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Hedging the S&P 500 with Lizard King

I’m buying a hedge.

music selection:  “Instant Karma!” — John Lennon

There is an important referendum in Italy over the weekend.  If the challengers to the current government win, it will likely signal that Italy will exit the Euro common currency.  Right now, it looks like the effort will fail but we have recently been surprised by Brexit and Trump.  There could be a lot of carnage in the major indexes if the vote goes the wrong way so for a few days, I’m putting on a low cost hedge.

I bought 17 contracts of SPY190118P00150000 for 5.45 a share.  A ten percent drop in the S&P on surprise news might result in those puts being worth more than 8.50 a share.  My profit could be over 5,000 dollars.  Realistically, I expect that the S&P will be largely flat on Monday and to exit the position for a loss of a few cents per share.  A loss of a dime per share would be about 170 dollars plus round trip commissions.  I think that is a fair price to pay for protection against what could be a global commerce shaking event.

In other news, the price of oil has been rallying strongly on news of the OPEC production cut.  RIGP and SDLP have joined the rally for me and are now both in range to write covered calls again.

I sold RIGP170120C00017500 for 70 cents a share today.  The trade will be in force for 51 days and yields 28.63% annualized.  I remain eligible to collect on a fat 11% yield on the underlying.  In the same vein, I sold SDLP170120C00005000 for a nickle a share.  The trade will be in force for 51 days and yields 7.16% on an annual basis.  Like with RIGP, I can still expect to collect dividends worth over 12% at market.

Devour your prey raptors!

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Covered Call Disney (DIS)

My shares of MSFT were called away over the weekend.

music selection: “Son of a Poor Man” — REO Speedwagon

weigh-in:  212.0 +0.8 – Not bad for a week with an obligatory overeating holiday.

The last of the positions I’m trying to exit to raise cash is The Walt Disney Company (DIS).  I hold 100 shares with a cost basis of 100.  Shares are currently at 98.50 and I am writing a covered call to try to exit.  I sold DIS161230C00100000 for 75 cents a share this morning.  The trade will be in force for 33 days and yields 8.30% annually.  I’ve lost some dividend income over the last couple weeks as shares have been called away and I expect to lose some more to tax loss harvesting before year end.  I will be under 100% budget coverage by year end making trading income all the more important.  I hope to reduce the cash I hold in checking and increase my holdings of Closed End Funds after year end to alleviate that.

Devour your prey raptors!

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Write Put Digital Realty Trust (DLR)

I wasn’t able to get into PMT at favorable pricing and am substituting DLR.

music selection:  “Closer” — Nine Inch Nails

Digital Realty is a REIT that specializes in renting server space.  This is a growing company thanks to the trend towards cloud computing and towards the creation of large amount of data.  There are a lot of names in this space but I like DLR best because 77% of its revenue comes from long term contracts.  Most of the competitors are primarily on one year or month to month contracts.  The DLR contracts come with rate escalation clauses too.  This gives us a great deal of revenue certainty.  The past performance is very strong with continuous growth.  The stock has yielded over 30% annualized since inception.  Like all REITs, it pays out most of its operating cash flow as dividends and we see a rising distribution here.  The quarterly distribution has grown from 15 cents to 88 cents between 2004 and now.  The current yield is only 3.8% but there is a long runway of growth ahead of this company.

I want to get assigned and start writing out of the money covered calls on DLR to give the underlying some room to appreciate in price while collecting the growing dividend.  So I sold an at the money put, DLR161216P00090000 for 2.65 a share.  The trade will be in force for 24 days and yields 44.78% annualized.  It comes with 2.93% downside protection.  With any luck, I will get assigned and be able to write out of the money covered calls with a yield around 12-18% going forward while collecting the growing distribution.

I haven’t given up on PMT but it is currently in a price range between the 15 and 17.5 strikes where the annualized yield just isn’t very attractive.  I’ll keep watching it for an opportunity to strike.

