Long/Short XLF and C

This post describes a strategy CCI uses to try to achieve an alternate investment returned.  It deploys

• Leverage - by being long, longer term, deep ITM options (usually using LEAPS to replace being long a stock/ETF)
• Hedging - by being short, nearer term, OTM options (basically, a rolling covered call strategy)
• Pairs - these two options can be in the same underlying or in a pair of entities

This type of trade is bullish and profits when the underlying stock rises. Further, the LEAP is by its nature provides leverage to the position which means it will gain or lose more on a percentage basis as the underlying price moves around.  The obviously increases the potential reward and also the potential risk. To offset some of that risk, a nearer term call can be written against that position.  While this caps the gains it also reduces the cost/risk of the trade.

Explaining all the rationale for these positions can be somewhat involved. Over time, CCI  intends to develop a more overall, general description of this approach.  This post describes a position in-play this year. Hopefully, this example position can also be an effective way to illuminate the strategy.  Here is one of CCI's current positions using this strategy.

• In early January, CCI bought the $10 Call that expires Jan of 15 (22  months from now) in the financial sector ETF (XLF).   CCI paid  $7.04/contract.  At the time XLF was trading around $17.00.  Hence that position theoretically provides 2.4 times leverage in the holding.   Perhaps that is best illustrated by the current trade prices. XLF  closed trading today at $17.62 a gain of 3.6%.  The final bid for the Jan 15 $10 call was $7.60 a gain of 8.0%. That is a demonstrated 2.2 times leverage.
• While it is nice to have achieved that paper gain, it is important to note that the gain was only achieved because of the increased risk of the leverage.  To try to minimize that risk, CCI has sold calls against the position.  In many cases that could simply be a call in the same underlying stock/etf.  For example, selling the $18 Mar call in XLF.  In this case, as an alternative strategy CCI has been selling calls in Citigroup (C).  This paired stock was selected for several reasons including:
• C and XLF are highly correlated, in fact C is about a 6% holding in this ETF.
• In general, CCI feels the big banks may underperformed the rest of the financials sector.
• XLF strikes are $1 wide which is 6% of the underlying price.  That large distance between strikes makes it challenging to find effective covered calls.   C has $1 wide strike as well but that is just 2%of the underlying and offers more choices.
• Implied volatility in C's options is higher than XLFs.  That means C's options offer more premium when sold.  

•  CCI has successfully sold and bought back options in C in January and February for a combined gain of   $.28/contract  That adds 4% to the returns of the amount at risk on the LEAPS, but does almost double the amount of cash required for the position.  Factoring in both returns and both capital requirements results in only bumping the total return from 8.0% to 8.5%.  However, perhaps more importantly this position acted as somewhat of a hedge if the LEAP had not gone positive
• Today, CCI sold the March $44 call in C to try to add to this type of gain. 

Hopefully, that was illustrative of the approach and stay tuned for more examples, descriptions, and tracking of these type of positions.

Re-establish Weekly Covered Call in EEM

The Index Covered Call Trading Plan  (aka: ICC) is CCI's approach for managing a position of index ETFs and related covered calls.  The most recent trade against this plan is described below.  A reader can find details about the rational and management of the trades at the ICC trading plan tab on CCI's home page.

UNDERLYING ETF: EEM    

DESCRIPTION: iShares Emerging Market Shares 

TRANSACTION TYPE: Sell Call to Open. 

CCI had no covering call in place during last weeks holiday shortened week.  Late last Friday, a covered call position for this week (option expiring 3/1/13) was established.      

TRANSACTION DATE: Fri. 2/22/13
 

Action: Sell to Open
Exp. Date: Mar. 1, 2013 (one week out) 
Strike: $43.50
Price: $.28 
 

Net Credit/contract: $.27 after commissions

Do you have 54% in Alternative Investments?

This week's Review Section of Barron's quoting this study by Common Fund that said college endowment funds had an average of 54% of their assets allocated to alternative investments.   

Obviously, endowments have better access to a wide variety of alternative investments such as venture capital, private equity, commodities, etc than an individual investor.    However, my review of the press release describing this study shows over one third of these alternative investments are marketable alternative strategies such as absolute return, long/short, market neutral, etc.

Hmmm...........food for thought

•  if the smartest, leading edge investors at endowments are using these strategies aggressively

•  doesn't common sense indicate that an individual investor might want to consider understanding and deploying some of these strategies in their portfolios?

