Position Repair: CRUS

After I wrote my to-do list in the November monthly report, I quickly set out to do a position repair on the CRUS holding in the Rescue My IRA account.  As it was, I had adjusted the strike price down from $20 to $18.50, and if I had let the stock get called away I would record a loss on the shares totaling $600.  I decided to roll back up to $20, combined with a roll-out, as a way to mitigate this risk.

The position doesn’t meet all the rules of my trading plan, and as a matter of fact, I set it up as an exception.  For example, I typically look for shares that have a 4-star or better S&P rating, but CRUS was a 3-star stock when I bought it, and I also look for a dividend yield of between 3 and 5% per year, but CRUS doesn’t pay dividends.  Then I rolled down to $18.50 because I wanted to divest the shares after they were no longer rated by S&P. 

I’ve come around to not writing the position off after all – the volatility of this stock means there are plenty of covered call premiums available, enough to meet the yield expectations I have for shares in this account – 12% annualized.  So on Monday I rolled the shares out from December to March, and up from $18.50 to $20.00.

Here’s the current position plan for CRUS, net of fees and commissions.

CRUS

This is a 400-share position established in February 2014 with a basis of $8,038.00, or $20.10 per share.  The current covered call is $20 Mar 2015, I have been selling covered calls with strike prices ranging from $18.50 to $22.00.

Total covered call premiums:  $1,576.28

Total dividend payments (no dividend on CRUS):  $0.00

Total stock loss at $20:  -$56.00

Total, absolute gain on the position:  $1,520.28

Total, absolute return percentage ($1,520.28/$8,038.00):  18.91%

Annualized total return percentage (approx 375 days if held to expiration):  18.41%

Selection Criteria, and New Positions (TGT and TRV)

The August contract date has come and gone, but I did not have any open covered calls on Friday, since I had unwound a couple of my August positions or rolled them out until September.  It looks like I was lucky on my timing, since the markets took a scare about upcoming Fed action and had a couple of down days in a row.

Meanwhile, I have two new positions to report today, bought with the proceeds of the unwinding I did earlier in the month:  TGT and TRV.  Before I provide the analysis – my position plan for these two, if you will – let me recap my selection criteria.  I’m hoping that these criteria will serve me well in the consolidating market I expect for the next few weeks!

I choose my stocks based on the following:

• S&P 500 Index standing (starts with 500 high-quality companies).
• S&P rated four or five star stocks (narrows down to about 200 companies).
• I look at annual dividend yield next, seeking from between 2 and 5 percent.  This criterion also provides me with a little up-side opportunity and down-side protection in the shares, and adds a cash flow factor to the account.
• Next, I will try to have a price criterion, depending on the funds available in my account.  If I can set up a multiple lot position, I like that, and I also want to keep the bulk of the positions at less than 10% of the account value – but also to be sure that I have between 12 and 16 positions going at any one time for diversification.
• By this time, I am down to ten or fewer symbols, which I balance against other companies already in the portfolio, and screen for earnings announcements coming up (avoiding those), and ex-dividend dates in the upcoming quarter.  These generally break any ties when choosing positions (for example, if I were considering an investment choice between MRK and PFE).

So that’s how I arrived at TGT and TRV.  Here’s the analysis, or position plan, if you will – all values are net of commissions and fee: 

TGT

Transactions

8/13/2013 Bought 100 shares at average share price $70.80 (total $7,079.99)
8/13/2013 Sold 1 TGT Sep 2013 $72.50 for a net of $61.24 (I usually try for $100 net, but I wanted to stay in the next calendar month)

Net Profit:

1) Options Income:  = $61.24
2) Dividend Income: Ex-date is Aug 19, dividend is $0.43 ($43.00)
3) Capital Appreciation if assigned at $72.50:  $152.90

Total Net Profit if Assigned and dividend collected:  $257.64
Absolute Return on Investment: ($257.64/$7,079.99) = 3.64%
Annualized Return if Assigned (30 days):  3.64%*(365/30) = 44.27%

TRV

Transactions

8/9/2013 Bought 100 shares at average share price $82.11 (total $8,210.99)
8/9/2013 Sold 1 TRV Sep 2013 $82.50 for a net of $135.74

Net Profit:

