UDC Portfolio Q3 Results

At the end of this turbulent third quarter, CCI must report that the Utility Dividend Capture fund (description here) lost 2.0% this quarter. This is the first loosing quarter in the funds 9 quarters of existence, and hence the first time the fund has failed to meet its absolute return objective of 0% per quarter in down markets and 3% in up markets. 

The fund once again generated significant dividend income (6.85%), as planned. Unfortunately, this is the first quarter that the anticipated capital loses were not able to be kept less than the dividend income (-8.89%).

Of course the S&P 500 was down about 13.9% (fter dividends) over the same period, so the draw down was much less than that traditional benchmark. However, the utility sector ETF (XLU) still managed to eek out a 1.4% gain this quarter. Hence that would have been a better, simpler way to go this quarter.

While the fund failed to meet its idealistic, arbitrary quarterly objective (maybe I should change the objective to -2% in down quarters, ...lol) it still obviously avoided a big down draft which is perhaps the most critical element to achieving good long-term performance. Additionally, UDC is the least volatile of these three funds. (as measured by SD).

CCI plans to continue with this approach both for its return profile and to illustrate how disciplined approach might work. Below is a lot of performance data so the reader can judge for themselves the merit of this approach.

RETURNS	UDC DIV.	UDC CG	UDC TOTAL	XLU	S&P500 (DSPIX)
2009 q3	7.73%	-2.86%	4.87%	6.26%	11.43%
2009 q4	8.22%	-4.29%	3.93%	7.02%	6.02%
2010 q1	8.10%	-5.93%	2.17%	-4.38%	5.36%
2010 q2	7.98%	-7.89%	0.09%	-3.68%	-11.39%
2010 q3	5.53%	1.08%	6.61%	12.16%	11.24%
2010 q4	5.62%	-3.25%	2.37%	1.05%	14.80%
2011 q1	5.95%	-3.34%	2.61%	2.69%	5.90%
2011 q2	5.96%	-0.39%	5.57%	6.10%	-2.10%
2011 q3	6.85%	-8.89%	-2.04%	1.44%	-13.89%
Compound Return			29.09%	31.24%	25.74%
Standard Dev			4.4%	4.9	9.1

Correlations between these three funds are shown below.

• udc/xlu .74
• udc/spy .67
• xlu/spy .43

TRADE STATS	Trades	Wins	Loses	Win %
2011 q3	20	13	7	65.00%
Total	165	122	43	74.00%

"When the facts change, I change my mind. What do you do?"

Bespoke Investment Group provides a large amount of interesting, thought provoking market data.  On Wednesday 10/5 they had a post about recent market volatility.  You can read their whole post and better see their conclusion graphically at their website here . However, the key bit of info CCI found interesting was the following:

"Up 8.31%. Down 7.34%.  Up 5.34%.  Down 5.68%.  Up 7.38%.  Down 8.70%.  Up 7.34%.  Down 10.14%.  Up 6.65%. Those are the swings the S&P 500 has seen over the last thirty trading days."

That nets to a little over a 1% loss. Of course that was published before Thursday's 1.8% gain in the market. WOW. That is an exciting way to achieve .........nothing. 

I think this type of data should make an investor question their theory on equity investing.  Modern (circa 1952) portfolio  theory is based on many assumptions including that equity performance will be something like an annualized 8% gain with a standard deviation of 15.  I wonder what the SD for this zero return of the last 30 days might be? Perhaps this volatility is just unique past 30 days.  However, I'd guess ( not audited) that over the past 12 years the S&P has had something like an average return of zero with a standard deviation of 20.  So perhaps this is not really that unusual any more.

So why do so many investors blindly believe the advice from the financial services industry that says:  traditional passive portfolio theory is "good" and more active trading is "bad".  

Paraphrasing the famous quote from the title of this post:

When the underlying assumptions change this dramatically,  I change my approach to investing. 
What do you do?

HPQ - using options to trade the range

CCI is long and wrong two lots of Hewlett Packard.  CCI developed a strategy to manage this loosing position in this article.  One of the main premises of that article is that HPQ's valuation is providing some base for the stock, but it will meet strong selling resistance in the high $20s for a long while.  In an attempt to repair some of the damage from this trade and exit the position,  the article describe an initial option trade. The trade is built around the assumption that the stock would  bounce around a lot in a range between the low and high $20s. CCI has had one round trip using this strategy.


