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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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Changes at the Raptor

I made a few changes to the organization of the site.

music selection:  “So Into You” — Atlanta Rhythm Section

weigh-in: 212.8 +0.4

First up is the Discuss page.  The forum was attracting zero content and much SPAM.  So it is gone.

In it’s place is a feature requested by multiple readers.  I have created a tab that includes all of the Transparency posts in chronological order.  You can read them all start to finish in one place.  That is located at: http://velociraptor.cc/transparency/

I have no trades to report this week so that is all for now.

Devour your prey raptors!

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Financial Transparency 31OCT2016

Down 1.75% this month.

music selection:  “Yankee Rose” — David Lee Roth

weigh-in:  212.4 +1.6 – doh!

 

ASSETS:

Wells Fargo (taxable): This is up from 28,697 to 28,860.  A gain of 163 dollars or 0.57%.  The compositions is a little different in that I sold CPLP to harvest the tax loss and replaced it with AGC.

Interactive Brokers (taxable): This is down to 254,752 from 258,232.  That is a decline of 3,480 or 1.35% versus last month.

Interactive Brokers (tIRA): This is down to 128,571 from 130,754.  The decline is 2,183 or 1.67% versus last month.

Checking: This is down from 10,777 to 8,760, a decline of 2,017 or 18.72% from last month. The main drivers to the decline were paying school tax and homeowner’s insurance.

Total Assets: Down from 428,460 to 420,943, a 1.75% decline over the previous month.

 

LIABILITIES:

House: Paid

Car: Paid

Taxes: I have harvested enough tax losses to eliminate my additional tax liability for the year and to qualify for an Obamacare subsidy.  W00t!

 

WITHDRAWAL RATE:

Projected twelve month withdrawals is being updated this month to reflect the change in distributions in my Wells Fargo account to checking.  That figure now stands at 23,784.  Against a total liquid networth of 420,943, the withdrawal rate is 5.65%.  Offsetting the budget is projected twelve month distributions, dividends, and interest which comes to 25,664.   That comes out to 107.91% of my budget.  I also earned 1,695 in options premiums in the month of October, bringing my yearly total to 22,675.

 

SPENDING:

Spending is up big this month to 3,329. Almost two thousand of that is for home insurance and real estate taxes.  I have two more real estate tax bills coming for about 1,700 dollars.  I’ll be above monthly target for the rest of the year but it looks like the annual budget will come in under target.

 

Devour your prey raptors!

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Friday Expiries (AAPL, AXP)

Positions in AAPL and AXP expired today.

music selection:  “Youth Without Youth” — Metric

A cash secured put in Apple (AAPL) at the 109 strike expired out of the money today.  The trade was in force for 40 days and yielded 14.40% annualized.  I am continuing to raise cash so I will not be rolling this position on Monday.

A covered call in American Express (AXP) at the 65.50 strike finished the day in the money and shares will be called away.  I collect, in addition to the premium, 50 cents in short term capital gains.  The trade was in force for 40 days and, including the capital gains, yields 23.40% on an annualized basis.  I will not be opening a new AXP trade on Monday as part of my plan to raise cash.

I’ll be back after market close on Monday with the October Transparency post.

Devour your prey raptors!

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Monday Trades 24OCT2016

I rolled some options positions from Friday expiries and also sold a discounted bond.

weigh-in:  210.8 (2.2) – w00t!

music selection:  “These Eyes” — Guess Who

First up is Genesis Energy LP (GEL), an MLP.  Shares were assigned some months ago at 37.50.  I am writing a second covered call at the 37.50 strike.  I sold GEL161118C00037500 for 70 cents a share.  The trade will be in force for 26 days and yields 26.21% on an annualized basis.  The underlying shares yield about 7.5%.

A second covered call I am writing is Mid America Apartment Communities (MAA).  I was previously assigned shares at 95.00 and am writing a 95 strike call.  I sold MAA161118C00095000 for 1.00 a share.  The trade will be in force for 26 days and yields 14.78% on an annualized basis.  The underlying shares yield almost 4%.

Next is a cash secured put.  A put in Blackstone Minerals (BSM) expired out of the money and I am replacing it with a put in CONE Midstream Partners (CNNX).  I like the risk/reward proposition better here as CNNX has a much stronger balance sheet.  I was able to sell CNNX161118P00020000 for 45 cents a share.  The trade will be in force for 26 days and yields 31.59% on an annualized basis while enjoying 8.13% downside protection.

Finally, among options trades is PennyMac Mortgage Investment Trust (PMT).  I had a cash secured put open here that was assigned on Saturday after closing 6 cents in the money.  I sold PMT161118C00015000 for 40 cents a share.  The trade will be in force for 26 days and yields 37.44% annually.  The underlying shares yield about 12.5% if I hold through the ex-dividend period before getting called.  Feel pretty good about prospects here.

I tried to sell a covered call on my shares of SDLP at the December expiry but could not get the market maker to take action.  I will try again tomorrow with a further out expiry to look for more liquidity.

