Building A DGI Portfolio With Options, The End Of The Experiment

|
Includes: ABBV, CVX, ET, F, GE, GWW, HBI, IRM, KIM, MO, OHI, PAG, PEP, PM, T, XOM
by: Andrew Ryan
Summary

Used PUT options  to create a DGI portfolio w/ 14 different equities.

Experiment was for 2 years (Based on free trade period with Fidelity).

Started w/ $100,000 in a tax deferred account.

Collected $15,800 in PUT & Call premiums, capital gains, and dividends.

Favorable and growing dividend stream, Overall success - debatable.

Background

In February of 2018, I wrote an article (Building a DGI portfolio with PUT options, An Interesting Experiment) (Building A DGI Portfolio With PUT Options: An Interesting Experiment) wherein I described a plan and initial implementation to build a DGI portfolio primarily through selling PUT options. I thought PUT options would provide the means to start a DGI portfolio when the majority of stocks I was interested in were overvalued. It also turned out that a majority of the stocks on my target list were not only extremely overvalued, but also had lousy PUT premiums. I didn’t see any advantage to being PUT an overvalued stock via a low PUT premium. As such, I looked for companies that were not on my target list but would still be decent holdings, offered good option premiums, satisfactory dividend yields, and potential covered call yields should they get PUT to me.

I'm still a rookie with both DGI and options, so definitely don't take any of this as investment advice. This article then is a recap of what I did and the results. Hopefully some of you can glean some value, either as good or bad examples, for your own way forward and I can learn more from your comments.

Executive Summary

I would like to report that with an inflow of $15,805 ($8,304 PUT premiums + $693 CALL + $1,834 capital gains+ $4,974 dividends) plus stock appreciation over the last two years that my experiment was a rousing success but that would be a bit of an overstatement. The income has been nice but the highest valuation my portfolio has seen was $112,150 about a month ago, the lowest was $94,400 during the little crash in December 2018 and currently resides around $111,000. So even though I’ve had decent income, the valuation for my choice of equities has definitely suffered. What’s interesting is a number of these are on my target list, are Dividend Aristocrats, and commonly held by many of the SA community.

Process and Detailed results

I typically have not done deep dives into financials of the companies I’ve targeted. 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 Stock Options Channel (Stock Options Channel) websites to develop a “Fair” value. 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. What I ended up using was the criteria below:

  • Stock’s 1 year price target was higher than current stock price
  • Had a dividend of 3% or higher (if PUT)
  • Had a favorable F.A.S.T. Graphs valuation if PUT
  • Was close to or below the 52 week High/Low split value
  • Had favorable SA author & commenter recommendations
  • Provided favorable option premiums for that period
  • Yielded option premiums equal to or higher than dividend payments would be
  • Had a probability of 75% (based on Stock Options Channel information) or more that PUT would expire worthless

If a potential option trade would meet or be close to most of the above criteria, I would enter the trade. My theory was that I would probably develop my portfolio rather slowly, make more in option premiums than dividends, and when I did get PUT, the stock would be fairly or undervalued. Well, that was the theory anyway, reality was different as you will see below.

Since I started April of 2017, I have had 63 PUT and 11 CALL transactions with 2 equities called away. I’ve hardly touched Fidelity’s 500 free trade limitation. Something about not having enough money or time to get there. Shorter option durations free up funds faster for more trades. I’ve averaged ~$132 premiums per PUT and $63 per CALL net commissions of ~$.05 per trade. Fidelity’s normal trade fee of approximately $5 per trade, would have been a significant burden to my trades if I had had to pay them.

PUT options

The graph below displays total premium by company but does not display the quantity of trades per equity.

(Spreadsheet by author)

As shown below, I have 7 trades each on AbbVie (ABBV) and Ford (F), 3 each on Chevron (CVX), Realty Income (O), and Genuine Parts (GPC), 2 each on KIMCO Realty (KIM), TROWE Price (TROW), Omega Health (OHI), Exxon (XOM), General Motors (GM), Altria (MO), CISCO (CSCO), Procter & Gamble (PG), Philip Morris (PM), Century Link (CTL), Southern (SO), and Iron Mountain (IRM). The rest are single trades. The majority, except Ford and General Electric (GE), were also for a single block (100 shares).

