An Updated Enhanced Income Investing Strategy For BlackRock

Jan. 3.12 | About: BlackRock, Inc. (BLK)

By Mark Bern, CPA CFA

BlackRock (NYSE:BLK) stock remained above our target price in our first attempt to purchase the stock through the use of our strategy. Those who read my first article on BLK (here) will recall that we picked up a $309 profit in less than one month without buying the stock. That amounted to an annualized return (calculated by a method explained in the initial article of the series which is linked in the next paragraph) of 21.5%. If that sort of return is of interest, please read on to understand how we achieved it and how I intend to achieve more of the same on BLK in the next few months.

Let me begin with a detailed explanation of the strategy that can be found in my original article that I used to initiate this series (here). As you will see in the conclusion of this article, you may be able to collect in excess of 9% annually in cash while holding BLK stock. You may also get paid 8% to 10% in cash in your account while you wait for a better price. If you find the returns mentioned in this article intriguing, I suggest that you take the time to understand the full strategy by reading that prior article.

I should point out that I make use of options, but in a very conservative fashion. Approximately 83% of all options contracts expire worthless. That is why I do not recommend, as part of this strategy, to buy options. I only sell options myself because that is the side of the contract that wins 83% of the time. I like the odds to be in my favor. But I also don’t sell options just because of the odds, I do so with a purpose: To buy great stocks with rising dividends at a discount and to collect extra cash income while I hold those same stocks long-term.

My objective is to create at least 8% per year in cash payments from a combination of dividends and option premiums each year in addition to the long-term appreciation that quality stocks provide. I believe that a 15% total return is achievable and that is what I intend to demonstrate over the next two years with this series. I should also remind readers to never, ever sell put options on a stock that you don’t really want to own. If it’s a stock that you would buy anyway, great. otherwise don’t fool with it.

On October 20, 2011, the price of BLK was $152.16 (all prices and premiums quoted are as of the close of the market on that day). We sold a November put with a strike price of $140 for a premium of $3.10. We received the $310 (one contract equals 100 shares; $3.10 x 100 = $310) less the commission of $9 for a net of $301 return on cash in our account held to secure the put option contract until expiration of 2.15%. That works out to an annualized return (using the method explained in detail in the original article linked in the above paragraph) of 21.5%. These numbers are slightly different from the first article on BLK since I used the stock price instead of the strike price to calculate and didn’t use my own methodology for annualizing the return. Please accept my apologies for any confusion this may have caused.

Had the stock price dipped below $140 and held there through the expiration date we would have been put the stock, or obligated to buy 100 shares of BLK at $140. That would have resulted in a cost basis of $136.90 ($140 less the premium of $3.10). Not bad considering that the price of the stock on the day we entered into the trade was $152.16. But we didn’t get the stock, so we need to put that money, plus our gain, back to work again.

Right now I like the April 2012 $160 strike put option contract with a premium of $7.80 ($771 net of commission) which provides us with a simple return of 4.8% on the trade over the next four months. I only need one contract to balance our portfolio’s diversification. When we annualize the rate we find that we have locked in a 14.4% return on our cash. If the stock drops below the strike price of $160 at expiration we will be obligated to purchase 100 shares of the stock at $160 per share. This means we will need $16,000 of cash in our account to secure the contract. Obviously, we really only need to have $15,229 (also covering the commission) in our account before the trade because we can use the $780 received from the option premium received to make up the difference. Our cost basis would be $152.20 ($160 - $7.80). This price is still very near the price we would have paid on the original trade date back in October of $152.16 and substantially below (15% discount) the current price of $178.24.

I hope readers are enjoying the series and that you are just as interested to see how this experiment all turns out over the next two years. One last caution and I already said this once in this article before but I feel it is important enough to repeat. Unless you really, really want to own a stock don’t sell puts on it. Selling puts on stocks because of the premiums available only is the worst way to make a decision and usually ends up losing money. I use stocks in my strategy that I like and want to own for the long term. If you haven’t read the summary article with results compared to a buy and hold portfolio that article can be found at this link here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.