Last week I wrote Part I of an article on portfolio overwriting, a covered call-like strategy for buy and hold portfolios. In today’s article I will walk you through the process of how this strategy can be accomplished. Keep in mind that there are many ways to approach any given strategy, this is one of them.
Let’s start with our assumptions:
- We have a long-term buy and hold portfolio in a non-sheltered account with many securities having a low cost basis
- Our goal is for the portfolio to generate higher returns and at the same time avoid exercise and subsequent sale of the shares
- If the strike is in-the-money on or near expiration Friday we will roll the option (buy it back and sell the next month’s option)
- On the 4 months where ex-dividend dates come up, we will hold off on selling the option until the ex-date passes or sell a 2-month option
- We will set our goal to enhance our portfolio returns by 6% per year or 1/2% per month
In Part I, I gave a free link to access ex-dividend dates:
Let’s have a look @ Home Depot (HD), a staple in many buy and hold portfolios regarding its ex-dividend date:
HD: ex-dividend date
I produced this screenshot on November 29th so I will wait through the weekend and sell the option early next week on December 4th. Our other choice would be to sell a 2-month option at the end of the November contracts (the Monday after the third Friday in November). Let’s explore the first choice where we sold a 1-month option the day after the ex-date:
Now with HD trading @ $80.44 and a 6% increase in annualized returns as our goal we will check an options chain for a 1-month return of 1/2% or about $0.40:
HD: 1-month options chain
The $83, out-of-the-money strike generates $0.41 or .051%, meeting our monthly goal. It also allows share appreciation up to the $83 strike or 3.1% ($2.46/$80.44). If the price of the stock is above $83 by expiration, we can roll the option. Because we waited until December 4th to sell the option, early exercise is highly unlikely.
Next, let’s explore our second choice where we sell a 2-month option also significantly minimizing the risk of early assignment. Below is a screenshot for a 2-month options chain (actually 7-weeks at the time I created this image) for HD:
HD: 2-month options chain
Please note the following:
- Our 2-month goal is now 1% because our annualized goal is 6%
- With the shares trading @ $80.66, our goal is about $0.80
- Our 2 closest choices are the $82.50 strike ($1.06) and the $85 strike ($0.44)
- If I were dealing with multiple contracts I would do half of each, averaging out to the 1% goal
- If I had only one contract I would favor the $85 strike, take a lower return and allow for greater share appreciation while minimizing the chance of needing to roll the option
- Not every month has a choice of the same strike prices…there is no $83 choice as there was last month
A general risk regarding covered call writing:
Most of our members reading this article already know this but I am including it in this article for those completely new to covered call writing. If a stock dramatically goes up in value, a covered call writer will not partake in any share appreciation above the strike price prior to expiration. This is the reason we are generating modest monthly returns and selling strike prices above current market value thereby having the opportunity to generate 2 income streams each month.
Conclusion:
Portfolio overwriting is a low-risk (but not no risk) way of enhancing portfolio value as long as we understand how to circumvent the issue of early exercise in non-sheltered accounts. Since dividend distribution is main reason for early exercise, selling the option after the ex-date or writing a 2-month call option on the month of the ex-date will usually avoid this issue.
Holiday Discount Coupon:
HOLIDAY DISCOUNT:
From now through December 24th, the BCI team is offering a 10% holiday discount on all items in the Blue Collar store. Use promo code “HOLIDAYDISCOUNT”
Premium members please enter the store from the premium site to get your additional premium member discount.
Keep in mind my latest book, Stock Investing For Students for friends and family not nearing retirement.
