UnThreaded | Threaded | Whole Thread (3) | Ignore Thread Prev Thread | Prev | Next | Next Thread
Author: PaulEngr Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 46815  
Subject: Re: Update Date: 9/1/2012 8:37 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 3
Two week update...

My bullish strategy on basic materials has not changed. If anything, Mr. Market seems to disagree and has driven them slightly low again. As I said before though my strategy is to hold until at least November or December. Sold a $42/September call on CLF @ $0.52. As of today the call is at $0.23 and the stock is at around $36 so it's got a pretty good chance of expiring worthless. The spread is to the point that the call itself is definitely in the money.

Doesn't look like there's anything fruitful on NUE and given the volatility on it I don't like anything less than a 10-15% margin. On these stocks my goal isn't really to sell premium or get called away...just to create artificial dividends if the stock doesn't go anywhere. I also don't like to sell calls below $0.25 because the brokerage fees tend to negate too much value.

I re-evaluated M/I homes (MHO) as I stated earlier. It doesn't seem to be going anywhere and the runup seems to be over. So I can either wait for it to get from $19 to $20 or take my gains (~25%) and move on. Pigs get slaughtered and it's basically at my target price...so I move on. This was a value play, and a nice one at that.

Still holding NC and BTU. Sold a BTU call, $25 September @ $0.38. Right now it's at $0.10 and the stock is at $22 so it looks likely I won't get called on this one. Good because it's a buy-and-hold strategy. Target price is $35. MCP (another speculative item) moved back up to the $11 range from $10. This is basically a "holding pattern" for a stock that can do $5 jumps in a day and double or triple in a week. Need to see what Mr. Market does at the next quarterly when I expect at least a mediocre quarter when the stock is priced for another bust.

Note on selling covered calls. For stocks that I intend on selling within the next 30-60 days, I use the strike price I intend to sell the stock at or a little more. Usually this nets me another 1-2% on a stock that I was going to sell anyways. It seems like a very small amount of money but if you are going to sell within the next 30 days anyways, 1% is equal to 12% on an annual basis...well worth the time to do it. Quite often the best returns are near or slightly in the money calls which kind of gaurantees your selling. So for instance if the stock price is at $20 you may find that the maximum profit potential is selling $19 calls @ $1.50 instead of $20 calls at $0.25 or $21 calls at $0.05. In addition if you sell the $19 call then your stock will sell at anything above $19 whereas with a $20 call, if the stock drops below $20 you get $0.25 but didn't make as much money if the stock drops below $19.75. On the other hand if the stock goes above $20.50, you still only made $21.50 less your buy price no matter how high the stock goes. So you are essentially selling today and locking in a contract where you get paid in full 30 days later.

If I'm not selling soon then I'm looking at the probability of selling a covered call as a "dividend" strategy. I look first at the volatility of the stock. I'm interested in two things here. First, since I'm really not intending on having my stock called away, I don't want to set the strike price too low. Second, I need to know if it's an "up" day. If the stock price doesn't wiggle by at least 1% upward on a given day, 95% of the time the options market won't produce a return worth even considering for this strategy. So by doing this quick check I'm both setting my minimum strike prices and determining which options to check. Next, I look at 30 and 60 day or less covered calls. I ignore all calls worth less than $0.25 unless it's a cheap stock where I own a significant number of shares. Anything less than this and the brokerage fees kill the value of the option play. I take the option price and multiply by 12 (for 30 day) or 6 (for 60 day) and divide by the stock price to get a "dividend rate" (as a percentage). Anything less than around 10% is a waste of time and limits my underlying stock strategy. If I find one worthwhile then at this point I don't have anything mechanical...I simply look at the available options and sort of pick one based on my gut feelings about stock volatility, whether or not I can stand to have the stock called away (and price for it), the current market conditions, etc. If my gut tells me I'm forcing a number just to make a sale, I move on.

I do this with every stock that I don't currently have an open covered call on that I am OK with having called away and I believe is not due for a huge uptick any time soon due to forecasted events. I will also do this with any open covered call where the option price has significantly declined. In this case I set the bar even higher but the goal here is to look at whether or not I can buy back the call and sell another call with a lower strike price and collect a higher premium. The hurdle is quite high here since I'm paying brokerage fees twice so my minimum hurdle goes up to $0.50. That is, as a minimum I want to close the open option with at least a $0.50 margin (sell price/share minus buy price/share) and I still want the new option that I will be opening to have at least a $0.25 margin. So I don't even execute this strategy for any options where I sold the original option for less than $0.55.


On the dividends are king approach...I was called on an open call on SDT and looking at the chance that it will continue to hold value and the dividends continue to flow at current levels, and dumped it. There are safer alternatives. Total dividends for holding it for about 18 months was about 13%. Considering the S&P 500 during the same time did 10% and the stock price ended roughly even from where I started, I'll count that as beating the market.

Held onto KMP, RNF, and CPLP. RNF has continued to increase in value and is up almost 12% in less than a month. Again I'm a value guy and the Collective is nominally a value board so it's nice to be validated.