Rolled QQQ Covered Calls Out and Up

The Index Covered Call (aka: ICC) trading plan is CCI's approach for managing a position of index ETFs and related covered calls.  The most recent trade against this plan is described below.  A reader can find details about the rational and management of the trades at the ICC trading plan tab on CCI's home page.

UNDERLYING ETF: QQQ 
DESCRIPTION: Power Shares NASDAQ 100 

TRANSACTION TYPE: Roll
DESCRIPTION:  Rolled the QQQ covered calls out one week and up $.50.  The Feb.22 calls generate a modest .4% profit in two weeks  (Sold at $1.35 bought back at $1.00).  Moving out to $66.50 got the strike to closer to OTM where we would ideally would like to return the option position.

TRANSACTION DATE: Thur. 2/21/13

Action: Buy to Close 

Exp. Date: Feb. 22, 2013 (weekly) 
Strike: $66.00 

Price: $1.00 
 

Action: Sell to Open
Exp. Date: Mar.1 , 2013 (weekly, out 1 week ) 
Strike: $66.50
Price: $.88

Net Debit: $.17  after commissions

Establish Covered Calls on Bonds

The Index Covered Call Trading Plan  (aka: ICC) is CCI's approach for managing a position of index ETFs and related covered calls.  The most recent trade against this plan is described below.  A reader can find details about the rational and management of the trades at the ICC trading plan tab on CCI's home page.

UNDERLYING ETF:  TLT   

DESCRIPTION: iShares Barclays 20+ Year Treas Bond

TRANSACTION TYPE: Established March $119 Covered Call

TRANSACTION RATIONALE:  As discussed  here another covered call candidate is the long term bond ETF. As Fed. meeting minutes noise seemed to drive the price of this ETF up, CCI took that as an opportunity to re-establish a covered call position on the position.

TRANSACTION DATE: Thur.  Feb. 21, 2013

Action: Sell to Open

Exp. Date: Mar. 16, 2013

Strike: $119

Price: $0.65

 

Net credit: $0.61/contract after commission

HPQ - Earnings Trade Gone Wild

Hewlett Packard  (HPQ) reports earnings after the bell today.  Option prices for the stock are incredibly high.  More like a start-up than a dow component.  It is understandable that there is more than average uncertainty in this earnings announcement but option implied volatility over 100.....that does not seem "rational".

CCI still holding a losing position.  Here are the "wild" trades placed against half my position today with HPQ trading around $16.80

• Sold the March 16, $18 call for a $.33 credit after commissions
• Sold the Feb. 22 $17.00 put and bought the Feb. 22 $16.50 put for a credit of $.22 credit after commissions. (As an aside, something to ponder: a weekly option, with 1 day until expiration, with $.50 width strikes, with volatility over 180.   That is not your father's stock market..lol)

There are too many scenarios to document them all, but here are a few thoughts.

• CCI collected $.55 in credits... mine to "keep".
• Worse Case  - My thesis is that HPQ has missed and lower estimates so many times that management will not let that happen again....but I've been wrong about that before and could be again.  If earnings are disappointing the stock will very likely fall below the $16.50 strike.  In that case, CCI will make the $.55 form the option trade, and lose the $.50 width of the strike on the put spread.  That means pocketing a whole $.05/contract  and continuing to have the "opportunity" to hold this "blue chip" stock.
• Best Case - Earnings are received positively and the stock goes up past $18 and stays there. In this case half our position will be called away at an effective price of $18.55 ($18 price plus $.55 option credit)
• Middle Case - There are many scenarios in-between these extremes.  Scenarios where the stock manages to hover between $17 and $18 will allow the opportunity to take most of the option profits and live to fight another day.  Not a bad outcome.

Results for Covered Calls On Bonds

Like many, CCI feel that the only way for interest rates to go is up.  To me" the only debate is the rate" of the increase.  Will it be

•  a slow drift sideways/higher as the central banks of the world continue to keep the short end of the rate curve low and this stunts the growth of the long end of the curve, 
• will there be a "big  bang" moment when Mr. Market says enough is enough and rates spike.

Given the above overall belief, CCI has generally been reducing exposure to bonds.  In fact, CCI even took some short option positions in bonds which will be the topic of a future post. However, most of the reduction in bond allocation has been moving into a covered call portfolio of equities as an alternate way to generate income and lower the volatility of a pure increase of the equity allocation. 

