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I will tell you all upfront, I'm new to both DGI and options, so definitely don't take any of this as investment advice. It's just documentation of what I'm doing, and from that I'm hoping to learn more through your comments.
I retired mid-2015 at age 60 following a voluntary layoff after working 36 years for a large aerospace company (formerly headquartered in the PNW). I'm very fortunate in that both the wife and I have pensions and the company supported a great 401 plan which we both participated in. That 401, which had limited fund/stock choices, plus some company stock options, were my sole investing experience prior to retirement.
I had been reading Seeking Alpha (SA) and other sources for a number of years prior to retirement and eventually decided I preferred a DGI approach. Being already retired, I'm a bit late to the party to initiate a DGI portfolio in order to get good compounding but a ten year window is acceptable. We will be relying on our pensions for majority of living expenses and possibly take either one or both of our social security benefits early. Still working through the analysis on the social security schedule. I believe even starting this late with a DGI portfolio will help mitigate sequence of return risk for the inevitable correction. Additionally, in order to satisfy several years' worth of liquid needs, I keep a portion of our 401 in a stable value fund that has minimal risk and a modest return, to minimize sequence of return risk.
Using SA, I developed a list of about 60 stocks that were common within other SA member's DGI portfolios. Those stocks became my initial watch list and I planned to build a portfolio with 20 to 30 stocks from that list. I developed a draft investment plan which included investment requirements including target yields, holding sizes, portfolio mix, etc. I also subscribed to F.A.S.T. Graph to assist with valuations.
As we all know, the market has been on a tear for a few years now, and the general belief is that sometime soon ("soon" is a variable moving target) the music is going to stop. There is a diverse opinion on SA between time in market and buying at the current rising lofty valuations or keeping powder dry for the inevitable correction. That created a dilemma for me trying to establish a new DGI portfolio.
In the meantime I had been to some free Options Industry Council (The Options Industry Council (OIC)) classes, taken a few other options training courses, and read a lot of articles on options on SA and from other sources and gradually concluded I should try selling PUTS to establish a base portfolio at a reduced cost, or at least get paid while waiting.
I must confess here in that I'm pretty lazy on the research and due diligence side. If an SA author, especially one of the more "respected" contributors, writes a particularly convincing article, and gets a large number of supporting comments, I will consider it and do a little follow-up research using F.A.S.T. Graphs (F.A.S.T. Graphs - Fundamentals Analyzer Software Tool), additional SA articles, and NASDAQ (www.nasdaq.com) and Dividend Channel (Stock Options Channel) websites. My original plan was based on certain criteria I developed from other SA writings; focusing on Dividend Champions, dividend yield of around 3%, growing dividend yield, etc. However I quickly found out that most of my target companies were 1) highly overvalued, and 2) provided minimal option premiums. As a result, I became more reliant on SA recommendations for companies that were not on my target list but wouldn't be bad holdings, and offered both decent option premiums, satisfactory dividend yields, and potential covered call yields should they get PUT to me. As a result, my PUT target list expanded from those stocks I truly want to hold in my portfolio, to also include some temporary holdings that fit some of my criteria, but had decent premiums.
Finally, in April 2016, I opened a Fidelity account and rolled over a $100k into a tax deferred account which gave me 500 free trades for a 2 year period (Note: they still charge ~$.05 per lot for option trades) - as such at least for another year I don't worry about commissions. I created a set of Excel spreadsheets to evaluate PUT opportunities for various companies by month. An example is provided below:
(Spreadsheet created by author)
In my full model, there is another table to the right for the next available option month (Sept. in this example) so I can compare returns for different expiration dates.
Green cells require manual inputs, tan cells are calculations, and the blue is just a highlight. Data comes from NASDAQ, F.A.S.T. Graphs, and the Dividend Channel.
The top portion of the spreadsheet is basic data, and comments regarding my decision process. In the matrix below, the 1st column is the strike price, while the 2nd column calculates effective cost if PUT (strike - premium). The Option Boost column compares the PUT premium value to the current dividend while the Premium Yield column calculates the total Premium / total Lot Buy Cost. One of my criteria is for the option return to be equal to or greater than what the dividend would have paid for the same period. The next column in blue just converts the Premium Yield to an annualized value using the calculated number of days from the tan cell above it. The next couple columns provide various dividend yield calculations and are sort of gee-whiz values. The last column is the Dividend Channel's assessment of probability of being PUT.
Shortly after I opened my Fidelity account, Brad Thomas had written a promising article on KIMCO Realty (KIM) and a significant number of SA members joined in w/ support. Not on my target list, but it sounded like the perfect initial PUT. The May17 PUT, with a strike of $22.5, was relatively low cost so I wasn't risking much if I messed up my 1st ever trade, had a dividend yield of 4.8%, 4.9% on my effective price if PUT, paid a $65 premium and had an immediate yield of 2.9% for one month (~29% annualized). NASDAQ was showing a $22.50 one year target, 52 High/Low split was $22.77, and F.A.S.T. Graphs had a FMV of ~$25.50. It seemed everyone loved KIM and the numbers were OK so what could go wrong?
Turns out that was about the time that malls fell out of favor and at expiration I got PUT a stock valued at $18.55 for which I paid $22.50 less $.65 per share for a net of $21.85 - a paper loss of $3.30 per share. As I write this it's around $16 and change. Not the start I expected but I figured I would: 1) get decent dividends; and 2) start selling covered calls to earn some additional revenue. My KIM PUT also gave me another educational opportunity - stocks that have fallen as fast and far below the effective price I paid do not offer stellar CALL premiums. Almost a year later and I have yet to write a CALL on KIM. My first attempt with options was off to a less than admirable start.