Devour your prey raptors!

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Write Put SXCP

I wrote puts on SXCP.

music selection:  “Dead & Bloated” — Stone Temple Pilots

I tried to write out of the money puts on this one yesterday and failed to get attractive pricing.  I gave it some thought and decided that the coal space might deserve its new higher valuation in the Trump world and wrote at the money instead today.

I sold SXCP170120P00020000 for 1.15 a share.  The trade will be in force for 60 days and has an annualized yield of 34.98% while enjoying 8.05% downside protection.  This is an excellent yield.  Assignment would result in a yield on the underlying over 11.5%.  I expect to do well here.

Devour your prey raptors!

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Monday Trades

I rolled most of the positions that closed Friday.

music selection:  “Tonight She Comes” — The Cars

weigh-in:  211.2 (1.8)

I wrote a covered call (again) on PSEC.  I sold PSEC161216C00008000 for 10 cents a share.  The trade will be in force 26 days and yields 17.55% on an annualized basis.  If I hold onto shares, the underlying yields over 12%.

I sold a cash secured put on BPT.  I sold BPT161216P00020000 for 65 cents a share.  The trade will be in force for 26 days and yields 45.63% on an annualized basis (quite good!)

I wrote a covered call (again) on GEL.  I sold GEL161216C00037500 for 15 cents a share.  The trade will be in force for 26 days and yields 5.62% on an annualized basis.  I am likely to retain the shares and collect an underlying yield over 8%.

I wrote a covered call (again) on MAA.  I sold MAA161216C00095000 for 30 cents a share.  The trade will be in force for 26 days and yields 4.43% on an annualized basis.  I am also likely to retain these shares and collect on the underlying yield of 3.5%.

I sold a cash secured put on CNNX.  I sold CNNX161216P00020000 for 20 cents a share.  The trade will be in force for 26 days and yields 14.04% on an annualized basis.

New action this month includes writing an in the money covered call on HCP.  This one recently had a share price decline related to a spin off an operating unit.  I like the prospects for this one but am striking to harvest the tax loss before year end.  I sold HCP161216C00027500 for 1.65 a share.  The trade will be in force for 26 days and yields 18.38% on an annualized basis.

I was unable to roll SXCP or PMT for attractive pricing.  I’ll try again tomorrow with a 2017 expiry to see if I can find some additional liquidity.

Devour your prey raptors!

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18NOV2016 Expiries

Seven positions expired today with the closing bell.

music selection:  “Sunshine Of Your Love” — Cream

Unlike most people who have taken to blogging about options, I usually let my contracts go to expiration rather than close early.  I just don’t feel it is worth the effort to squeeze out a few more basis points but trade twice as often.  Six of my seven positions expired out of the money.  One covered call will result in shares being called away.

A covered call in PSEC expired 3 cents out of the money.  I earned 18.70% annualized on that position and will roll it forward on Monday.

A cash secured put on SXCP expired well out of the money.  I earned 55.85% annualized on that position.  The position has run away from me a little bit.  I don’t want to go up a strike so I’ll probably take less premium and more downside protection here on Monday.

A cash secured put on BPT expired a buck-fifty out of the money.  I earned 55.30% annualized on BPT.  I should be about to roll for something in the range of 40% annualized on Monday.

A covered call in GEL expired 3.38 out of the money.  I earned 26.21% annualized on that position.  I will open a new covered call at the same strike on Monday and expect to fetch a lower return as I’ll be writing further out of the money.

A covered call in MAA expired 5.95 out of the money.  I’m a little disappointed by price action here but I’m being compensated well by dividends while I wait for this one to recover.  I earned 14.78% annualized on the options position and will reopen on Monday.

A cash secured put in CNNX expired out of the money as the position moved mostly sideways since inception.  I earned 31.59% annualized on the position and will roll it forward on Monday for more fun and profit.

