The Covered Call DGI Portfolio - June 2016

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Includes: ETE, T
by: Donald Thompson Jr

Summary

New Portfolio Goal - invest $500 a month in dividend stocks.

Using covered calls to boost income.

Use of options to hedge portfolio risks.

As a contributor to SA, I felt the need to start a new portfolio with the sole purpose of using quality dividend stocks to write covered calls to boost income. Since I have a lot of experience with options, I will use them accordingly to boost returns and hedge from market risks. This portfolio will have $500 of cash invested into it on a monthly basis. Premium from option writing will not be included in that monthly cash contribution. Any form of option trading will also be used to further purchase more dividend stock. All dividends will also be reinvested for the length of this portfolio. If cash is removed from the portfolio it will be stated at any time.

I officially started the portfolio on June 26th 2016. My first purchase was 200 shares of Energy Transfer Equity (NYSE:ETE) using a buy-write strategy. Performed through TDAmeritrade, I was able to buy 200 shares while simultaneously selling 2 July 15th 2016 $15 strike calls for $84. This lowered my share cost as well as lowering commissions paid since this is counted as one transaction. My basis for buying Energy Transfer Equity can be read here. I plan on using this stock as an income producing tool since the option premium is very high. A high dividend also should provide nice returns. I see ETE breaking past $15 by the end of the year. If Energy Transfer Equity does not break past $15 this year, the income produced from selling the particular call I sold would be $1613.69. This is good for an annualized return of 57% not counting dividends or any capital appreciation. Obviously this is an extreme case and not all stocks have such juicy option premiums.

I also bought 25 shares of AT&T (NYSE:T). My reasoning for this purchase and in depth analysis can be read here. This is a stock that will be a stalwart in this portfolio. Once the position gets large enough to write calls, we will do so only when the stock is overvalued. AT&T has performed very well for us in the short time span of us owning it. I believe that this stock will continue to be strong for years to come. AT&T will be a stock that only has a covered call written against it when it becomes over valued. Unfortunately at 25 shares in the portfolio, we do not have enough to sell a covered call just yet. Once AT&T reaches $50 a share, I will write covered calls once I reach 100+ shares.

Covered Call DGI Portfolio
Ticker Shares Cost Basis Mkt Value $ Gain % Gain Yearly Dividend Yearly income
ETE 200 $2802 $2988 $186 6.64% 1.14 $228
T 25 $1043.75 $1070.75 $32 2.59% 1.92 $48
Total $3845.75 $4063.75 $218 3.92% $276

Income for June 2016

Ticker/Trade/Cash addition Income
ETE July 15th call -2 $84

This portfolio also currently has a bear call spread option open for August 19th 2016 219/220 strike. The structure and reasoning for that trade can be read here. If that trade is successful, it will provide another $534 in profits to this portfolio. It is currently $283 in the profit. As a trading rule I take profits when it reaches the 75% max profit threshold. I use spreads to produce short term profit that can be used to purchase more stock.

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 (27 years old), I like to follow Warren Buffets rule of "Protect Precious Capital".

Not Without Weakness:

Two major issues 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 selling 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 new portfolio worth your time. As a young investor, I am putting in over 15 years worth of investing knowledge and expertise into this venture. The end goal is to create a portfolio which can supply a 6 figure income in twenty 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. July is already shaping up to be a good month of profits from our bear call spread trade. Goals for this portfolio is +15% yearly returns until we reach a yearly income production of $100,000.

Disclosure: I am/we are long T, ETE, SHORT SPY THROUGH BEAR CALL SPREADS.

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.

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