Seeking Alpha

Option Generator's Portfolio Review: January

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Includes: C, CELG, CSCO, INTC, JNJ, MU, RDS.A, RDS.B, T, XOM
by: Option Generator
Summary

January was a good trading month, as I looked to take advantage of attractive option premiums. Our portfolio value increased by 11.35%.

In total, net option premiums received amounted to €16,573.

Also, we set our investment goals for 2019.

Introduction

Back in 2018, I started to learn about covered-call writing and selling cash-secured puts. The first one is embedded the best in my short-term trade setups, while the latter is applied occasionally depending on the market circumstances. Although empirical research has shown that selling calls against an index underperforms a buy and hold portfolio, I do believe that a portfolio tailored to your own risk tolerance will beat the market over the long haul, as long as you select individual names with great fundamental and technical conditions.

It's a new month and so once again it's time to evaluate my trade setups highlighted here on Seeking Alpha, and my own portfolio performance. In this article, I will also investigate whether I am on track to meet my investment goals for 2019.

January Trade Setups

Over the past month, I've outlined different model trade setups, but none of these option contracts expired in January. That's why I will be assessing the intermediate profits/losses.

Article Date Stock Days Active Expiration Date
1/10/2019 Exxon Mobil (XOM) 21 days 3/15/2019
1/14/2019 Cisco (CSCO) 17 days 2/15/2019
1/15/2019 Intel (INTC) 16 days 2/15/2019
1/15/2019 AT&T (T) 16 days 2/22/2019
1/17/2019 Celgene (CELG) 14 days 6/19/2020
1/17/2019 Citi (C) 14 days 2/15/2019
1/21/2019 Royal Dutch Shell (RDS.A) (RDS.B) 10 days 2/22/2019
1/24/2019 J&J (JNJ) 7 days 2/22/2019
1/27/2019 Micron (MU) 4 days 2/22/2019

(Source: Author's work)

As one size doesn't fit all, I constructed these setups in two different ways: selling in-the-money calls to get an insurance policy on top of our maximized time value returns, and selling at-the-money or out-of-the-money calls when the chart technicals are strong, allowing you to get your hands on additional but limited upside potential. Depending on which type of investor you are, annualized returns will vary from individual to individual.

Below, I've inserted the profits/losses these trade setups have generated so far. Returns from selling covered calls continued to exceed those from holding the stocks.

(Source: Author's work)

AT&T: Selling New Calls With A Lower Strike Price

As you can see, AT&T and Intel shares have dropped below their break-even levels over the past month, while the option contracts against Cisco are now slightly in the money. Since covered-call writing is not a static event, we need to determine whether there are possibilities to generate more income streams.

Let's focus on AT&T right now. Due to its weaker share price, the option contract sold for $0.24 has depreciated significantly and we now face a loss on the stock side. What can we do to lower our cost basis and turn a loss into a profit? Well, rolling down will allow us to generate a higher premium than the cost-to-close. I've selected the $30.5 call that expires on March 1, 2019. As depicted in the table below, our break-even level is now $30.0 for the shares we've already purchased.

(Source: Author's work)

By mastering this covered-call writing principle - namely buying back the option and selling new contracts with a lower strike price - we've lowered our cost basis and turned a loss of 0.10% into a profit of 0.54% by giving up upside potential. More importantly, after buying back the $32.5 call, our time value return is still a nice annualized 15.62%. Simply holding the stock would have resulted in a loss of 1.83%.

Cisco: Assignment Or Buying Back The Option?

If today's share price is above the strike price, buying back your contracts sold only makes sense if you want to avoid getting called away at expiration. In fact, if you've reached your initial goals, you'd better take your profits off the table and move on to the next trade.

As mentioned previously, Cisco's option contracts are not that deep in the money right now, allowing us to take the time to evaluate our initial trade setup.

(Source: Author's work)

Assuming shares get called away at expiration, we've reached our intended maximized return of 8.30%. Now, let's say we don't want to lose our shares and look for another income stream. How do we prevent that our shares get called away on February 15? Therefore, I need to feed the option prices into my calculator.

(Source: Author's work)

Let’s assume we can close for $1.80. Of that $1.80, $0.79 is intrinsic value, the amount the $46.50 strike is in the money. Our net cost to close (excluding commissions) is $1.01 or $101/contract. When the shares are sold, we have maxed our initial trade in the month, less $101, and can initiate another covered-call trade in the same month with the same cash. To make this exit strategy work, we need to generate an amount greater than $101/contract from the sale of other calls. So, if the cost-to-close is pretty low, you can find another trade that makes up for that time value loss in the same month (same options cycle), allowing you to generate a second income stream. Simply put, buying back the contracts against your Cisco position wouldn't be a smart move if there is still ample time value left, which is indeed the case right now.

Portfolio Performance

Since the beginning of the year, my parents and I have decided to combine our portfolios to facilitate monitoring of our positions. Today, 46% of our investment capital is deployed on pure buy and hold investing, while the remaining part is allocated exclusively to monthly covered-call setups with the possibility that our shares can get called away from us (the list of securities in this real-life portfolio is shared with premium members of my website).

We set the following goals for 2019:

  • Generating a dividend yield of at least 3%
  • Re-investing 90% of our total income streams (dividends and option premiums)
  • Growing our portfolio from €609,427 (level of 12/31/2018) to €950,000, adjusted for additional cash inflows. This return is mainly driven by selective covered-call writing.

We kicked off the year with a total return of 11.35% which is ahead of our two major benchmarks (S&P-500 and the EuroStoxx-600). Net option premiums received amounted to €16,573.

(Source: Author's work)

The chart below plotted the actual portfolio value against my expectations:

(Source: Author's work)

My Belgian brokerage account, which is used for option selling only, registered my return as follows (including the value of the contracts sold).

(Source: BinckBank)

Conclusion

My model covered-call trade setups highlighted here on Seeking Alpha have generated an average return of 1.88% (or an annualized 22.6%). Since the beginning of the year, my parents and I have combined our portfolios to facilitate monitoring of our positions. So far this year, our portfolio value rose from €609,427 to €678,576 thereby exceeding my already ambitious target of €647,250. So I'm looking forward to navigating our portfolio through the next period and continuing to generate reliable and growing income streams.

Disclosure: I am/we are long CELG, t, xom, MU, csco. 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.