Several of our Premium Members have requested we provide sample portfolios based on the CURRENT Premium Watch List as a guide to assist in mastering the strategy of covered call writing. In today’s article I will use the watch list dated 3-8-13 (stats taken on Wednesday, 3-13-13). The stocks we select in general are based on several factors:
- Our personal risk tolerance
- Cash available for share purchase (GOOG may not be appropriate based on the amount of cash available)
- Our market assessment (We may favor high beta stocks and high implied volatility options in bullish market conditions)
- Nature of the other stocks already in our portfolio (proper diversification must be accounted for)
- Other factors we deem important (industry rank, dividend yield)
Therefore, whenever we provide a sample list of this nature, we will first describe the parameters this portfolio is based on. Remember, this is NOT a list of recommended stocks but rather a sample portfolio meant for educational purposes. Future sample portfolios will be based on different parameters so ultimately we will focus on a portfolio that applies to each of our members. In the future, these portfolios will be published and archived in the “resources/downloads” section of our premium site.
In this first edition we will make the following assumptions:
- $50 thousand cash available
- Conservative investor
- Market assessment is slightly bearish
- Personal risk tolerance is low
- This is a new portfolio with no other stocks available for covered call writing
- This investor favors bold stocks on the premium” running list” (although ALL stocks are eligible on the “running list” with the exception of the “gold” rows which indicate an earnings report announcement prior to the current expiration Friday)
First we eliminate stocks that show earnings reports due during the April contracts (WOR through KSU on our watch list). Next we check the options chains for the stocks in bold and eliminate those with insufficient option liquidity. Here is the BCI guideline:
We require an open interest (OI) of 100 contracts or more and/or a bid-ask spread of $0.30 or less. Thus far the process has taken about 10 minutes and resulted in an initial list as follows (stock and industry):
The reason we include the name and rank of the stock’s industry in our premium reports is to ensure appropriate industry diversification, one of BCI’s common sense principles. For example, in a portfolio of 5 equities will NOT select BOTH LL and GMCR since both reside in the “retail” industry segment.
Next we access the option chain information and since we are conservative investors with a bearish outlook and low-risk tolerance, we look for in-the-money strikes with solid returns and protection. We feed this information into the “multiple tab” of the Ellman Calculator:
Of the 4 stocks in duplicate industries, I eliminated LL and EMN because they offered lower downside protection of the option profit than their counterparts in the same industry. Of the 6 remaining securities TRIP and OPEN had the lowest downside protections but GMCR had a better ROO (return on option) so I went with GMCR. The final 5 are highlighted in yellow.
Next, in keeping with our BCI principle of appropriate cash allocation we compute the number of shares to purchase:
This results in a cost of $50,172 + commissions, over our budget. So let’s eliminate 100 shares of HTZ resulting in a cost basis of $48,073. This will leave us $1927 (minus commissions) for exit strategy execution.
Here are the final stats for the initial returns on our sample portfolio:
As you can see, we generate an excellent 1-month, initial return with outstanding downside protection of that profit. As always, we have our exit strategies in place in case needed.
I want to thank Sunil and other premium members who suggested the concept of sample portfolios as a learning tool for our Premium Members. I will periodically publish additional such portfolios in our premium site in the “resources/downloads” section. Scroll down to “Sample Portfolios” In the future I will alternate parameters and portfolio size so we will ultimately feature the parameters that coincide with the specific needs of ALL of our members.
My Next Speaking Engagement:
March 21, 2013 6:00 pm – 9:00 pm
This week the market showed a slight rise despite increasing gasoline prices:
- Retail sales in February rose by 1.1% much better than the 0.5% anticipated and up 4.6% year-to-year
- February’s Consumer Price Index (A widely followed indicator of inflation. The CPI is a measure of the average
change over time in the prices paid by urban consumers for a fixed market basket of consumer goods and services. The “core” CPI excludes food and energy prices, which account for roughly one-quarter of the broad CPI and tend to fluctuate widely, providing a truer reflection of inflationary trends) was up 0.7%, the highest since June, 2009.
- Excluding volatile food and energy CPI was up a modest 0.2%
- Fed officials indicated that near zero interest rates would hold until unemployment drops to 6.5% as long as inflation isn’t projected to rise above 2.5%
- The University of Michigan’s consumer confidence index fell to 71.8 in March, a 15-month low, a product of higher payroll taxes and worries over the sequestration
- Business Inventories (A report of the dollar value of product inventories held by manufacturers, wholesalers, and retailers. Included in the report is the inventories/sales ratio, a gauge of the number of months it would take to deplete existing inventories at the current rate of sales, which is an important indicator of the near-term direction of production activity. The report’s formal name is Manufacturing and Trade Inventories and Sales) rose by 1.0% in January and up 5.6% from one year ago
- Industrial production rose by 0.7% in February well above the 0.4% expected
- Construction output was up 1.5% in February, rising for the 4th straight month
- Initial jobless claims for the week ending March 9th came in at 332,000 below the 350,000 anticipated
For the week, the S&P 500 rose by 0.2% for a year-to-date return of 10%, including dividends.
IBD: Confirmed uptrend
BCI: This site remains bullish but favoring in-the-money strikes 3-2 until the sequester issue is put behind us.
My best to all,
Alan ([email protected])