Wash Sale: LXK for DDD

They have that saying about trying to put lipstick on a pig – it really hits home these days, after the market correction we’ve experienced during August and September.  I had resolved that we would stick with the covered call strategy in Rescue My IRA and manage the holdings with roll-outs, roll-ups, and roll-downs – with a deliberate effort to not take losses on the positions until things settled down.

This approach was in synch with the overall market.  At one point during the correction more than 20 of the Dow 30 stocks showed a negative return for the year, which I interpreted to mean that everybody was feeling the pain.  That further reassured me that I should hang tight.

Fast forward a few weeks, and now in mid-October better than half of the correction has been recovered.  The list of Dow 30 stocks down for the year was back in the low teens, where it was before the correction.  I took the recovery as an opportunity to do some weeding Rescue My IRA, focused on my DDD position, established with a 500 share purchase in July 2015.

This position tanked, and while I had managed to offset some of the depreciation with roll-outs and roll-downs (the initial strikes were at $22 and the final ones were at $17), but the stock continued to fall to $13, and it didn’t seem to have good prospects to get back to the strike price over the next 12 months, so I sought out a wash sale opportunity.  I decided to unwind DDD and move the proceeds into a new LXK position.

Before I mention the results of the DDD trade, I want to make a note about the portfolio approach I use in Rescue My IRA.  I try to maintain from 12 to 16 holdings in the account, along with a cash reserve that varies in size.  This diversification allows for risk management – I expect a loss or two every year, balanced by 2 or 3 really good gains, with an overall goal of an average return ranging from 10% to 12% per year.

So the DDD position counts as the big loss of the year – I took a hit of around 30% on the original investment, net of commissions, fees, and covered call premiums.  I immediately rolled those proceeds to LXK, as I mentioned above, with a position that is summarized below – forcasting a 30-day gain of around 5%, which will begin to earn back the DDD loss.

Here is the position plan for LXK, net of fees and commissions; this position was established as a wash sale for the poorly performing DDD contract.

LXK

This is a 200-share position established in October, with a basis of $6,285.00, or $31.43 per share.  The current covered call is $32 Nov 2015; the position is a wash sale on a DDD trade that went south.   

Total covered call premiums:  $240.50

Total dividend payments (no dividends):  $0.00

Total stock gain at $32:  $97.00

Total, absolute gain on the position:  $337.50

Total, absolute return percentage ($337.50/$6,285.00):  5.37%

Annualized total return percentage (approx 40 days if held to expiration):  49.00%

New Position: DIS

In July I had begun to consider whether I should up the cash reserves in Rescue My IRA to around 30% of the account value.  An adjustment of this sort seemed justified since we are in the last year of the current administration; the market’s track record suggests that if you’ve had a good run as we have these last few years the seventh or eighth year of a presidency isn’t going to go as well.  I figured I had until October to act on this decision, but that’s not how I worked out – at the present I have about 15% in reserves.

One reason the strategy wasn’t fully implemented was my decision to add a position with 100 shares of DIS – which I started in August 2015 with a $110 October covered call.  Since until this year DIS was an annual dividend paying stock, I have often gone to the stock for an end-of-year play on a potential dividend run, targeting December contracts.  While I started with the October contract I have now rolled out the position to December.

Despite the correction that subsequently happened through August and September, the DIS position is holding its own.  Assuming the shares are assigned before the ex-dividend date (the stock now pays dividends twice a year, July 1 and January 1), the absolute yield will be about 5%, which equates to an annualized yield of 15%, based on a four-month holding period.    

Since I did not post on the new trade when it was initiated, here is a recap of the position plan, net of commissions and fees.  My next post will be an example of a trade that did not do as well. 

DIS

Transactions

Bought 100 shares at average share price $108.72 (total $10,872.00)
Sold 1 $110 Oct 2015 covered call, subsequently rolled out to Dec 2015

Net Profit:

1) Options Income:  = $440.25
2) Dividend Income (Jan ex-dividend is after the contract period): $0.00
3) Capital Appreciation if assigned at $110.00:  $110.00

Total Net Profit if assigned on the contract expiration date:  $550.25
Absolute Return on Investment: ($550.25/$10,872.00) = 5.06%
Annualized Return if Assigned and Dividend Collected (120 days): 5.06%*(365/120) = 15.39%

The Hiatus and The Correction

I’ve been away from the blog since the beginning of August…over these last two months I’ve been watching the market as carefully as ever, and I have been working on Rescue My IRA.  I simply haven’t posted due to a couple of distractions, such as the hops harvest at my farm (link here), and the ribbon cutting on the building we just delivered at my day job.  I’ll try to catch up with a couple of posts this week and then make a goal of staying up-to-date after that.

The big news in the market, of course, is the correction that began in August.  Although there have been minor downward swings since I opened this account in 2011, this was the first to really test the covered call strategy I use here in Rescue My IRA.  More volatility is forecast, but now that the markets have recovered about half of the correction, it’s a good time to assess the situation.

I read the Washington Post every weekday morning.  While their business section isn’t much, there is a little table of Dow 30 performance.  At the depths of the correction during the last week of September, fully 24 of the 30 stocks showed a negative return from the year – I figured that meant everyone, even the big guys, were showing losses…all the more reason to keep the faith.

My resolution was not to sell my shares at a loss during the correction.  I determined that continuing to hold the companies I had chosen and staying true with the covered call strategy was the best path forward.  I bought and resold options throughout this period – “buy low, sell high” – using roll-downs and roll-outs as the way to keep the account updated.

I had hoped to increase my cash reserves to around 30% by October, but the correction got in the way.  Instead, cash is around 15% of the account – I’ll continue to work on getting this number to my 30% benchmark, since a presidential election year can be highly variable and I think I could use the correction.

Yesterday, when I checked the Dow 30, the number of stocks showing a negative return had improved to 18 or so, and it is likely that after the good day Friday, a couple more are back in positive territory. 

That’s the story with Rescue My IRA as well – at the end of September, we were showing a hit of around 10%.  After the strong week we had, the account is back to its starting value for 2015 – right at breakeven.  Once again I have covered calls written against every position, and it looks like I will make my cash flow goals for October.

I follow this post with a summary of some of the roll-outs and roll-downs I executed over the last two months.  Let’s get caught up!