(Spreadsheet by author)

Below is an interesting but mostly useless “feel bad” graph. It displays PUT premiums by month via blue columnar data, the cumulative PUT value via the grey line (scale on right), versus the monthly and cumulative values of the net Put when I was PUT the stock. By that I mean, if I subtract the difference between the strike price, offset by the PUT premium, from the price of the stock when it was PUT, the amount I “overpaid” for the stock that I ended up adding to my portfolio. Sometimes the premium covered the gap, many times it did not.

As an example, W.W. Grainger (GWW) was priced at $189.13 when I sold a PUT with a strike of $180 earning a premium of $4.60 per share. I grossed $495.95 after the $.05 commission for a cost basis of $175.40 ($180 strike - $4.60 premium) if PUT. I got PUT 2 months later when GWW hit $164.9 at expiration, $15.10 per share less than my strike price, $10.50 ( $164.90 – $180 strike + $4.60 premium) less than my cost basis. As such, on paper, I lost $10.50 per share. The orange bars and line display the NET results of option premiums vs portfolio value. $8,304 of real cash income nets out to about $194 in paper portfolio value.

(Spreadsheet by author)

I call it a useless “feel bad” graph because 1) seldom are we able to buy a stock at the market bottom, and 2) I had already determined the price (strike value) I was willing to pay for the stock. It does make me question my stock valuation and my probability of being PUT methodology however. The other interesting point is that many of my new stocks, which were highly recommended on SA, are still underwater after up to two years.

Call Options

Over the two years I’ve collected $693 in CALL option premiums. I have not worked this area very hard partly because many of the stocks I bought are part of my target holdings and I don’t want to risk losing them. I’ve had two stocks called away, Grainger and Haines Brands (HBI). Neither were target holdings. Grainger kind of hurt to lose. I originally got PUT the stock at $180, with a cost basis of $175.4 per share. I wrote a CALL at $190, with a premium of $2.90 per share. It got called and I netted another $1,750 of capital gains. Sounds great but GWW is ~$275 as I write this. That’s one of the “beauties” of CALL options – missed opportunities. That extra $10 grand (100 shares @ $100) would sure have made my portfolio valuation look better. Regarding HBI, it had been pretty range bound for a while but was bouncing off my $18 strike price after I wrote the option. I considered rolling it to a higher strike, but just before expiration it took a sudden drop. I took my eye off the ball for a day or so and it bounced up and got called away. Lesson learned - Options require monitoring! Another lesson learned regarding CALL options, when a stock takes a sudden price crash in valuation, so do the CALL premiums such that often you can’t even find anything above breakeven. GE is a perfect example. GE was $18.41 when I wrote a $16 PUT which subsequently was PUT to me. I used the same $16 strike when I wrote the GE CALL, when the market price was $13.62, and got $.29 per share premium. Now, as I write this, with the price hovering in the low $10 range, July $11 CALLS are being bid at $.17, July $12 CALLS are bid at $.03, and it goes downhill from there. I can’t get to breakeven.

Company

Premium Total

Trade Qty

Ave $/Trade

T

$ 25.95

1

$ 25.95

GWW

$ 289.51

1

$ 289.51

PAG

$ 94.90

2

$ 47.45

XOM

$ 39.95

1

$ 39.95

MO

$ 49.95

1

$ 49.95

GE

$ 49.45

1

$ 49.45

HBI

$ 94.85

3

$ 31.62

ABBV

$ 47.96

1

$ 47.96

Total

$ 692.52

(Spreadsheet by author) -GWW and HBI were both eventually Called

Portfolio

My portfolio stands as follows (as of 6/12). Share quantities that are not in even hundreds indicate where I have reinvested dividends directly into additional purchases.

