Monday, October 31, 2011

Downgrade Portfolio - End of October Status

Readers will recall that about the time S&P downgraded US debt, CCI put some dry-powder to work on the simple assumption of “buy when others were fearful”. As October comes to an end, it seems like a logical time to report on the status of those trades.The specifics of those trades and update status can be found at this google doc and are described below. 

Overall this basket of nine diverse positions is up just over 5%. Of course the S&P500 is up about 11% in that same time frame. So the reader can judge for themselves if the glass is
  • half-empty – it would have been much better to just “buy the market” or buy with some leverage
  • half-full – the timing of the call to put more capital to work was very good. While the positions taken did not match the market performance,  they did go up.  Further,  almost all were hedged in such a way that they would not have lost as much if the market had not cooperated.
CCI “unbiased” opinion is that the glass is half full. It is not all that easy to overcome the fear of the moment that existed at the downgrade time to put money to work. The easy course of action would have been to do nothing and make nothing, or worse panic sell and miss the opportunity. While the option based hedged positions put in place damped the gains, they not only reduced risk, but helped make it psychologically easier to invest at a time of fear.

Trade Status

Let's start with the worst position. Bank of New York (BK) is down 7% along with the overall financial sector. The stock and sector had bounced some based on last weeks alleged positive European news, but that faded away likely in sympathy with the noise related to MF Financial bankruptcy today. CCI continues to believe this is somewhat a unique play in the financial services industry and read the charts to say it can get back over $23.  So we continue to hold and may sell some calls against this position on a bounce.

Three long positions and associated covered calls

Ford (F) - Bought a lot of stock at $10.18. Sold and then subsequently covered a lot of $11 Sept calls against the position for a gain of $.35. Established another $11 covered call position in November for a credit of $.79. The stock closed today at $11.68. If the stock stays above $11 through November options expiration the position will close with a gain of 19%. Conversely, with all the premiums taken in the stock would have to fall to $9.04 before loosing money. Still generally bullish on Ford so it if does pull back we would likely skim the profits from the option position and hold for better days to re-establish yet another covered call position.

Waste Management (WM) - Sold Aug $30 puts for $.70, and the stock was put to us at an effective price of $29.30. Closed today at $32.90. Over the past months we sold calls against the position for a $.63 gain and collected a $.23 dividend. Overall the position is up 16.5%. I would plan to exit the stock if it nears $35 but in the interim, I am Ok owning this for the dividend and possibly another round of covered calls on a bounce.

Utilities ETF (XLU) – Originally bought the etf at $31.72 and sold Jan $32 calls against it for $1.23.
The intent was for this conservative group of utility stock to stay stable through the end of the year and pocket both the option premium and two dividend cycles. The etf close trading today at $34.85. The original plan remains in place. We plan to hold through the dividend cycle and assuming it is still trading above $32 will likely exit the trade at near a 7% gain.

Four short puts trades were made. Three are closed for a profit, and one is still open and showing a gain.
  • Japan ETF (EWJ) $9 put – closed for a profit of .9% in a little more than a week.
  • Health Care Sector (XLV) Jan $29 puts – closed at $.39 for a gain of 4.6% in about 2 months
  • Bank of America(BAC) – first the Sept $7 puts and then the $6 puts for a gain of 5.5% in about 2 months.
  • Corning (GLW) – Initially sold Oct $13 puts for $.75 cents. Those expired worthless and put the same trade on for $13 puts in November for $41 cents. The stock is currently trading at $14.20 and the options at $.18. Looking to harvest a little more of the premium before closing the trade.
The final trade was on the materials ETF (XLB) – Initially we sold the Dec $31 puts and used those proceeds to buy the Dec $34 calls. Zero out of pocket costs. When XLB was trading higher we were able to finance the covering of the short Dec $31 puts by selling the Dec $37 calls. Received a very small credit. In option language, that was starting with a risk reversal and converting it to a vertical call spread. In common sense language that was risking less ($31) to now have a can't lose shot at making $3 or about 10%.It is nice to be sitting in a place where we are now essentially playing with the houses money. XLB ended the day at $34.45 so the spread is barely in the money. However, as stated we just need for this volatile etf to bounce back toward $37 anytime between now and December expiration and the position will turn nicely positive with nothing at risk now.

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