In other news, another discounted bond sold today.  Linn Energy went into bankruptcy and has been in debtor in possession status for a couple months.  It could be some time before the bonds convert to equity and I had an opportunity to sell the bonds at a nice profit when a limit order cleared.  Back on 8DEC2015, I bought two units of the 15MAY2019 maturity 6.500 coupon bonds for 23 cents on the dollar.  I paid 2.00 in commissions and 37.00 in accrued interest.  Today, I sold the bond for 28.600 cents on the dollar.  I paid 2.75 in commissions.  No accrued interest was paid as the bond is in default and “trading flat”.  I picked up 60.50 in coupon payments during the holding period before the bond defaulted.  The trade was in force for 321 days and yields 29.79% on an annualized basis.  Not bad for a trade were I was “wrong.”

Devour your prey raptors!

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Update UVXY (tIRA)

I sold my UVXY puts in my tIRA account.

music selection:  “When She Begins” — Social Distortion

I’ve been trying to close this position at a favorable point of the bid/ask spread for a couple days as it has moved into the money.  On 29JUL2016, I bought 15 of the 16 strike UVXY 19JAN2018 expiry puts for 8.40 a share.  That was a cash outlay of 13,440.  Today, I sold those puts for 9.95 a share for proceeds of 15,920.  My profit is 2,480.  The trade was in force for 84 days and yields 80.18% on an annualized basis.

I rolled about half of the position into new UVXY puts (the other half will remain in cash as a hedge).  I purchased the 11 strike 19JAN2018 expiry puts for 6.05 a share (10 contracts).  My cash outlay is 6,655.  I will target 200% annualized return or will sell around 10, whichever comes first.

In other news, I have positions expiring today.  A 15 strike put in PMT will be assigned after closing a stinking 6 cents in the money.  A put in BSM expires out of the money and will likely be replaced with puts in CNNX on Monday, depending on pricing.  Covered calls in SDLP, GEL, and MAA expired out of the money.  A covered call in HCLP will be exercised.  This was as planned as I wanted to exit the position to harvest a tax loss of 3,000.  Proceeds will sit in cash until the beginning of the year at a minimum while I play some defense.

I won’t be declaring the profit on UVXY in my accounting for monthly transparency as it is in my IRA and can’t really be spent.  I don’t consider money I can’t spend as “income”; call me crazy.  It will count towards my liquid networth however and be part of the withdrawal rate calculation.

Devour your prey raptors!

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Monday trades

I am continuing to raise cash.

music selection:  “Through Glass” — Stone Sour

weigh-in:  213.0 +0.6

Of my Friday expiries, MSFT, LNG, and DIS left me with open long positions.  I have exited LNG by selling 400 shares at 40.99.  That raised 16,396 in cash and booked a 3,276 profit in about 8 months.  For Microsoft (MSFT), I sold MSFT161125C00057500 for 1.50.  The trade will be in force for 40 days and yields 23.8% annualized.  I hope to get called to continue raising cash.  For Disney (DIS), I sold DIS161125C00100000 for 8 cents a share.  The trade will be in force for 40 days and yields a miserable 0.73% annualized.  I remain eligible to collect dividends at least.  I could be some time before I am able to exit this position profitably.

I also did some tax loss harvesting on Capital Products Partners LP (CPLP).  I sold 4283 shares from Interactive Brokers for 3.07 a share.  That raised 13,148 in cash and resulted in booking a 15,467 capital loss (ouch!)  The position was roughly break even after dividends collected during the holding period but harvesting the tax loss was more important than hoping for a full price recovery.  I should have used a trailing stop loss on this one and locked in a fat gain.  Live and learn.  I also sold 619 shares of CPLP from my Wells Fargo account.  That raised 1900 in cash and resulted in booking a 2,204 capital loss.  I no longer expect a tax liability for 2016 and should qualify for the maximum Obamacare subsidy.  Bonus!

I redeployed the cash proceeds from CPLP.  In Interactive Brokers, I sold BPT161118P00020000 for 1.00 a share.  That trade will be in force for 33 days and yields 55.30% annualized with 5.48% downside protection.  In Wells Fargo, I actually put some additional cash back in the portfolio (withdrawal rate will reflect this change at month end).  I bought Advent Claymore Convertible Securities and Income Fund (AGC).  I picked up 579 shares at 5.55 each.  I’ll earn 10.16% yield on those shares.

Devour your prey raptors!

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Friday Expiries (QCOM, MSFT, LNG, DIS)

Four options positions expired with the closing bell.

music selection:  “Erase/Rewind” — The Cardigans

The only position that expired in the money is Microsoft.  I will be assigned shares at 57.50.  I earned 18.23% annualized on the position and should be able to earn similar on a near the money covered call.

Expiring out of the money are a Qualcomm put (63 strike), a Cheniere Energy call (52 strike), and a Disney call (100 strike).  I’ll be rolling the MSFT and DIS positions but exiting QCOM and LNG, including a sale of shares to raise cash.  I am still playing defense in light of the European banking troubles and the 4DEC2016 Italian referendums.  That includes opening fewer new positions when positions expire.  If things go smoothly, I’ll go back into risk on mode after the first of the year.

Devour your prey raptors!

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