Recent volatility saw HPQ trading below $22 earlier in the week and $25 today.  (Once again an example of those "efficient and rational" markets ...lol). CCI was able to buy a lot of $24 Nov options late last week and this week sell 2 lots of Nov. $28 calls. This basically mimics the original trade described in the article.   With the high implied volatility of the options and the 2:1 ratio, the trade was established for a net credit of $.22/share.  

In "option speak" this would be considered a 1x2 ratio spread which can also be viewed as the combination of a $24-$28 vertical call spread and $28 cov calls.  From a more common sense perspective the following scenarios are in play.

- Pullback - HPQ falls back below $24 - CCI keeps the $.22 (just under 1%) to lower the losses of the position and will still own two lots of shares that are deep underwater.
- Sideways - HPQ moves mostly sideways over the next weeks ending at $26.  CCI will make $2 on the call spread and keep the option premium from the covered call and still have two lots of shares that are less underwater. .

- Rises over $28 - CCI makes $4 on the call spread, keeps the premium from the covered call, and one lot of shares is called away at $28. (My target price)
- Volatility continues and CCI will be able to leg out of  (and maybe even back in) to these option positions

Stay tuned.

Cisco - Coverd Calls......Again

CSCO hit $16.50 this afternoon. Yes, that is right. In less than 24 hours Cisco went from $15 to $16.50.  Gee...I wonder if the "value" of the company change by 10% in the last 24 hours? 
You really have to love those efficient markets that factor in all available information to identify a "true" price. ...lol
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In any event, CCI sold the  Oct $16 calls for $.78 this afternoon against our long Jan 12 option position.
Yes, that is the same trade that we just closed  on Monday.  If it worked once, why not again!

CCI still thinks Cisco is a "value" stock, but now that the overall market has moved down,  there are a lot of "value" stocks to choose from.  Some of them likely have greater growth potential than Cisco.  So we are content to have this last lot called away at Oct expiration for an effective price of $16.78, and redeploy  the capital to another trade.  Conversely, if the stock decides to retrace some of its 10% recent pop, we will also be content to skim some short-term premium off this trade......again.

Q3 Results for EEM2

Near the beginning of the year, CCI was looking for ways to more globally diversify the portfolio.  I described a portfolio of three ETFs that I felt would diversify away from the US markets but have less risk than choosing a popular emerging market ETF such as  VWO or EEM .   A portfolio of 3 small cap, international ETFS all of which focus on the emerging consumer while trying to be less dependent on China than standard emerging market etfs was developed.  The portfolio, called EEM2, is described in the article here.   It consists of a wide ranging emerging consumer etf econ and small cap etfs for Brazil brf and India scin .

Diversifying away from the US to emerging markets around the beginning of the year was a bad idea.  The emerging market etf VWO is down 25.6% this year.   Far worse than the US market.  The Chinees ETF fxi is down more, about 27.3% including dividends.  EEM2 performance was similar, but better. Down 24%. 
The performance of the Brazil and India etfs were both large drags on performance, both down well over 30%. Econ performed better (less bad) and CCI still likes the make-up of the fund.  It seems to put a focus on companies that might serve the emerging middle class in a wide variety of countries.   CCI plans to stick with this portfolio for now.  However, it is possible that we may add to the ECON position and close the Brazil and India portions for tax losses in q4.

Q3 Results for GSPY

Near the beginning of the year, CCI was looking for ways to more globally diversify the portfolio.  I described a portfolio of four ETFs that I felt would diversify away from the US markets but have less risk than choosing an emerging market ETF such as  VWO .   The portfolio consisted of country etfs from Brazil ewz, Canada ewc, South Korea ewy, and Switzerland ewl.  I called that portfolio globalized SPY (S&P500) or GSPY and rationale for those specific countries and how they might work together is described at the original article here.

Let's start with the bad news...ok really bad news.   Diversifying away from the US markets to almost anywhere else in the world as of the beginning of the year was a bad idea.   Seems like the US is viewed as a safe-haven...imagine that.

The following data includes dividends. While the S&P 500 is down around  8.7% for the first three quarters, the emerging market etf VWO is down about 25.6% .  OUCH.   The "good" news is that GSPY is down only 21.2%.  OK that's not really good news.  However,  if the objective was to move away from the US and perform better than the emerging markets then the portfolio has met its goal .  Additionally the monthly standard deviation for GSPY is 6.3 vs. 7.3 for VWO (still volatile, but less volatile). Correlation of GSPY with VWO is .98. (real high).