1) Options Income:  = $135.74
2) Dividend Income: Ex-date is Sep 6, dividend is $0.50 ($50.00)
3) Capital Appreciation if assigned at $82.50:  $21.90

Total Net Profit if Assigned and dividend collected:  $207.64
Absolute Return on Investment: ($207.64/$8,210.99) = 2.53%
Annualized Return if Assigned (35 days):  2.53%*(365/35) = 26.37%

New Position: JPM

Frequent readers of Rescue My IRA know that I don’t like to have funds sit idle for very long once positions are assigned and there is a cash balance in the account that is much more than a standard 5% reserve.  Once the remainder of the URS position was called away last week, there was about $15,000 to deal with, so I went to work to develop a new trade.

Once again, I used a stock screen from Scottrade to get a few candidate opportunities out on the table.  I use my trading plan for this purpose:  I like S&P 500 shares because they are readily liquid; I choose only S&P four or five star rated stocks – this reduces my universe for selecting shares to less than 100; I look for dividend yields between 2 and 6 percent annually, paid quarterly – this generally eliminates some utility limited partnerships, REITs, and some financial stocks that have higher yields; and I will look for ex-dividend dates in the upcoming quarter.  From the initial list, I further refine the choice by comparing what’s identified here with what I already have in my portfolio, to make sure that I am not concentrating too much capital in a given industry and to eliminate any holding that are already in the account.

This generally will leave me with two or three choices.  From there I have a simple proforma template that I use to estimate the returns of a given trade – I seek a 12% annualized return based on an initial holding period of three months or so.  This time the screen led me to select JPM for my next investment, and I bought 300 shares at $49.07 – the basis of this new position is $14,722.00.

That is the second largest holding I have placed since I started the Rescue My IRA account.  Interestingly enough, the largest position was URS, the position I am replacing.  That’s just a matter of coincidence, I guess, for now.  The positions will begin to get larger over time as the account continues to grow, and I maintain my diversification goal of 12-16 positions.

Here are the details of the new position:

JPM

Bought 300 shares at a total of $14,722.00, share price basis $49.07

Estimated net profit:

1) Sold to open April 50 2013 covered call (x3):  $187.24
2) Dividend Income: $90.00 (April 3 ex-date, so there is the potential of an early call)
3) Capital Appreciation if assigned at $50.00:  $260.89

Total Net Profit if assigned and dividend collected:  $187.24 + $90.00 + $260.89 = $538.13
Absolute Return on Investment: ($538.13/$14,722.00) = 3.66%
Annualized Return if Assigned (25 days):  3.66%*(365/25) = 53.37%

Called Early for the Hat Trick on URS

Earlier this month I wrote about how 200 shares of my URS position had been called away on the ex-dividend date, March 13: I had held a position of 400 shares, and the stock was in the money by more than $5 – and it had remained there ever since.  For the second time during the course of the Rescue My IRA account I had a partial assignment, but that was rectified on Wednesday this week when the remaining 200 shares were called away.  So today’s post will be the close out entry for the URS position, which I held for about 300 days. 

I had purchased the URS shares as a replacement for my legacy holding, ACM.  I had worked at that company and one of the benefits was the ability to purchase shares within your 401(K) – after I was laid off there in 2011 and rolled the account over to Rescue My IRA, I still held 800 shares, which I wrote covered calls against.  For the record, ACM does not meet my stock purchase criteria and I wouldn’t have bought the shares in the first place if it hadn’t been for the extenuating “legacy” circumstance.  Eventually I decided to exit the position, taking the largest loss I ever have had in this account, around $5,000 – or about 25% of the position value.

Still desiring to hold a position in a major construction company, I chose URS, which did meet my selection criteria at the time, and I rolled the ACM proceeds over to a 400 share position.  As the analysis below shows, over the course of the 10 months or so that I held URS, I gained back $1,900 of that loss when the URS shares were called.  

In the end, because I was able to collect a gain on the share price, dividends, and covered call premiums, URS is another hat trick position.  I call that a win for the Rescue My IRA trading plan and a lesson well learned.

Here’s the analysis of the URS position.

