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Tom Armistead
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I'm a well-informed retail investor and post on SA in order to expose my thought process to critical examination and comment from readers. It makes me a better investor. I'm particularly proud of bullish macro articles posted in 2009 and later, in which I presented ideas that encouraged me to... More
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  • Starting To Build A Hedge

    The S&P 500 (NYSEARCA:SPY) hit a 5 year closing high on Friday. Meanwhile, VIX plummeted to 13.83, which places it in its lowest quartile. Now would be a good time to start hedging again.

    I would consider the index to be at a mid-point valuation in the 1,525 to 1,540 area. At that point, there is no compelling reason to be invested in equities, although the lack of viable alternatives in the current low-interest environment does serve as an inducement, of sorts.

    With that in mind, and SPY at 146, I placed the following trade:

    Buy to Open 1 SPY Dec 20 2014 165.0 Put @ 29.50

    The plan is, to add another put every time SPY goes up another dollar. I've had good results with this method of hedging, since I'm always buying protection at the top. The last time I did it, I more or less accidentally closed the hedge at the bottom, scoring a very nice return.

    Why Hedge?

    Here's a chart:

    (click to enlarge)

    The market goes up more often than it goes down, by a substantial margin. But, when it does go down, losses can pile up quickly. At a five year high, the market is unlikely to never look back. Congress has many opportunities ahead of it, to subject the economic recovery to the Perils of Pauline. The world is a dangerous place.

    The distant expiration, deep in the money puts perform very predictably in downturns, and can be cashed in at a profit as a source of dry powder, or to cover immediate cash needs without selling assets at a loss.

    What If?

    What if the market continues to advance, inexorably destroying the value of the steadily increasing hedge? Long positions will increase in value. Also, as the strike on the put gets closer to the money, it will pick up time value. If, for example, SPY makes it up to 165 as of the end of 2013, and volatility stands at 11, the put will still be worth $6.

    But suppose VIX makes it up to 25, not unheard of. The put will be worth $15, as an approximation, using an options calculator.

    What else?

    I made a start on transitioning my portfolio toward Dividend Growth and away from Deep Value. I have outsize positions in MetLife (NYSE:MET) and Prudential Financial (NYSE:PRU), that together represent an extreme overweight in Financials and particularly Life Insurers.

    I started scaling out, at $1 intervals for PRU and 70 cent intervals for MET. I will be out of both investments if and when they hit my target prices. For now, these sales serve as a source of funds for the hedging operation. In due course, they can be redeployed into the more conservative Dividend Growth selections, hopefully in the wake of a correction.

    Disclosure: I am long MET, PRU, SPY.

    Additional disclosure: I own the Vanguard S&P 500 index mutual fund, so I'm net long the index. The hedge is simply a source of funds in the event of a correction.

    Tags: SPY, MET, PRU
    Jan 05 8:49 AM | Link | 22 Comments
  • Abbott LEAPS Are Attractively Priced

    Yesterday I bought some ABT Jan 2014 50.0 calls for $15.60. With the stock trading at $65.47 when I got it done, the time cost at 13 cents was very reasonable. If I had borrowed money to buy Abbott (NYSE:ABT) shares, it would cost me considerably more than that in interest.

    Abbott will be spinning off its R&D based pharmaceutical business as AbbVie (NYSE:ABBV) by means of a special dividend on 1/1/2013, and the new stock is expected to start trading on the NYSE the next day. The company's shares have been trading below their historical average multiples, and the transaction represents an effort to create shareholder value by letting the two separate parts of the company find their own level.

    The company comes up on a screen for dividend growth with above average quality, and is well-known and widely covered. Checking on FASTGraphs (I'm a paid subscriber), I interpret the charts to show that ABT is undervalued. I'm estimating the 5 year return from holding the shares at 10% annualized.

    Normally, my methods would involve selling covered calls as a way of funding the time premium on the LEAPS. However, with volatility as low as it is, there is very little cost to controlling the shares, and volatility may increase after the spin-off. The options I own will become non-standard, calling for the delivery of shares of both ABT and ABBV, plus a small amount of cash in lieu, since there will be no fractional shares.

    In any event, I feel that the low cost of controlling the undervalued shares makes for an attractive investment opportunity. After the transaction completes in January, I will continue to monitor developments, and sell covered calls if either of the two companies makes an upward move. Hopefully share prices and options premiums will increase when they are trading separately.

    As a disadvantage, my broker won't accept non-standard options as coverage for the sale of calls, so there will be some maintenance requirements.

    Disclosure: I am long ABT.

    Dec 18 9:26 AM | Link | 4 Comments
  • Portfolio Review And Strategy Change

    As the market slogs along toward the end of the year, I've been conducting a strategy review and have now started to transition toward a strategy I think of as "Dividend Growth and Yield on Steroids."

    Briefly, after much experimenting with a screener, I've concluded that dividend stocks, whether high yield or dividend growth, are likely to outperform the market going forward, not so much based on total return as based on reduced volatility and lower drawdowns in declining markets.

    In order to give the strategy some pop, I'm implementing it with diagonal spreads. Rather than buying the shares, I control them by means of deep in the money LEAPS. Covered calls are sold against the resulting positions, as a way of funding the time cost, and replacing the dividend income that would normally accrue from owning the shares. I expect that this will amount to about 2.5 X leverage on the results I would achieve by owning the shares.

    Recent trades involve new positions in 3M (NYSE:MMM), Occidental Petroleum (NYSE:OXY) and Johnson & Johnson (NYSE:JNJ). Healthcare and Energy were not previously represented in my portfolio, which has been overweight Financials (insurance companies) and old Tech.

    Performance year to date has me ahead of the S&P 500 by about 7%, not that much considering the volatility of the existing portfolio. Hence the change to a less volatile type of stock.

    Many of the most profitable trades have developed to where they consist of vertical or diagonal call spreads with both legs deep in the money. I closed all but one of these positions today, on the grounds that from where they are they amount to the sale of low-cost, out of the money puts, not an activity I consider rewarding. Closed with fine profits were Chubb (NYSE:CB), Travelers (NYSE:TRV), Illinois Tool Works (NYSE:ITW) and General Electric (NYSE:GE).

    Using StockScreen123, I've combined Dividend Growth and Dividend Yield into a Screen that backtests very well for the past 5 and 10 year periods. It produces an equal weight portfolio that varies from a low of 26 to a high of 60 depending on market level. Looking at the past, it has a tendency to produce more prospects when market levels present buying opportunities. Right now, it produces 56 prospects, compared to 60 as of December 2008.

    I'm picking from among those prospects, using FastGraphs as a tool for quick analysis. I'm holding position size small, in order to get a decent level of diversification. I'm starting with sectors where I'm underweight or not exposed.

    Disclosure: I am long MMM, OXY, JNJ.

    Dec 07 12:07 PM | Link | 8 Comments
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