A quick note: I use the discounted dividend model as a way of calculating whether or not a stock is overvalued. As far as undervalued, I watch the payout ratio as well as the general prospects for the stock. If it looks likely that my dividend stream is in jeopardy then I re-evaluate at a projected lower dividend and decide whether or not to keep the stock. Right now based on a discounted dividend model the above stocks are worth...
KMP: $83, IV $85, dividends 6% with a 6% annual increase. Fairly valued.
RNF: $34, IV $54, dividends 13% with assumed 3% annual increase (pure guess). Undervalued. Stock is still worth $39 even with no increase in dividends.
CPLP: $7.70, IV $7.70, dividends 12% with no growth. Fairly valued (my discount target is 12%). Note that I bought this one with an expectation that the dividend would increase in the near future. It's a MLP so they are not allowed to accumulate a lot of cash.

New strategies are:
GM. Government Motors? Yes, that one. December calls were way up and I just couldn't pass up a stock that has been consistently running in a narrow range of $19-$22 for 4 months and before that was up as high as $24-$26. I bought at $21.77 and immediately sold a December $21 put at $1.50. This means that I make money as long as the stock does not get below $19.75. It's an election year, we're entering new model introduction season, and all my inside contacts in Detroit say they feel their jobs are secure. No dividend but I don't care...my goal is not to hold this one long enough to matter. My strategy is three fold:
1. If the stock drops to the $20 range or less, buy back the put and sell. This is a liquidation/break even strategy.
2. If the stock stays where it's at above $21 hold until I get called in December or earlier. This is where I make 10%, or annualised about 20%/year.
3. If the stock goes between $20 and $21 sit on it until the call expires and then sell, or else buy it back for pennies and sell the stock if I need the money. This is a break even strategy.

Opened HEK. Will sell for around $3.50. This is an oil and gas field services company that got whacked from the natural gas glut. It's all momentum selling since the underlying company is making good money. If I sell at $3.50, I make 30%. I will monitor for now and do a full re-evaluation towards the end of the year when natural gas prices tend to go up from the winter heating season.

Opened IPGP @ $61.50. I calculate around $85 for an IV, making 38%. This appears to be a very solid company that took a nose dive due to some financing moves which caused it to miss analyst expectations with lots of built in good things going for it. My only disappointment with this one is there is no dividend. I'll hold and sell once it gets North of $80 when it is fairly valued. My only disappointment here is that I didn't notice back in July when I could have picked it up for $40 and collected a two-bagger.

Opened SFL. Another dividend move. It's another tanker ship business like CPLP. Strategy is to hold unless price gets over $20 again in which case by a discounted dividend model pegs it at around $23 so I sell at around $23 or higher. Dividends are 10%.

For those unfamiliar with it, the DDM (discounted dividend model) is a very simple DCF. With a DDM, you assume that the company is near or at maturity and is paying out substantially all of their profits as dividends. Due to tax structures, this applies to MLP (master-limited partnership) stocks. In this situation, simply look at the dividend yield, the rate of growth in dividends, and your discount rate. You get a very simple calculation: IV = Annual dividends per share / (discount rate - dividend growth rate)

The problem with the DDM model is that it assumes infinite dividend growth rate and does not consider the financial condition of the firm at all. So when applying this model use ratio analysis to carefully look at the condition of the company. If you start getting red flags on the company, do not use DDM. This method applies to stable companies with solid finances and strong prospects of future growth. It works best for "boring" MLP's.

So basically I'm not your traditional "dividend" investor. A dividend investor after all is looking at dividend stocks essentially as a stock-based annuity. They are happy as long as the stream of dividends continues to come in or even slightly increases over time at least fast enough to overcome inflation. In my case however I'm still decades from retirement. I look at MLP's as a fairly lucrative source of investments. The major difference is that I intend on selling it if it becomes overvalued. So I not only monitor the performance of the dividends just as the buy-and-hold-forever crowd does but I also want to be aware of the stock price and whether or not the stock is overvalued.

I use 12% as a discount rate on MLP-type stocks simply because they tend to be more consistent in terms of valuation than the rest of the stock market where I expect 15%-30%+ depending on the situation. Simply put, on average I would expect 10-11% return on the S&P 500 or similar types of broad index investments. So for an individual investment to be worth something it has to have either a significant negative correlation with the stock market as a whole and return nearly the same, or else it has to have market beating results. The greater the likelihood that the investment may not work out (probability), or the longer I expect to achieve it, the greater the minimum return that I assign to it. I used to set my time horizon out at about 10 years. However over time I've found that my most conservative, longest wait has been more like 3 years with today's extremely volatile market. In other words things I expect to take 10 years actually occur in more like 3 years. So over time I've significantly reduced my time horizon expectations.
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post  
UnThreaded | Threaded | Whole Thread (3) | Ignore Thread Prev Thread | Prev | Next | Next Thread

Announcements

Post of the Day:
Macro Economics

The Future, or What's Left of It
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Community Home
Speak Your Mind, Start Your Blog, Rate Your Stocks

Community Team Fools - who are those TMF's?
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and "#1 Media Company to Work For" (BusinessInsider 2011)! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.
Advertisement