Before leaving for a few days vacation, I’m checking my regular positions that provide me with a nice regular income.  On Aug 26^th I sold 10 calls on my Medtronic stock (MDT).  My stock is still below what I paid for it, during a high period, but I’m way ahead by continuing to sell these calls on a regular basis, and I still have confidence that the stock will come back next year.  I received $905 for the Nov 34 calls.  The stock is now about $32.50, so I have to watch it, and roll up if the stock goes to 34.

As usual during periods of weakness in the market, I continue to write a bearish call spread every few months.  On August 23 I bought the March 125 SPY at $1.32 to hedge, and sold the Dec 117 for premium.  I paid out $1,375 for the March position, and received $1,615 for the December position, so I’ve got about $240 in my pocket.  If the S&P index doesn’t run up past 117, in December I’ll write another call and take in another $1,500 or so, maybe more, then start over again in March.  With virtually no investment this activity earns about $5,000 a year or so on average, with very little work on my part.  Of course, when I mis-guess and the market surges, I don’t do as well.

Aren’t options wonderful?

WHAT AM I DOING NOW?

I’ve been laying low for the past few weeks, watching the bad economic information.  I have a number of stock holdings, many of which are down from my cost, but which are providing me with some income from my writing covered calls against, them generally y each quarter.

There are a few stocks which look good to me for those of you who don’t already own them.  For example: RIG, COP, BK, GS, JPM, HPQ, MFFT, AMGN, MDT.  These are stocks I wouldn’t mind buying if I had a lot of cash, and writing calls against at 5-10% out of the money (above purchase price) if I can get $1 or  more in premium.

Last week I bought back my Nov calls on Medronic with a $40 strike price, for ten cents, taking a nice profit, and I bought back my Oct calls on Costco with a $62.50 strike price for nine cents, also taking a nice profit. Then I sold a new January call on Costco with a $60 strike price for $1.15.  I usually do 10 positions at a time, on 1000 shares, so I took in $1,125 net on this sale.

Last week I was put 1000 shares of RIG from my recent sale of a naked put (when the oil spill hit) and the stock is down a lot more than I had expected, but I’m still very optimistic about it.  While I’m waiting for it to recover, I sold 10 calls of the Nov 57.50’s for $3 and took in just under $3,000 in premium.  Since I also took in about $3,000 in premium from the sale of the put, that puts me in an overall position of about $3,000 under water.  I will either recover that, and more, from a recovery of the stock, or from the sale of more calls in December.  Because the premiums are so high (typical of volatile stock) an investment in RIG (Transocean) with covered calls seems very safe to me.

These are all my typical monthly trades.  But I did so something a bit different this week:  I got tired of waiting for Bank of America stock to go up—and even more tired of watching it go down.  It no longer pays a dividend, and there are insufficient option premiums to make it worthwhile to write calls on it.  So I sold half of my holdings (and may sell the other half soon) and used the cash to buy 500 shares of Enbridge energy (EEP).  I bought it at $54.78, for a total of $27,400.  Then I sold 5 calls of the April 2011 55 calls and took in $2.70 each for a total of $1,325.

EEP is paying a dividend equal to about 7.4%.  With the call premium I’m now getting over 8% on my money.  If the stock is called away at $55 I’ve earned that amount while owning it and I’m not hurt by the call.  If the stock goes down I get the same return, and I’m hedged for a downside of a point and a half anyway from the call premium.  It’s hard to see the stock going down much further with that kind of dividend, unless something unusual happens.

Now I’m looking at doing the same thing with my GE stock.  It too isn’t moving in the right direction, but Altria is paying a 6.5% dividend.  I might do the same kind of trade there.  More later.  mlh

With Atria stock (MO) selling at $22.70, the $1.40 dividend is 6.1%.  That’s a really nice dividend, unless you lose it back if the stock goes down.  With that kind of a dividend I usually look for an opportunity to buy the stock and put on a “collar.”

A collar is typically a short put and a long call.  I buy a put just under the price of the stock to protect me from a decline in the stock.  I sell a call above the price of the stock to take in a premium to pay for the put.  This kind of collar is called a “no-cost” collar since you are hedged at no cost.  Of course, you are giving up the upside if the stock rises.  But that’s OK in this situation because you are not buying for the upside, you are buying to capture the dividend.

For example, in this situation you can buy the December 20 put for $.38, and sell the Dec 23 call for $.36—maybe with some luck you can do both at $.37.  Your risk of loss is less than $2,000 on 10 positions.