Description

# of shares

Current Value

Total Gain/Loss Dollar

Cash

$5,431

n/a

ABBVIE

305

$24,040

($920)

CHEVRON

105

$12,622

($277)

ENERGY TRANSFER

100

$1,432

($22)

FORD

350

$3,462

$142

PUT (F) FORD JUN 21 19 $9 (100 SHS)

($2)

$124

GENERAL ELECTRIC

300

$3,020

($1,694)

PUT IRON MOUNTAIN JUN 21 19 $30 (100 SHS)

($15)

$20

KIMCO REALTY

318

$5,861

$470

ALTRIA GROUP INC

118

$6,129

($1,663)

OMEGA HEALTHCARE

200

$7,204

$1,214

PENSKE AUTOMOTIVE

100

$4,412

$212

PEPSICO INC

100

$13,401

$3,081

PHILIP MORRIS

112

$8,739

($1,826)

AT&T

236

$7,591

($1,324)

WABTEC

$68

($6)

EXXON

100

$7,428

($228)

Total

$110,822

($2,696)

(Spreadsheet by author)

The portfolio currently consists of the following segments. I intend to increase both quantity of holdings, to around 30 total, and add some Utilities and Financials to the mix. However, unless I roll over more funds from my 401k, this will take a while.

(Spreadsheet by author)

Conclusion

The ultimate goal of this experiment was to create a Dividend Growth Portfolio using PUT options to lower my cost in an overvalued market and achieve favorable portfolio valuation. While I’m disappointed in the valuation aspect, the portfolio is starting to generate a decent dividend stream.

(Spreadsheet by author)

The above graph is a little misleading however, because much of the growth is due to equities being added over time as I got PUT the stocks, not strictly from dividend growth. From here on out, unless I add more funds, the dividend growth will actually be just from dividend growth, dividend reinvestment, and potentially CALL premium reinvestment.

As I was creating this portfolio, one of my criteria was to look at equities that would provide 3% or greater dividend payments. Based on the strike price less that particular option premium my effective weighted dividend yield is ~4.5%. Because my real cost basis is actually lower than shown in my Fidelity statements due to multiple option premiums for some of the stocks, my effective dividend yield on cost is somewhat higher.

For example, I’ve made 7 PUT trades on ABBV with 2 of those being PUT. I used the $89.62 at 4.1% and $77.94 at 5.49% (average $83.78) for my weighted dividend yield, but my total cost basis for ABBV due to all of the option premiums is $78.48. I have not calculated actual percent dividend return yet as my cost basis keeps changing and new dividends for recently PUT stocks are being added. My portfolio cost basis will stabilize soon and the dividend stream will reach a consistent flow that will facilitate an easier dividend return percentage.

So how did this portfolio perform in relation to funds I left in the company 401k account? If I compare the two year performance of this account to the S&P and US Large accounts in my company 401k, I’ve performed as well or slightly better. The S&P index funds generated 11.2% and the US Large generated 9.2% whereas I’m about 11% growth in the above. At least my experiment didn’t cost me and I will be getting a dividend stream now as opposed to having to sell off assets to use in my retirement. It’s not quite an apples to apples comparison however partly because the funds in the Fidelity account were not fully invested 100% of the time. When I initially started writing PUTS only a portion of the funds were being used, the cash only earned around 1%. Alternatively, the PUT premiums artificially increased the returns during this period and unless I add more funds, I can only rely on CALL premiums to “juice” the returns. Otherwise the returns will have only organic growth similar to the company 401k accounts.

So did the experiment work – in my opinion, sort of. I think it has potential but the implementation could be improved.

Lessons Learned

Options take a significant active amount of effort and definitely have a learning curve. Had I been a little more experienced I could have rolled some of my PUTs prior to being PUT, and potentially lowered my cost basis. However there is a high probability that would have also resulted in not being PUT the stocks, thereby not having a DGI portfolio.

I still have a lot to learn

Disclosure: I am/we are long ABBV, MO, T, CVX, ET, XOM, F, GE, KIM, OHI, PEP, PM, PAG, WABI-USD. 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: Additional disclosure: I have PUT options on F and IRM.