Building A Capital Preservation And Income Portfolio, Part 7

Includes: CVX, NLY, TE, WBA
by: Mark Bern, CFA

By Mark Bern, CPA CFA

<< Click to view Part 6

In Part 5 of this series I introduced the concept of selling call options to enhance the income from a conservative, dividend-paying portfolio. For the detailed, simply to understand basics on that strategy please review "Part 5." The emphasis of this series remains buying and holding stocks that will preserve an investor's capital while throwing off a decent dividend income stream. Parts 5 through 8 are for those investors who would like (or need) to earn more than 3.8% from their portfolio. The objective of selling call options is to increase that income to a range between 8% and 10% per year.

This article will simply concentrate on the four companies first recommended in "Part 2." Those four companies are NLY, TE, CVX and WAG. If you haven't read Part 3 of the series what you will find there is my reasoning behind why I want to own each of these stocks. The whole series began, of course, with "Part 1." In Parts 5 & 6, I only recommended two recommended call options to be sold due to the low premiums available at the time of the articles. I intend to provide updates, probably in the comment section of each article if there are call options with premiums that meet my requirement available on a particular day, so if you are interested in that feature I would suggest checking the box at the top of the comments section to be notified whenever a new comment is made to the article.

Annaly Capital Management (NYSE:NLY) is a mortgage REIT, or mREIT as they are often called. The company invests primarily in agency-backed mortgages, borrowing at lower, short-term rates and profiting from the interest rate spread. The current price of the stock is $16.57 (all quotes are as of the market close on Thursday, February 16, 2012) and the dividend is $2.28 per year, providing a yield of 13.8%. This is another one that rarely offers a good premium on calls, especially in a low-interest rate environment. The dividend and the stock price will likely trend lower over time due to reduced revenue resulting from prepayments. So, this one is a bit different from the other companies. It is a well-managed company but it is more subject to movements in interest rates that the others. The only call that might make sense here is a longer-term play such as the January 2013 call with a strike price of $15 and, even then, only if the premium were more than $1.58. The strike price and the premium added together almost equal the current price, which means there is no time premium. I'll continue to watch this one but am not very hopeful of finding a call option to sell. This one was added to the portfolio with no thought of selling calls. This is purely a yield play. I recommend holding the stock and collecting the fat dividends.

Teco Energy (NYSE:TE) is a Florida electric utility that owns its own coal mine. The stock is currently priced at $18.04 per share and pays a dividend of $0.88 annually to yield 5.0%. There are no call options with adequate premiums on Teco and I don't expect any unless something changes in the company's unregulated business to create some volatility. This is primarily a growth and income investment for long-term investors who need income that will grow faster than the rate of inflation. My recommendation on TE is to hold tight and collect the dividend.

Chevron (NYSE:CVX) is a major integrated oil company. The current stock price is $106.52 and the dividend is $3.24 per annum providing a yield of 3.0%. The stock has been as high as $110.99 and nearly breached the $110 level four times this year before finally breaking through on January 3rd. This level has provided a significant resistance level for CVX and I would like to sell calls on this stock when the stock price gets closer to that level once again. It made a nice move today so let's watch it for a few more days before taking action. For now, my recommendation is to hold the stock and collect the dividends while we wait for the right opportunity to sell calls.

Walgreen (WAG) is the largest retail drug company in the U.S. CVS has more revenue in total, but not as much from its retail outlets. I mention that here because it seems to come up every time I write about WAG. The stock took a tumble with the rest of the market during the late summer months but did not rally along with the broader market due to a contractual disagreement with Express Scripps. The two have parted ways causing WAG revenue to decrease. But this is a solid company and I continue to believe that the divorce has created a buying opportunity. I believe that most investors will wait for 1st-quarter earnings before there is significant upside movement in WAG stock. I like selling the April call option contract (expires on April 20, 2012) with a strike price of $36 and a premium of $0.92 (Bid) and $0.94 (ask). Assuming that we are able to sell a contract at the bid price we will collect $92 when we sell the call and net $83 (after commission) for a return of 2.42% for two months, or 14.5% annualized. My recommendation is to sell the April $36 strike call option for a premium of at least $0.92 per share.

In summary I am making only one recommended call option sale on WAG. In retrospect, I may have decided to write these articles a week or two later than I should have since the market seems to be trending lower and may not provide the opportunities to sell calls that I had hoped. We'll just have to see what tomorrow brings as the volatility seems to be rising and things could change quickly.

>> Click to view part 8

Disclosure: I am long NLY, CVX, WAG. I am also considering selling puts on TE in the very near future.