And that points up the problem in finding a good collar.  Ideally we would want some chance on the upside if we are taking some risk on the downside, but the premiums available for MO don’t seem to permit this, even going out as far as Jan 2011.  The puts, that we want to buy, seem to be more expensive than the calls, that we want to sell, suggesting that the market does not value the stock highly.

And so if I want to take advantage of this dividend I probably would elect just to sell a put.  I can get $1.43 for the January 22.50 put, which means I’m safe down to about $21.50, and if I am put the stock at $21.50 I can immediately write a call against it and probably pick up another dollar.  So if I end up with the stock at just over $20 a share the dividend will be closer to 7% and I’ll just keep writing calls on it.

Mlh August 21

Take a look at our RIG positions in Merv’s Trades.  When a stock goes down because of an event that is primarily psychological in nature as opposed to financial, it’s a time to write naked puts.  We wrote puts when RIG (Transocean) first went down, then when it went down further (to my surprise) we wrote again.  Since then it’s bounced up nicely.  While the first write is still at a loss, the second write is nicely in a profit position and the net position is up about $800 so far.  I think RIG will continue to go up as the psychological negativism fades and the true value of the company is again recognized.  More later.

Merv

A lot of my colleagues are saying that Apple stock will go over $300 a share by the end of the third quarter. One analyst has predicted $400 a share. With all of that hype I decided to try to benefit from this by writing a put spread on Apple.

So when the stock was around $260 I sold 20 puts of the Oct 260’s for about $46,000, and bought 20 puts of the Oct 250’s (to protect me against a loss greater than $9,000) for about $37,000. (See “Merv’s Trades”).

This means that I put $11,000 in my pocket! I can reinvest that while the options are in place—or I can take a nice vacation with it.

If Apple stock stays about $260 a share through Oct 17th, I get to keep the $11,000 forever. I will keep the $46,000 premium and lose the $37,000 premium I paid for the long position, which will expire worthless. If the stock goes below $260 I will lose $2000 per point, for a maximum loss of $20,000 less the $11,000 premium I collected at the outset. So my maximum loss is $9,000.

I think the odds are pretty good, but I’ve been wrong before.

Mlh July 28, 2010

When the BP oil spill happened, the stock dropped like a bomb.  BP is a really big company, so I figured that they would fix the leak quickly and the stock would go back up.  So I sold puts on both BP and RIG, the two companies most affected.  By selling puts, I agreed to purchase the stock at a certain price.  In the case of RIG that price is $60.  In the case of BP that price is $47.50. (see Merv’s Trades for details).

As is so often the case—I was probably right, but there’s the question of timing.

In fact, the leak got worse and the stock of both companies dropped much further than I expected.  When it about hit near bottom, I sold two more puts to improve my position.  I sold two more puts on RIG at $45, and puts on BP at $30.

I took in about $4,000 in premiums. Today, July 17, RIG is at $52, and BP is at $37.  So it looks as if I will be able to keep the premium on the second set of trades, about $2,000, but I’m at risk of having to buy 200 shares of each stock at prices above the current market price.  (I’ve already been PUT the BP stock, so I had to buy it at $47.50).  At today’s prices that would put me down about $2,000 in market value on the BP, ($47-$37=$10 times 200 shares) and $1,600 on RIG ($60-$52=$8 times 200).  But I collected in a total of over $2,500 in premiums, so—surprisingly—I’m only down about $1,000.  And now that I’m being put the BP stock, I can sell calls against it and garner more premium, even though I own it at a cost considerably higher than today’s market value.  That will put me about even within 3 months, even if the stocks don’t continue to go up.

I don’t mind owning these two stocks and selling calls against them.  I think both are excellent companies, and the price will continue to climb as the memory of the problems fades, and people once again look at the value of the companies.

But in hindsight, with more research into the issues of liability, I would have only sold puts on RIG.  Transocean has indemnity agreements with BP so most of the losses will fall on BP, and very little on Transocean (RIG).  Live and learn.

merv

I get emails from several web sites that promote options. It seems to me they always make a profit. When I see that I know that they are not reporting honestly. So when you look at merv’s trades, you will usually see some loss positions.

But one area where we have not lost in a long time, overall, is in our SPY spreads. If you have been following our trades you have seen a profit of almost $2,200 from the current sequence so far since we started on April 1st. Here are the trades:

4/1. Bt sep 129 to write calls against. -1,255
Sld may 121 calls. + 1,145
4/23 bt bk may 121 -1,905
Sld. Sep 124. +3,556
5/5. Bt back sep 124. -2,701
Sld jul 120. +2,325
5/25 bt back jul 120. -280
Sld sep 120. +1,515

That’s a nice profit so far. This week we will buy back the sep 120 at a nice profit and sell the sep 117 for about $1,115 because the market is down. I’ll keep you posted.