GSPY performance was hurt badly by its acknowledge overweight in the materials sectors of the market, and the pegging of the Swiss Franc by the Swiss government.  CCI is sticking with the portfolio for now, but will be considering adjustments and/or  tax loss selling in the fourth quarter.  

Cisco - Covered Calls Removed

With CSCO trading back down around $15.30 along with the market, CCI bought the Oct $16 calls for about $.33 after commissions to close the option position.   These calls were sold for a little over $1 about two weeks ago. The portfolio made about $.67 or 4+% on this transaction.  There was "only" about 2% left on this trade.
A small bit of green in a sea of red in the portfolio the past month.


CCI would still like to exit the CSCO position, but I think/hope there might get a chance to exit closer to the top  of Cisco's trading range.  Hence, a similar  covered call position might be reestabslished if the stock moves back up in this volatile market.

3m - adding a second lot....again.

MMM has been getting beat up the last few days.   With MMM trading down near $74, CCI stepped into the onslaught and sold one lot Oct $72.50 puts for $2.09.   A few scenarios:


Worse case  - the pummeling continues.  The stock fall below the chart support around $72.50 in the next three weeks, and CCI is the "proud" owner of a second lot of MMM shares at an effective price around $70.50.  Frequent readers will recall, we are already long one lot of MMM at $79.50.  Hence, overall we will be in the trade at an average price around $75.   MMM estimated earnings are $6.20/share this year, for a reasonable p/e of 12.1.   Analyst estimates for 2013 are currently closer to $7.  Those are probably optimistic, but at some point in time, I'm willing to bet that MMM will ultimately grind its earnings upward towards $7 per share in earnings, and/or get some multiple expansion.  If the stock is put to me, I'm comfortable with a cost basis of $75.  Perhaps q3 earnings in late October can provide a short-term catalyst, but I'm prepared to just sit on the trade, collect the 3% dividend and wait for better days for this blue chip stock. 

Best Case - The stock holds $72.50 support and/or bounces back after the quarter end.  Then CCI can pocket some or all of the nearly 3% option premium over 3 weeks.   With this volatile market, it is even possible that MMM trades back towards $80 in the short term, in which case we will consider taking the other side of this trade and selling calls against the first lot.

"Reverse Hedging" via Gold

Gold is suppose to be the uncorrelated, hedge against just about anything; including a stock market fall.  Unfortunately for anyone hedging equities via gold for the past week, that hedge has not worked.  The price of gold has fallen generally in lock step with the market this week.  It always seems challenging to determine what is driving the price of gold. Usually some government policy decision du jour is the rational for the change of price.  However, it see right now it seems like in the short term the price is either being driven by some big players selling to raise cash (meet margin/redemptions) and/or the technicians driving the price to fill the gap on the charts.  

Whatever the reason, the momentum in gold has been down and CCI just decided to try to go with the flow.  Successfully traded the double short gold fund (GLL) for a 2+% gain.   12-0-5 on trading double shorts this year.  

"reverse hedging".....yes..... I just made up that oxymoron.   Hmmm.. perhaps I should trademark it before someone on wall street decides to create an etf that does it.....lol

Boeing - Crash Landing or Just Some Turbulence?

Always nice to see those "rational" markets plunge straight down in the past 24 hours.
Are we having fun yet???

* * *

Boeing (BA) stock came crashing down about 5 % to $58  with the rest of the market today.   I assume largely because of concerns that if Asia slows, the demand for aircraft will slow down.   Or possible competition for new plane orders from Airbus is of concern.  Or.....who knows?  Conversely, Asian carriers and their governments likely see improving their air travel as a cornerstone of advancement and probably won't rush to cancel orders, and Boeing remains a very unique company in the world (i.e. not many plane makers left),

With the market hitting its alleged support at S&P 1120, I took the "bold" move of stepping into the blood bath by added my fourth and final lot of Boeing.  I decided to add this lot via a little option leverage.  Sold the Jan 13, $50 puts and bought the Jan 13 $65 calls to create a synthetic long  for nearly a $.50 credit.

Some scenarios
- In the most unlikely scenario,  the stock stays between $50 and $65 AND CCI just sits on this position for 15 months we will make 1% (a rate far better than cash)

- 15 months from now, Boeing has crashed down another 15% (below $50) and we will start loosing money.
- 15 months from now the current market action will have just been turbulence.  Boeing will be fulfilling their backlog for new planes, still be a company with one-of a kind abilities and trading well over $65.  In this case, since the portfolio only has $50 at risk,  profits will start to grow in a leveraged manner.