However, also in April, still being naïve and obviously prior to having any results yet of my pending option success with KIM, I also sold PUTS on Chevron (CVX), TROWE Price (TROW), Omega Health (OHI), AT&T (T), Exxon (XOM), and General Motors (GM). Total premiums for those picks were $932. A summary of the year's efforts is included in the table below.
(Spreadsheet created by author)
In the above table, the rows highlighted in tan are stocks that eventually got PUT to me while those in light blue are PUTS that expired for which I received the premium with no obligation. The white rows are current open options. You can see I target a lot of little returns, looking for the accumulative return, as opposed to large value premiums. I will need to rethink my trades when I need to start paying commissions.
The 1st Green column is either actual stock price at closing or if in red, current price. The 2nd and 3rd green columns are highlighted in red and show how much I "overpaid" either the strike price vs price when PUT, or my effective cost (strike less option premium) when PUT.
The Net PUT Premium column summarizes total PUT premiums received to date of $4,548.68 which includes $199.90 from this year (2018). On the surface, an approx. 4.5% yield ($4,549/$100,000) for a partial year is something I wouldn't be to unhappy with, especially since I took August, Sept, and most of October off to go fishing every day. Annualized that would be close to 9%. Normally I would be ecstatic about that kind of return but it is nowhere near what the balance of my 401 is providing, but then I'm trying to create a more defensive DGI portfolio and protect myself from risks the 401 is subject to.
However, I took a paper loss of $4,094 on the stocks I was PUT if you compare strike to market at closing, or $2,735 loss on effective cost (strike less option premium) vs market. I ended up getting PUT 7 stocks, 4 of which were on my target portfolio list, and 3 (KIM, Grainger (GWW), and Penske Automotive Group (PAG)) were strictly option plays. On paper, my cash inflow of $4,549 offset with either the $4,094 or $2,735 doesn't look so bright The supposed "beauty" of being PUT stocks is that while you overpaid for them, you didn't overpay as much as if you had bought them outright when you made the initial trade. Not sure that's a great consolidation!
Part of my "plan" was to write covered calls on stocks that were PUT to me, especially on those that were not part of my target portfolio. I built a similar spreadsheet for CALL analysis as I had done for the PUTS. An example is included below. I've only written 5 CALLS to-date for a total of $440 in premiums. GWW was called away after some crazy pricing action during which I netted a total of $1,750. Not too shabby for a stock that wasn't on my list that I only held for 4 months. Percent return for the 4 months was $1,750/$18,000 strike equals 9.7%. Of course, the down side to covered calls was I could have sold it outright instead for $223 per share, assuming perfect market timing, and netted $4,300 plus the PUT premium already in hand.
(Spreadsheet created by author)
My option activity is not passive, I usually spend an hour to hour and a half every weekday going through Seeking Alpha and other sources looking for potential PUT targets. Additionally, Fidelity puts a hold on my account for the value obligated funds if PUT, and that value changes daily with the current stock price. As such, I have a limit of how much I have to use for options and need to keep a little margin available for fluctuations. I try to maximize the number of active options to keep the money working, but that has caused me to miss some good opportunities (i.e. - higher premiums on higher priced stocks) due to insufficient cash on hand for larger potential obligations.
The goal (remember the goal?) was to build a DGI portfolio. I acquired 7 stocks but had one called away. Once those stocks were PUT to me I became eligible for dividends. To date my little portfolio has also been paid $616 in dividend income as follows:
Altria (MO) $0 (missed ex-div by 4 days)
GWW $256 (rec'd 2 quarters before being called away)
OHI $0 (Just PUT in December)
Only a small portion of the dividends have been used to buy additional shares so far. Of the stocks listed above, only MO, T, XOM, and OHI are part of my target DGI portfolio.
My Fidelity account shows a balance of $105,634 which takes into account the $4,549 PUT premiums, the $440 CALL premiums, the $1,750 GWW sale, the $616 dividends, and the offsetting paper loss on strike price vs PUT price. That nets out to 5.6% since April, including a few months when I wasn't active and was out fishing around. My target for a DGI portfolio is >3% for dividends so I am exceeding that, but I don't have much of a DGI portfolio yet to show for it. If I compare this return to that currently being received in the 401, my little experiment cost me about $15k. That's not optimal but then again, many SA writers point out that most DGI portfolios, at least those made up of dividend aristocrats, don't keep up with the market during intense growth cycles, but outperform when the market crashes. I'm hesitant to buy stocks at the current valuations with the widely expected potential market correction, yet at the same time if a major correction were to happen now, I would be PUT a number of stocks that I'm OK with, but are not my preferred targets. With the current market action on most of the stocks, on paper anyway, I would be way ahead right now if I had just bought them outright albeit at an overvalued price. Also I would have had to have a lot more funds committed.
So I think my experiment was not a screaming success, nor a dismal failure. I've learned a little and had an interesting and enjoyable time doing it. When the correction comes I will need to be more prudent in my selection of PUT opportunities as the likelihood of getting PUT will increase. I'm also working to establish better target metrics and trying to increase my knowledge on the Greeks, volatility, etc. Thank you for reading my ramblings on this experiment. I certainly would appreciate any reader's thoughts and comments.
Disclosure: I am/we are long MO, T, XOM, KIM, OHI, & PAG. 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: I have PUT and/or CALL options on ABBV, BAC, CSCO, CTL, GE, HBI, LUV, MO, OHI, PAG, PG, PM,SKT, & UNIT