My covered call in PMT is going result in shares being called away.  I earned 37.44% on the options position and will go back to the trough with a cash secured put on Monday.  The yield will be a little lower but well within my 12% target.

Two positions expire next Friday (DIS, and MSFT) and I hope to be called away on each to raise cash.

Devour your prey raptors!

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Update UVXY 50% annualized return

I sold my 13 strike UVXY puts.

music selection:  “Jersey Girl” — Bruce Springsteen

I purchased UVXY180119P00013000 for 6.95 a share on 15AUG2016.  I put in a sell order as the strike has moved into the money.  I sold my contracts for 7.85 a share this afternoon.  The trade was in force for 94 days and yielded an exceptional 50.28% annualized.  I collected over 3.3k in profits on my 37 contracts.

I rolled down and out to the 8 strike with UVXY190118P00008000 and paid 5.65 a share. I’ll be looking to exit the trade after 30 days or when the strike moves into the money, whichever comes first.  I’m keeping my allocation here to 10% of my IB account balance by cost basis.  I also have an 11 strike play on this same theme in my IRA account that should move into the money and be ready to roll soon as well.  Long dated, out of the money, puts on UVXY remains my highest conviction idea.

Devour your prey raptors!

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Trailing Stop Losses – Protection Against Catastrophe

I want to talk about portfolio protection today.

music selection:  “Cinnamon Girl” — Neil Young

weigh-in:  213.0 +0.2

Traders that let their emotions rule end up selling winners early (lock in my gains!) and holding on to losers too long (I’ll wait for recovery!)  This results in a portfolio that is short on big winners and high in big losers.  Clearly, a portfolio composed of no big losers and several big winners will outperform the opposite.  I’m going to show you a simple rules based approach to ensuring you don’t fall into these traps: the trailing stop loss.

I currently have a 25% trailing stop loss on all positions.  I’ve previously violated my own rule and suffered severe consequences such as a greater than 90% loss on VNR (I would have locked in a small gain if I had stuck to my rule).  In light of the market being at a high CAPE, I’m recommitting to following my stops.

A trailing stop loss is a heuristic rule to sell when the stock price falls before a predetermined percentage below the high water mark.  This method keeps you from holding onto dogs that are on their way to zero in hopes of a recovery. Remember that the trend is your friend!  It also allows you to protect large gains from turning to dust.  I use a 25% trailing stop on my positions.  This is calculated by taking the highest closing price during your holding period and multiplying by [high water mark] * (1.00 – 0.25).  If the stock closes below that price, sell the next day!  You can get back in after a three month uptrend.

I like to adjust my trailing stops to reflect gains from dividends and options premiums.  That formula looks like this: [(high water mark) – (collections)] * (1.00 – 0.25).  It is entirely possible to end up with a stop loss figure that is below zero.  These stocks have moved into “never sell” territory.

I like to track mine in a spreadsheet, updating my high water marks after daily close.  If you want a lower effort approach, there is a for fee service called Trade Stops that will send notifications to you.  There are less user friendly but completely free cell phone apps that will do the same as well.

For my options positions, I use a “hard stop” rather than a trailing stop. This means I do not adjust the stop loss for gains (the high water mark) and just go with a straight 75% of the strike price.  Since my positions are roughly 6 to 8 weeks, there isn’t much time to collect large gains.  I make one exception which is for my UVXY puts.  These can move 100% up in a short period time and fall back just as quickly.  I could easily get shaken out of a winning trade that has a peculiar volatility profile so I just grit my teeth and hold.  That has always worked out so far.

One twist that many traders like is that when a stock is a large gainer, to start protecting gains by “tightening the stop”.  To do this, you change your multiply to a smaller percentage.  So you might move from a 25% trailing stop to a 20% trailing stop.  The new formula looks like: [high water mark] * (1.00 – 0.20).  This provides greater protection while still giving a winner room to run.

I’ve covered asset allocation and position sizing in the past.  You also need trailing stop losses to make a three legged stool.