Additionally, as another alternative,  CCI started writing covered calls against some of the remaining bond position.  This approach should work best if rates just drift sideways/lower as opposed to spiking lower.  In essence this strategy is planning on the premium from options to outpace the rate of decline from rate increases. As stated above, I'm not sure of the pace of the interest rate increases, and it is even possible I'm totally wrong and rates somehow fall more. (yes, I know it is shocking to think about it....but I am wrong from time to time...lol)

I wrote the first call against the long term US treasury bond ETF (TLT) on July 7, 2012.  For the remainder of the year nine covered calls positions were taken and closed.  The option strikes were based on market conditions, but usually written 1 to 3 weeks out in the future and about 2 % out of the money.  Seven of the option cycles were winners and two were losers for a net premium collected of 3.3%.  Unfortunately the underlying fell 3.8% (5.0% capital loss less 1.2% in dividends collected).  So these covered calls turned a 3.8% loss into a 0.5% loss. Early results for 2013 are similar.

Obviously, with perfect hind sight it would have been better to totally exit the long-term bond position, but at least this approach reduced the loss, and will generate a positive return if there is a run back the safety of treasure bonds.

 CCI will start tracking these covered calls as part of the ICC portfolio going forward.

Took Profits in HPQ Covered Calls

Long time readers will recall that CCI's portfolio  is "blessed" with a long position in Hewlett Packard.

As discussed here, on Jan 14 (one month ago to the day)  CCI sold two lots of Feb $17 calls for a credit of $.63/contract.     With HPQ trading around $17 today and 1 day until expiration, CCI closed the position pocketing a gain of $.49/contract.  A small get back on the overall loss in this position.

CCI still looking to exit this position.  HPQ reports earnings next Thursday.  CCI is considering re-establishing an option position just prior to that event.  Stay tuned.

Rolled SPY Option Out and Up

The Index Covered Call Trading Plan  (aka: ICC) is CCI's approach for managing a position of index ETFs and related covered calls.  The most recent trade against this plan is described below.  A reader can find details about the rational and management of the trades at the ICC trading plan tab on CCI's home page.

UNDERLYING ETF:  SPY   

DESCRIPTION: SPDRs S&P500

TRANSACTION TYPE: Roll the February $149 to March $154

TRANSACTION RATIONALE:  The market continues its melt up and Feb option expiration is here, so it was time to take the loss on the covered call, preserve the gain in the underlying and move out to the March expiration.

TRANSACTION DATE: Thur.   Feb. 14, 2013

Action: Buy to Close

Exp. Date Feb. 16, 2013

Strike: $149

Price: $3.42
Action: Sell to Open
Exp. Date: Mar. 16, 2013
Strike: $154
Price: $0.92

 

Net debit: $2.59 after commissions. 

 

Rolled Gold Miner Puts to June

As last discussed here  CCI continues to get portfolio exposure to gold via holding options in the gold etf (GLD) and funding that via selling puts in the gold miners etf (GDX).

Gold has continued to trade down/flat and with low volatility.   With ony two days until expiration, CCI rolled the short put position in GDX from the Feb. $44 strike all the way out to the Jun $39 strike. The closure of the Feb $44 put essentially closed the February cycle for this approach at a 4.8% loss.  On a relative basis that was worse than the 1.1 6% loss for the gold etf over the same period.  At the same time, the proceeds of the GDX Jun $39 puts were used to obtain a GLD $162 Jun. Call

One of the goals of this approach is to  "Lose less if gold does not spike".  So this approach failed to achieve this objective this cycle.  That is because the correlation between gold and the miners has broken down over the past month.  Hopefully, that correlation will revert to the mean in the near term, and this will continue to balance itself over time.   More generally, it is important to remember that a holding in gold is primarily intended to be a hedge against a global macro event that would like adversely impact the equity market.  Fortunately, that has not happened and that means the vast majority of the portfolio is up over the past months.  Hence, this loss can be "rationalized" as a cost of hedging

Enough of the "rationalizations".  CCI continues to pursue this approach and current holdings are:

• Short 3 March $45 GDX puts for every 1 long March $170 call. 
  
• Short 3 June $39 GDX puts for every 1 long Jun $162 call.
• Long Feb $162 call which is assumed will expire worthless on Friday.

Both GDX and GLD drifted up after the transaction and are closed the day trading at $41.28 and $159.02 respectively. 

Rolled IWM Covered Calls

The Index Covered Call Trading Plan  (aka: ICC) is CCI's approach for managing a position of index ETFs and related covered calls.  The most recent trade against this plan is described below.  A reader can find details about the rational and management of the trades at the ICC trading plan tab on CCI's home page.