URS

Shares:

5/7/2012 Bought 400 shares at $39.55, total position basis $15,827.00 (the largest position to date in this account)

3/2013 Sold on assignment 400 shares at a strike price of $40.00 in two transactions of 200 shares each

Total stock gain:  $138.64

Options:

Total options income (a total of seven contracts):  $1,477.91

Dividend:

Total dividends collected:  $280.00, including dividends on 200 shares from the March 2013 ex-dividend date

Net Profit:
1) Stock gains:  $138.64

2) Options income:  $1,477.91

3) Dividend Income: $280.00

Total Net Profit after Assignment:  $1,896.55
Absolute Return on Investment: ($1,896.55/$15,827.00) = 11.98%
Annualized Return (300 days):  11.98%*(365/300) = 14.58%

New Positions: VIAB and IP

As the July expiration date approached and it began to look like my MAS and NOC positions would be called away, I began a scan for potential new positions that would meet the standards I’ve outlined in my trading plan.  I found six potential trades:  VIAB, WOR, T, CMCSA, CSCO, and SMP. 

After pulling some basic information on these stocks, I found that I was looking at a bunch of three and four star investments.  I then screened further for positions that included a dividend ex-date before an option with an appropriate strike price, either in August or September.  My list was narrowed to VIAB and WOR – and I planned to make a purchase on Monday…although, eventually I took a look at an old favorite, IP, as well.

When Monday came around, WOR had worked itself out of the price range I had set for it, and I was left with the choice of how much to invest in VIAB and IP, finally choosing to buy one lot of VIAB and two of IP.  I have enough cash in reserve for one additional lot of either of these stocks, and am considering a follow-on purchase in due time.

Here’s the analysis on the new VIAB and IP positions: 

VIAB

Transactions

7/23/2012 Bought 100 shares at $4,579.00
7/23/2012 Sold To Open 1 VIAB Sep 2012 $47.00 at $101.74

9/13/2012 ex-dividend date for VIAB, if not called away $27.50

Net Profit:

1) Options Income:  = $101.74
2) Dividend Income: The ex-date is before September expiration, potential dividend is $0.275 ($27.50)
3) Capital Appreciation if assigned at $47.00:  $103.89

Total Net Profit if Assigned and dividend collected:  $101.74+ $27.50 + $103.89= $233.13
Absolute Return on Investment: ($233.13/$4,579.00) = 5.09%
Annualized Return if Assigned (60 days):  5.09%*(365/60) = 30.97%
On the purchase date, VIAB was out of the money.   

IP – 8/12 Position

Since this is my second IP position, I am designating it with the initial options expiration date for the trade.

7/23/2012 Bought 200 shares at average share price $32.30 (total $6,459.00)
7/23/2012 Sold 2 IP Aug 2012 33, total $98.49

8/13/2012 IP ex-dividend date, if not called away $52.50

Net Profit:

1) Options Income:  = $98.49
2) Dividend Income: Ex-date is 8/13, $52.50
3) Capital Appreciation if assigned at $33:  $123.89

Total Net Profit if Assigned and dividend collected:  $98.49 + $52.50 + $123.89 = $274.88
Absolute Return on Investment: ($274.88/$6,459) = 4.26%

Annualized Return if Assigned (30 days):  4.26%*(365/30) = 51.78%
On the purchase date, IP was out of the money.   

Closing out COP

Earlier in the month I realized that the 100 share position in COP no longer fit in with my trading plan.  The company has been working on a strategy to spin off a portion of its assets and their action finally came to be with the issuance of 50 shares in PSX.  This was done as a dividend of 50 shares for every 100 share lot in the parent stock.  The problem was that my option contract on COP was now adjusted to be for 100 shares in COP and 50 in PSX. 

PSX is not currently a dividend payer and is unrated by S&P - two strikes against holding it in the Rescue My IRA account.  My normal strategy would have been to immediately divest the shares, but the option contract on COP was now adjusted to be for 100 shares in COP and 50 in PSX.  A second impact was the adjustment of the COP shares to reflect the spin-off. 

I’d held this lot of COP since November, and would have been content to maintain them for a while longer if they still met the requirements of the trading plan.  Instead, I divested the whole package at a slight loss.