Devour your prey raptors!

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Update Discounted Bonds

I sold my Cummulus bonds today.

music selection:  “Love Removal Machine” — The Cult

On 10FEB2016 I purchased two Cumulus Radio (CMLS) bonds for 33.15 cents on the dollar.  I paid seven dollars in commissions and 45.21 in accrued interest for a total cash outlay of 715.21.  A limit order cleared today at 50 cents on the dollar.  I paid 4.75 in commissions and collected 6.46 in accrued interest.  I also collected 155 dollars in coupon payments during the holding period.

The trade was in force for 274 days and yielded 82.23% on an annualized basis.  My total gains in discounted bonds since inception has been $8,431.  I’m doing quite well here and hope to buy more discounted bonds in the future.  I think there could be a rollover of the debt markets soon as defaults are slowly rising.  I am keeping my eyes open for bargains.

Devour your prey raptors!

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Synthetic Short Canadian Natural Resources (CNQ)

Introducing the Synthetic Short.

music selection:  “Burn In Hell” — Twisted Sister

First I want to make the case for shorting CNQ.  CNQ is an oil and gas company that has significant exposure to deposits that are expensive to produce from.  With oil looking to be at a new long term equilibrium price of 40-50 dollars a barrel, they are due to see some pain.  The company also currently has a rich multiple making it an attractive short.  A large portion of production comes from Canadian Tar Sands projects.  Tar Sands produce a type of heavy, sour crude known as Bitumen, that fetches a lower price on the markets than WTI or Brent crude.  It is also expensive to mine and has a break even price around 55 to 60 dollars a barrel by most estimates.

CNQ has a large Tar Sands project known as Horizon that is already projected to be about 10 billion dollars over budget; versus an original budget of only 7.6 billion.  The project is also a disappointment in that it was originally projected to produce 500,000 barrels a day.  The current projection is down to 250,000 barrels per day, cutting the economic justification in half.  Management reports its current mix includes 24% of its oil and gas sourced from Tar Sands and projects its long term mix to grow to 38% from same.  The company is betting its future on a high cost source of oil.  And it is executing that strategy poorly.  I think this company is an excellent short candidate but borrowing costs and a rich dividend yield make shorting the underlying unattractive.

Enter the Synthetic Short.  It is possible to use options to set up a profit/loss profile that mirrors shorting the underlying.  As a bonus, this position is immune to paying a third party dividends or paying the broker borrowing fees.  The process works best with long dated options and Jan 2018 LEAPS are available on CNQ.

To execute a synthetic short, you sell a call and buy a put at the same near the money strike.  In this case, I sold CNQ180119C00030000 for 4.35 a share and bought CNQ180119P00030000 for 4.58.  This is what is known as a “spread” with a “net debit” of 20 cents a share.  The underlying was at 30.19 at the time the spread was purchased so there is a negligible drag of about 40 cents a share to set up the spread.  This will ultimately be less expensive than paying borrowing fees and payments in lieu of dividends.

The time value of the sold contract offsets the time value of the purchased contract and will continue to do so as both positions experience time decay.  So the P&L profile is the same as shorting the underlying.  If the price falls to 29 dollars, the call will be out of the money by a dollar while the put will be in the money by a dollar.  Thus, unwinding the position would yield about a dollar in profit, the same as a short position in the underlying stock.  The opposite can be said for a price of 31 dollars.  The call would be in the money by a dollar and the put out of the money by a dollar.  Unwinding the position would result in a loss of about 1 dollar a share.

It is important to note that while this approach does not result in a margin loan, it does use leverage.  You are investing with equity that belongs to the broker rather than yourself and your returns and losses are magnified by the same.  So don’t overdo it.  I am buying two spreads here, setting my underlying exposure to 6,000 USD.  That is similar to the 5,000 exposure I set for my direct shorts.

Devour your prey raptors!

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