Happy holidays from…
Alan and the BCI team
Market tone:
The bears were roaring most of the week but were quieted on Friday with a favorable jobs report. This week’s economic reports:
- According to the Labor Department, non-farm payrolls rose by 203,000 jobs in November beating the 185,000 consensus
- The unemployment rate decreased from 7.3% to 7.0% in November, below the 7.2% anticipated. This is the lowest level in 5 years
- A second estimate for GDP for the 3rd quarter came in at an annualized rate of 3.6%, well above consensus estimate and due, in large part, to expanding business inventories
- According to the Commerce Department, construction spending in October rose by 0.8%, doubling consensus estimates
- Total construction spending in October was up 5.3% year-to-year
- The Federal Reserve’s beige Book described the economic expansion as “modest t0 moderate” for the time frame from early October through mid-November
- The US trade deficit narrowed by 5.6% in October to $40.6 billion according to the Commerce Department
- New factory orders in October fell by 0.9% after an increase of 1.8% in September
- Personal income declined by 0.1% in October below analyst’ expectations
- Consumer spending rose by 0.3% in October despite the low personal income stat
- The personal savings rate dipped from 5.2% to 4.8%
- The ISM manufacturing index rose to 57.3 in November, the highest level since April, 2011 and better than analyst’ expectations
- The ISM non-manufacturing index (service sector) rose for the 47th consecutive month indicated expansion but came in at the lowest level since June
- New-home sales rose by 25.4% in October to an annualized 444,000 units
- Housing inventories dropped from 6.4 months to 4.9 months in October
For the week, the S&P 500 declined fractionally for a year-to-date return of 29%, including dividends.
Summary:
IBD: Confirmed uptrend
BCI: This site remains moderately bullish on the economy but will take a cautious approach moving forward as the dip in the unemployment rate may motivate the Fed to taper its bond-buying program. It is unclear how this may impact the market. We are selling and equal number of in-the-money and out-of-the-money strikes.
Have a wonderful holiday season.
Alan (alan@thebluecollarinvestor.com)
www.thebluecollarinvestor.com
Premium Members,
The Weekly Report for 12-06-13 has been uploaded to the Premium Member website and is available for download.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the BCI YouTube Channel link is:
http://www.youtube.com/user/BlueCollarInvestor
Best,
Barry and The BCI Team
Alan, thanks for Part 2….very helpful.
All the best to you and your family. Have a great holiday season.
Ron
Alan,
Can I sell a losing stock before December 31st to offset some option gains to pay less taxes and then buy the stock back in January?
Thanks for your help.
Laura
Laura,
Check with your tax advisor first. As a general rule, if a stock is re-purchased within 30 days, it is subject to the “wash rule” which will prohibit a tax benefit. Again, since I am not a tax expert, please check with a tax professional first.
Alan
Premium members
This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options.
For your convenience, here is the link to login to the premium site:
https://www.thebluecollarinvestor.com/member/login.php
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To all BCI members,
The BCI team is proud to announce the expansion of our Premium Stock Report.
Effective with the January 17, 2014 report, these releases will include the following new features as shown in the screenshot below:
• Are weekly options available?
• Is open interest for near-the-money strikes > 100 contracts?
• Ex-dividend dates will be shown in the “comments” column, if applicable
Over the years, our team has always responded to the requests and suggestions by our members and these new additions have been the most frequently recommended recently.
Good news about premium member rates
Although the additional time and manpower required to add these features will result in a member fee increase there is good news for all current premium members and those who plan to subscribe prior to January 17th.
All current premium members and those who join prior to January 17th, 2014 will be grandfathered in at the current membership rates so you will see no fee increase.
Those who join after January 17th will see a modest increase for trial membership to $14.95 for the first month and then $39.95 thereafter. Annual memberships will also see an increase based on the new monthly rates. Current premium members (both monthly and annual) need to take no action as the upgraded reports will be available at no additional expense.
We encourage those who plan to join to do so prior to January 17th.
***Beta-testing for the new format will begin with the report dated 12-13-2013 so all premium members will see the new format and additional information with the current reports.
***Grandfathered rate will be in place as long at the continuous subscription is in effect. A cancellation and return to membership will result in a higher rate.
Thanks for your continued support.
Alan and the BCI team
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Money Show interview about “Stock Investing for Students”:
http://www.moneyshow.com/video/VideoNetwork/100/9568/Is-This-40-Year-Plan-for-You/