Here’s the analysis:

COP

Original November 2011 investment: 100 shares, $6988, average share price $69.88

Option Premiums (total – 8 contracts):  -$62.31

Dividends Collected (includes 50 shares of PSX):  $1,558.96

Stock Loss (sale price of $53.13 per share, adjusted by value of PSX dividend):  -$1,683.80

Total:  -$187.15

Absolute return -2.68%

Annualized return (210 days) -4.65%

Lesson Learned:  I had a good ride with COP, especially considering the early call I had on the previous COP position last October.  I probably could have gotten the position into a break-even status by waiting another month, but I feel like I took the correct action on this position to comply with my trading plan.  There is the problem with the net negative income off of the option premiums – this is the result of chasing the strike price up the ladder – although breakeven on the shares was at 70, I held contracts for 72.50, 75, and 77.50 during the course of this position.  I think I’ve summarized the impact of closing current contracts to chase a higher strike in a past post, and that is where the small loss came from – I’ve already fine-tuned my behavior in this regard to ensure I am always getting a net credit – a positive result – on contract trades.  

Biting the Bullet on Legacy Holding ACM

At last, I decided to end the roller coaster ride I was on with my legacy ACM position.  This is the stock of a company I used to work for, and my view as an employee had been that the company was slow to react to changing market conditions – certainly worse at it than competitors JEC and URS are, and I had also been an employee at JEC before (and done very well with the stock through the employee stock purchase plan, I might add!).

So when earnings came out last week and the stock took a haircut, back to test the lows that we had seen with the shares last year just after I was put on furlough, I decided it really was time to see if there was a better use of the money.  After all, this is a legacy position that was not established under the Rescue My IRA trading plan – it wouldn’t make the cut to begin with as a non-dividend stock, and since it is a company I am not in love with, well, it was time for ACM to hit the road, Jack.

My basis in the shares was around $25, and I don’t see getting back to that this year and maybe not next.  So I cut my losses this week and sold at $18.50.  That capital gain hit is going to set the account back a few months, but I immediately established a position in URS, which I will post about tomorrow, and the recovery has already begun.

Here’s the position analysis:

ACM

Shares:

November 2012:  Transferred 880 shares in from my 401(k) during the rollover.  I sold 80 shares immediately so I would have 8 round lots.  My basis was about $25.00 per share.

5/8/2012 Sold 800 shares at $14,784.66, average share price $18.49

Total stock LOSS:  -$5,233.34

Options:

Over the course of this holding, I have had covered calls with March, June and September expirations at strike prices between 22.50 and 25.00; total options income:  $204.91

Dividend:

ACM is not a dividend payer.  It is a legacy holding that was not selected based on the trading plan, and has always been a candidate for divestment because of this.

Net Profit:
1) Stock loss:  -$5,233.34

2) Options income:  $201.91

3) Dividend Income: $0

Total Net loss upon divestment:  -$5,233.34 + $201.91 + $0.00 = -$5,028.43
Estimated Absolute Return on Investment: -25.14%
Annualized Return:  Not calculated

All I can say here is good riddance.  I have my work cut out for me to recover this loss over the course of the rest of the year.

And we'll call it a lesson learned - the trading plan for this account is working; the investments I make here need to follow that trading plan!

Trading Plan - Initial

With a little more experience with the covered call strategy, and after completing the November status report, I decided I was finally ready to prepare a trading plan that will guide investing activities in the Rescue My IRA portfolio.

I used a template developed by one of my colleagues in the Covered Call Community - the basic framework is available from the Yahoo Board "Just Covered Calls."  I see it as a living document - I'm sure my approach will evolve and become more thorough with experience.  But here it is in its entirety, first edition.

“Rescue my IRA” Trading Plan

Objective and Background

The objective of this trading plan is to grow the amount I will have available for retirement.  The trading plan only deals with my IRA at Scottrade; I continue to participate in my employer’s 401(K) in addition to these investment activities.

A few years ago, I consolidated my IRAs – four accounts – into one with a large brokerage house.  I counted on the broker there to help me grow my resources, and since he had a good strategy, I felt confident we could reach a simple, not very specific, goal of “having enough.” 

After a few years and bad economic times, it became clear that my broker’s strategy wasn’t going to achieve my goal.  When I consolidated the accounts their nominal value was about $77K.  After a few years, I had seen values as low as $44K.  My conclusion, simply, was that I could do better than this; I then rolled the account, now valued at just more than $51K, over to Scottrade.

