The Covered Call DGI Portfolio - July 2016 Update

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Includes: ETE, PSEC, SPY, T
by: Donald Thompson Jr

Summary

Our portfolio made 13.04% returns for the month of July.

The new position in PSEC.

Our ETE position was called away.

Welcome back to the July update of the Covered Call DGI portfolio. July treated us well in the overall scheme of things. While the main priority of this portfolio is to use covered calls to boost income, I will venture off into other types of investments if I do not see any value in the market worth my time. The portfolio started with $5000 in cash. I also added $500 this month to the overall cash position.

New Additions

This month, I added Prospect Capital Corporation (NASDAQ:PSEC) to the portfolio. While yes, we realize that this is not your typical stock used for option writing, we believe that it is currently undervalued. At the end of March, the net asset value stood at $9.61. Based on Friday's close of $8.38 per share, the stock currently trades at a 14.6% discount to book. PSEC also pays a very lofty dividend. I added this position for both the capital appreciation and the 11.96% dividend yield. We have no problem waiting for this stock to appreciate while receiving a monthly dividend. I am sure some people believe that the dividend is not sustainable and at risk of being cut. Since this company is a BDC, it must pay out 90% of taxable income in the form of distributions. For the 2015 fiscal year, PSEC generated $1.31 of distributional income while paying out $1.19 per share. Based on those numbers and the quarters since then, I see no risk in the near future for a dividend cut.

The Covered Call DGI Portfolio

Ticker Shares Cost Basis Mkt Value $ Gain % Gain Yearly Dividend Yearly Income
PSEC 400 $3319.96 $3350 $30.04 .90% $1.00 $400
T 25 $1043.75 $1082.75 $38.50 3.69% $1.92 $48
Total $4363.71 $4432.75 $68.54 1.57% $448
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Income From Portfolio - July 2016

Dividend/Ticker/Trade/Cash Addition Income/Profits Taken
ETE Option Called Away $250.84
219/220 Aug 19th SPY Bear Call Spread $332.93
Cash Addition $500
Click to enlarge

Between the trades we completed and capital appreciation of stocks, we posted a gain of 13.04% in just 35 days. We started the portfolio with an even $5000 and currently have a portfolio value of $6152.31. Not bad for a 5 weeks' worth of work! If you have noticed, we have not added to the AT&T (NYSE:T) position at this time. However, we may look to add in the month of August depending on how the market reacts to this week's economic data.

For the month of August, we will collect dividends on both of these stocks, which will be reinvested into the security.

Sold Positions

I sold out the rest of my August 19th SPY 219/220 bear call spread due to the sudden uptick in market prices. Sometimes, it is best to just take the money and run. While I am breaking one of my rules of the "75% or more," the recent run-up in the S&P 500 was surprising (and unwarranted, but that is an entirely different story). Feeling that it could run higher, I pulled out of the position and took what the markets gave me.

Energy Transfer Equity (NYSE:ETE) had a strong run-up from the original price I paid for it. This resulted in the stock being called away from us for $15 a share. At the time the stock was called away, ETE was trading in the mid-$16 range. Unfortunately, I was down in Disney with my family and did not roll the option out or up. Just like our SPY bear call spread, when the market hands you profits in uncertain times, it is just best to take it. That is my method of trading and investing, risk management first and profits second.

Strengths of this Portfolio Strategy:

The biggest strength of this portfolio strategy has to be boosting income through covered call writing. The ability to double or triple your yield (above dividends received) can grow a small portfolio very fast. While some stocks provide a very high option premium, be reminded that they do so at the risk of higher volatility. Another strength of this portfolio is the ability to hedge your long positions by using options. By using collars on certain stocks we own, we can minimize portfolio losses during down times. When the economy is generally weak we can sell bear call option spreads, which will produce income. All of the trades we perform in this portfolio will be based off of risk management first and maximum returns second. Even though I am a long time away from retirement (28 years old), I like to follow Warren Buffett's rule of "Protect Precious Capital."

Not Without Weakness:

A major issue with a portfolio that uses options is the tax implications it has at the end of the year. Since options are a short-term tool, any profits or losses will be counted as short-term gains. Depending on your tax bracket, you could lose a good amount of your gains on options trading to Uncle Sam. Also, when you write a covered call against a stock and it is assigned, please be aware that this counts as you sell the stock. How long you have held the stock will determine how they will qualify the taxes you owe. Another weakness, which can be managed, is selling covered calls on a company that is rallying or trending. If a stock rises past your strike price you sold, you still sell the stock for that set price. This will make you lose out on possible capital appreciation above and beyond the strike price. One way to protect your long-term interest is to only sell covered calls on a stock you have no problem selling. If you do not want to sell the stock, then you should not write a covered call against it. Remember, this portfolio is mainly a dividend growth portfolio. We only use options to boost our returns in flat and down markets, or when a stock is done rallying and will retreat in price.

Conclusion:

I hope many of you find this portfolio worth your time. As a young investor, I am putting over 15 years' worth of investing knowledge and expertise into this venture. The end goal is to create a portfolio that can supply a six-figure income in 20 years. All stocks for consideration on this portfolio will be deeply analyzed and published for your knowledge. Along this journey, I will cover option strategies for any risk appetite to boost your income and returns. August is looking like it could be a struggle for the markets, I guess only time will tell. Goals for this portfolio is +15% yearly returns until we reach a yearly income production of $100,000. July was a wonderful month for the portfolio - hopefully August will be the same.

Happy Investing!

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All thoughts, ideas, trades and analysis are for information purposes only. I/We are not held responsible for any trades or investments the reader makes. All investors should perform their own analysis and determine what is right for their portfolios.

Disclosure: I am/we are long T, PSEC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We may in the next 72 hours open a options trade on VXX and/or USO