UNDERLYING ETF:  IWM   

DESCRIPTION: iShares Russell 2000

TRANSACTION TYPE: Roll

The small cap index moves higher and higher.  With just 4 days until expiration and the option delta of 90 it was time to roll out and up to March.   The upward movement in the underlying means that the covered call contract was a drain on performance over the past month.

 

TRANSACTION DATE: Tues  2/12/13

Action: Buy to close

Exp. Date: Feb. 16, 2013

Strike: $88

Price: $2.93

 

Action: Sell to Open

Exp. Date: Mar. 16, 2013

Strike: $92

Price: $0.93

 

Net Cost/Contract after commissions: $2.09

Sold Weekly EEM Calls

The Index Covered Call Trading Plan  (aka: ICC) is CCI's approach for managing a position of index ETFs and related covered calls.  The most recent trade against this plan is described below.  A reader can find details about the rational and management of the trades at the ICC trading plan tab on CCI's home page.

UNDERLYING ETF: EEM    

DESCRIPTION: iShares Emerging Market Shares  

TRANSACTION TYPE: Sell Call to Open. 

The weekly call last week expired generating a .46% gain for the week. 

With EEM trading around $43.70 this morning, replaced that covered call position.

 

TRANSACTION DATE: Tues. 2/11/13

Action: Sell to Open

Exp. Date: Feb. 16, 2013 (one week out,happens to be the monthly option)

Strike: $44.00

Price: $.17

 

Net Credit/contract: $.156 (.35%) after commissions

Yet Another Forecast For Lower Returns For The Next Decade

This  Credit Suisse Global Investment Returns Yearbook 2013 by London Business School authors Elroy Dimson, Paul Marsh and Mike Staunton came to my attention this week.  It can be found here.  It is not a "quick read", but does contain lots of information that can be good food for thought. 

One of its conclusions is that

• Estimated annualized real returns for the next 20-30 years (i.e. the most important time frame for most of us).
• global equities 3-4%
• bonds 1%
• Of course most financial services firms will quote, and generate investment plans around, something like the historical real returns since 1950
• global equities  6.8%
• bonds 3.7%

It seems there are more and more forecast coming out like this all the time. Perhaps these forecasters (and CCI) are guilty of just projecting recent results into the future.

Or.....perhaps the demographics, debt levels, artificially low interest rates, technological innovation,etc is driving a meaningful probability of this type of forecast for the next 20 years coming to fruition.  If there is some meaningful probability of this happening, CCI continues to believe that a meaningful portion of a portfolio needs to be geared towards out-performing in this type of environment even at the risk of missing out on upside performance if the market does meet or exceed the results since 1950.  This blog will continue to try to focus discussion on those type of investing ideas.

Rolled QQQ Covered Calls

The Index Covered Call (aka: ICC) trading plan is CCI's approach for managing a position of index ETFs and related covered calls.  The most recent trade against this plan is described below.  A reader can find details about the rational and management of the trades at the ICC trading plan tab on CCI's home page.

UNDERLYING ETF: QQQ 
DESCRIPTION: Power Shares NASDAQ 100 

TRANSACTION TYPE: Roll
DESCRIPTION: Today's market pull back (QQQ under $67) provided the opportunity to roll the covered call position. This covered call had been a loser, but on the roll-out the Feb. 8 calls were able to be closed for a small profit.  (Sold at $1.13 bought back at $1.00)

TRANSACTION DATE: Thur. 2/7/13 

Action: Buy to Close 

Exp. Date: Feb. 8, 2013 (weekly) 
Strike: $66.00 

Price: $1.00 
 

Action: Sell to Open
Exp. Date: Feb. 22, 2013 (weekly, out 2 weeks) 
Strike: $66  
Price: $1.35
 

Net Credit: $.30 after commissions

Re-establish Weekly EEM Covered Call Position

The Index Covered Call Trading Plan  (aka: ICC) is CCI's approach for managing a position of index ETFs and related covered calls.  The most recent trade against this plan is described below.  A reader can find details about the rational and management of the trades at the ICC trading plan tab on CCI's home page.

UNDERLYING ETF: EEM    

DESCRIPTION: iShares Emerging Market Shares  

TRANSACTION TYPE: Buy write. 

EEM position got called away on Friday for a one week gain of .78%. 

 Re-established a weekly covered call in EEM today.

 

TRANSACTION DATE: Mon. 2/4/13

Action: Buy - EEM 

 Price: $43.85

 

Action: Sell to Open

Exp. Date: Feb 8, 2013 (weekly)

Strike: $44.00

Price: $.21

 

Net Cost: $43.65 after commissions