I worked with a buy-and-hold strategy in the past, which probably won’t work in today’s markets.  I found additional information about using covered calls to improve investment yields – and this is the strategy I have chosen. 

My big-ass goal for this money is to generate 12% growth per year in the account, while continuing to save between 10 and 15% of my annual income in a company 401(K).  If I am successful, the value of this account could reach nearly $xxx by the time I am aged xx.

Strategy

As I noted above, I have chosen a covered call strategy as my primary method of achieving this goal.  I will identify, qualify, and buy stock in quality companies that pay a dividend.  I will then seek to trade in covered call contracts written against these shares as a way to build an income stream that supplements the dividends and capital gains that will be earned by the shares. 

The main risks I face with this strategy are simple:

·         Operational risk of making mistakes in stock choices

·         Process risk, consisting of the typical down side arising from holding stocks

Covered calls provide some downside protection in the amount of the premium received for the contract, so the process risk is partially managed.  I describe the stock picking method below; it is meant to manage the operational risk.

Capital

 

• The Rescue My IRA account is established at Scottrade, Alexandria, VA
• Account Type: IRA
• Capital Available: Initial investment was approximately $51K

Instruments

The focus of this account will be to invest in stocks and option contracts.  From time to time, the account may use alternative instruments, including ETFs, CDs, and mutual funds, but as the account is getting started, these will not be primary.

Timeframe

The overall timeframe of this plan is from November 2011 through December 2023, when I will be aged xx.  For now, let’s consider that a typical retirement age, and therefore a reasonable goal and investment horizon.

Position Sizing

My current plan is to hold no more than 15 positions in this account, with the optimal number being around 12.  After 20% of the value of the account is held in cash reserves, 80% will be invested in stock holdings, which the covered call contracts will be written against.  This means that on average, a holding will represent between 5% and 5.5% of the total account value, if 15 positions are established; or between 6.5% and 7.0% if I am working with 12 positions.

Trade Entry Strategy

Stock picking will be key to success in the Rescue My IRA account.  I will select stocks from US markets that include the following key elements:

·         Nationally known brand and industry leadership

·         Established record of dividend payments ranging from 2-5% annually

·         An S&P STARS rating of 4 or 5 and a Morningstar rating of 4 or 5

·         At the time of purchase, the shares should be trading within the middle 40% of their 52-week range

·         No shares will be purchased that have an anticipated earnings announcement in the next month

From time to time these qualifying details may be revised.

I will make purchases using limit orders that set a price within the middle of the 52-week trading range for each position.  The initial covered call transaction should generate at least $100 in cash flow, and the total trade to establish a position must generate a 12% annualized return on the purchase price of the shares.  The return consists of option premiums, capital gains, and dividends.

Trade Exit Strategy

When the time comes to close a position, I will simply place a limit order for the sale, assuming the stock has not been assigned based on the covered call written against it.  No positions will be closed until all associated options have been closed.

Since I am okay with a buy and hold strategy in this account, and with the covered calls and dividends most positions will continue to generate an income stream even while prices are moving down, I will not exit a position merely because the price is declining.  Exits for beaten-down stocks will be based on their not meeting the trade entry requirements listed above.

On the other hand, if a position is rising, the odds increase that a covered call written against it will be assigned, so that will be one way to close a position with a gain.

I will also evaluate a stock approaching its 52-week high to determine whether to continue holding it or whether to sell and reinvest the proceeds.

 

Position Management Strategy

The trading cycle for shares in this account will be driven by the options calendar.  Optimally, positions will be evaluated as the options expiration date approaches, and the decision will be based on whether it is feasible and profitable to roll-up, down or out the option contract; to let the contact expire unexercised; or to take profits when the contract is exercised.

Assuming the stock continues to meet the criteria above:

• If the price is stable, a new contract will be written for the same strike in a future month.
• If the price is slightly lower, a new contract at the same strike in a future month will be sold.
• If the price is significantly lower, the new contract may be based on either a lower strike price or a further out month.
• If the price is slightly higher, the new contract will be at the same or next strike price in a future month.
• If the price is significantly higher, it may be time to take profits or to continue to roll the contracts.

Tax Strategy

This is an IRA and therefore tax deferred.  A tax strategy is not necessary.