Next week: what are we losing on?

I have a friend with a lot of Apple stock.  As you might know until a few days ago it’s been running up like crazy.  My friend bought it at $60 not that long ago and now it’s at $270.

A few weeks ago my friend thought the stock would go to about 290 or 300, so he wrote calls against the stock, selling the 285 and 290 calls for a very nice premium.

Then the IPAD sales figures hit, and my friend’s estimate of where the stock would go to changes, and his new estimate is $330.  So he asked what he could do now to “readjust” his positions so as not to lose his anticipated run up of 30 points or more on the stock.  Here is what I replied:

“When you sell Oct 285 (averaged for ease of writing) calls, you are saying to yourself and your colleagues one of two things: (1) I do not think this stock will go over 285 between now and expiration in Oct; and/or (2) I will be happy if this stock is purchased from me at 285.

So that is what you said, in effect.  Now, sometimes when we say that, conditions change so we want to backtrack to accommodate the changed situation.  That seems to be what you are saying now: “now I think the stock will go to 320 or so and I don’t want to miss out on the 35 points I think it will go beyond my old thinking.

When you make such a new decision you trigger a philosophical aspect of option writing: if you believe that a stock is going to go up like a rocket, you should not write calls against it.  When you write covered calls, you are giving up a bit of the upside in exchange for a premium.  You should only do that when the premium is enough to satisfy your objectives, or your evaluation is that the premium outweighs the likelihood of increase in stock value.

So for Apple stock while it is so hot, ideally you would not have written options against it at all, and just let it ride.  But, before we got involved, you did.  So we find ourselves where we are.

There are two intelligent moves to make in light of your new assessment of the stock: (1) let the stock be called away at 280/90 (you want to sell it anyway this year because of the tax change) keeping the premiums to recoup earlier losses, and taking one nice gain on the stock.  At the same time, if you want to benefit from your expected increase above 285, buy some calls (doesn’t have to be as many as you have stock positions) and take the expected profit from the calls.  You can do that on margin without putting up more cash based on your stock holding.  (2) give back some of the premium you took in by “rolling up and out”.  This is the customary technique in covered call writing when you DONT want the stock to be called away.  In effect you backtrack by returning some of the premium, sell new calls at the new strike price (say, 315 or 320 to be conservative) and receive back SOME of the premium that you gave back (probably a fair amount if you go out far enough).  Read about rolling in my tutorials for more details.  You titrate the figures by making sure the anticipated profit in the stock increase above the original call price is substantially more than the amount of net premium you give back (net in the sense of paying to buy back and receiving when you sell the new higher, further out, calls).  The result is you might lose some money on the options but more than make it back on the stock price increase.

Since you plan to sell out the stock positions by the end of the year, if you write calls that go beyond that you can lease them in place by buying calls later with elevated strike prices, converting the covered calls into spreads until the time is ripe to close out everything.  The cost of the new long calls (protection in place of the old stock that acted as protection) should be less than the premiums which will be earned as time goes on.

I hope this covers it.  Don’t be like the guy that buys the insurance policy, and after one year when it’s time to renew, tells the agent “why should I renew?  I paid the premium for a whole year and lost the entire premium since nothing happened.”  Options are a process, not for the faint at heart, the short sited, the impetuous or the impatient.  But lots of fun.”

I hope this is helpful to any of you in similar positions.  And Apple is hot, but I’m also watching WAG as a potential hot stock for next month.

Mlh June 23, 2010

On May 25th, when I thought the market was really low (boy was I wrong there) I bought back the 10 SPY Oct 120 calls at $.28, paying a total of $325 with costs. So there was a nice profit, pretty much as anticipated there.  Now I’m left only with the long Oct 129 position, on which I expect to lose $1,200 eventually, since it was purchased solely as protection.  But when the market rallies (when and if) I will sell another short position.  So far it appears that the plan is working and we will make a nice profit with very little risk.

Below are the trades I’ve made on the Spider ETF, that tracks the S&P 100, over the last year.  It’s only been mildly profitable because in general the market has gone up strongly over most of the period.  Writing calls on SPY is not as profitable during periods of strong upticks in the market as when the market trends down.  That’s one of the reasons that it is a good strategy: when the market goes down these positions act as a hedge and make a profit while the underlying portfolio loses value.  And when the underlying portfolio goes up in value, the SPY strategy either doesn’t make a profit or makes a small profit.  That’s what’s happened here–as the market has gone up, I’ve made a small profit.  Twelve thousand dollars in the year–not bad!  mlh”