether they should Hold or Fold.

* If the stock rises, so does your margin of safety - and the stock may get "called" away early, increasing your % return by compressing the time. The combination of dividends and call "premiums" historically in extensive testing has steadily averaged an "annualized" 10% - fully invested and extended for 12 months at the same ROR -rate of return. You will lose any upside price of XYZ (rare these days), but still earn what has been the historical average: 10% for over 100 years. Probably less, since the last decade has seen zero return, besides dividends.

* If the stock remains the same- $50- ( winds up the same at expiration - January), you can just sell the next call - 6 months hence: July 2013 at $45 strike. Minimal monitoring.

* If XYZ works its way down to $45 by January - better yet! The call option expires worthless (no need for anyone to exercise it and take away your stock at $45 when they can buy it for $45). So you can "step down" selling the next call option at $40, making the same dividend - $2.00-  now earn 5% instead of the previous 4.44% or 4%. Additionally, when a stock drops the options "Volatility/Price" rises - witness the VIX in a down market.



* If the stock actually goes below $45 and stays there in January, you can write/sell the same covered call in the normal covered call fashion - above the stock price- again, at the $45 level, and wait for the stock to rebound - which it usually does. You are less likely to get "shaken" out just as the stock bottoms out.

* If the XYZ and/or the market goes into a BEAR phase - historically 1 or 2 times per decade since 1900- it is possible to lose some money, but much less than someone just holding stocks or an Index fund. Having the Safety Net gives one time of warning to hedge any or all positions - by using inverse ETFs, put spreads, etc.

* Laddering. Just like Bond portfolios, it is advisable to spread out ex-dividend dates, pay dates, and option expiry dates. It not only spreads the Risk by closing out mature positions cheaply, but provides a steady income each week/month from quarterly dividends and call-selling.

* Finally, with experience your returns should even get better. If you find  a stock that you like - dividend over 3%; calls with "juicy" extrinsic premium, and a stable trading range along with good fundamentals and market/sector outlook - but the ex-dividend is still weeks away- you can sell a put or put spread to take on the stock. This not only provides good income, but alerts you to the upcoming ex-dividend date. One idea that did not work out as well was to DITM stocks that only pay Annual dividends! If the stock drops, you cannot wait for the next (quarterly) dividend to bail you out ( next year?), plus most are foreign stocks that may have their own taxing authority.

Thursday, June 21, 2012

2011 UPDATE:

As we near the end of the first 6 months of 2012 it is time to report the results of DITM trades  that were opened in 2011 and closed out in 2012. That amounts to 18 trades; total earnings were $6626 and the 2 losses were $1035. Average holding time: 5 months.
Annualized % of wins only: 11.6%
Annualized % of wins less losses ( arbitrary number since you don't keep annualizing/reinvesting losses):9.3%.
Just about where every other measurement of DITM has been for over 3 years.
I was going to also present trades opened and closed in 2012, but of the 24 existing positions only 2 have been closed out YTD. This includes one win - TLT- and the Big Loss of CLF, which was finally closed out at the low trade of the year ($44.50)- it is now $51. The 24 current trades are close to ATM (at-the-money).
At expiry, positions above the pre-sold strike will be called away or rolled out, if profitable.
Positions ATM can be rolled DOWN 5-10%, resulting in 100% profitability, and higher dividend % due to lower cost basis (sans loss of principal).
Positions just under strike will probably have the same strike call sold ABOVE the stock price, a la normal covered call strategy - hoping to get called away 4-5 months hence.

Tuesday, June 12, 2012

DOWN IN THE VALE:

Except for very special circumstances it probably is wise to abandon the capture of Annual Dividends with a DITM covered call. Paradoxically what rewards one for getting the whole year's dividend up front, penalizes them if the stock declines (in a bad market or bad sector- or both). So with VALE, with the call expiring this week, since I only get charged for 1 commission on a rollout, I rolled out and down to Sept. 20 from the June 22. Not counting the minor loss, the rollout nets about 18% annualized. If VALE rises to 20 I can consider letting it get called away, or rolling UP.
 I was certain that if I bailed out of CLF it would V-Spike up without me, but I was wrong even here. I intend to watch it until late July when it goes ex-D again. I am not one to be afraid to put my hand on a cold stove after burning it!
Lots of stocks going ex-D the 13th and beyond: HUN, TOT, caveat emptor!

Monday, June 4, 2012

OVER THE CLIFF!!:

As I explained in my weekly Sentiment blog today, this sorry market has more time than I have Retirement money, so I am exiting all positions in Cliff Resources, although Mike Santoli in Barron's recommended it, as did other sites (several major brokerages now downgrade it after a decline from $101 to 45!.DOH!
This was a true, but unsuccessful, test of DITM - although I'm sure it will rally at some point before Oct. From my entry point of $70/share (200), to $45, had I only bought the stock I would have lost $5,000. As it was, with Call premium, dividends (today), puts and put spread hedging (on vacation), the loss was only half that.
  

Saturday, June 2, 2012

DITM TOP 20



DITM
TRADES
ANNUALIZED















DATE

#
BUY
STOCK
DIV'D
CALL
TOTAL
ANN.NET


SYM
SHS
PRICE
AMOUNT
AMNT
SOLD
RETURN
RETURN

2/23/2011
LO
200
79.71
15951
260
1686
614
46%

11/11/2009
NLY
300
17.8
5349
*0
241
133
45%

10/13/2009
NM
1000
1000
5009
60
802
844
40%
**
6/23/2009
BP
200
47.24
9457
168
1015
717
32%

3/3/2011
BTI
100
80.6
8069
266
214
217
32%

5/8/2009
HCN
100
34.09
3418
*0
700
273
32%

8/17/2009
BKS
300
20.05
6024
75
1090
434
29%

9/10/2009
SLX
100
50.21
5030
*0
593
354
28%

5/24/2010
CTL
200
33.57
6723
145
182
595
27%

12/27/2011
DOW
200
28.97
5803
50
888
326
22%

5/7/2009
GDX
200
36.7
7349
22
1468
1630
21%
**
3/23/2011
T
200
28.1
5629
*0
338
100
21%

7/14/2010
PFE
400
14.92
5977
*0
881
95
19%

1/11/2011
SI
100
118.72
11881
270*
1035
193
19%
***
10/18/2010
HCN
200
49.76avg
9961
276
400
706
17%

12/16/2011
NUE
200
40
8009
73
870
473
17%
****
12/2/2011
LO
100
110.45
11054
130
1464
1031
16%
 **
11/1/2011
INTC
300
24.18
7263
63
895
286
16%

9/16/2011
PM
200
70
14009
154
448
804
14%

11/28/2011
TAL
200
25.77
5163
104
798
230
13%











*******************************************************************************************************************
*0: STOCK CALLED BEFORE DIVIDEND; CALL PREMIUM FORFEITED


**: CALL ROLLED OUT ANOTHER CYCLE





***: ANNUAL DIVIDEND







****: INCLUDES SOLD PUT