My Mad Method: What Next To Buy, And Why - September 2012

| About: Medtronic plc (MDT)
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I know, I know, it's only been about a week since I wrote about all that happened in August, in three different articles no less (parts I, II and III), but Mr. Market being who he is, there have been some very recent developments, and thus, with a new month comes new possibilities.

If you've been following my "My Rookie Season Writing Options…" series, and read the last installment, you'll know that I still have an open call contract on Medtronic, Inc. (NYSE:MDT) that I wrote back in July for the September 21st expiration date. The call that I wrote was for a $40 strike, and MDT just closed at $41.21, up 1.35% for the day, defying the market in general, which was down for the day overall. That call option is a little over two weeks away from expiring, and if things keep going for MDT the way they have been for the last month or so, I'm expecting my shares to be called away.

The question then is, what to do next?


One thing I could do is just take the proceeds, plus a little extra cash, and buy the MDT shares back again right away. An alternative to that would be to write a cash-secured put either just out of the money [OTM] or just in the money [ITM], collect the premium, wait a month, and see what happens.

"But wait," I hear you asking, "isn't this a 'My Mad Method' [MyMM] article?" Why, yes, Dear Reader, it is. So, to the point: What if I don't want to buy back my MDT shares if and when they get called away on September 21st?

Now, I like MDT, even though it's pretty much just moved sideways since I first bought it back in March of this year; I've liked having it in my portfolio as one of the best representatives of the medical equipment companies out there. However, I have to look at whether I want it to remain in my portfolio, or whether there might be some better choices I could use the proceeds from the shares getting called away for. So for that, we turn to MyMM.

MDT currently holds the MyMM Rank of #3 in my portfolio of 28 stocks in my IRA, and 15th out of 41 in the combined "superlist" of my portfolio stocks plus the stocks currently on my watchlist when I weight the % Allocation metric of the superlist to 20% from the standard 5.88% which the other 16 metrics enjoy. This puts MDT pretty close to the middle of the pack of the weighted superlist.

(Giving "% Allocation" a 20% weighting causes the MyMM spreadsheet to apply a multiplier of 3.4 to this metric's data, as opposed to a multiplier of 1 for the rest of the metrics, which are weighted at 5.88%. This gives stocks that I have no position in, or a smaller position than others, a better ranking, causing them to "float to the top" in these weighted ranking results.)

Taking a closer look at MDT, I see that it is currently yielding 2.52%. That's actually a little low, considering I'd like all my positions to yield at least 3.00% or better to help me generate the income I need to increase my holdings as quickly as possible so that my total portfolio will be able to generate enough income when I retire (along with Social Security) to replace my paycheck.

And More Choices…

Looking at the weighted results on the MyMM spreadsheet, two stocks stand out as possible replacements for MDT that sport better yields and, possibly, have better potential for future gains given their current prices and MDT's current price relative to all of their 52 week highs and lows.

One of them is ConocoPhillips (NYSE:COP), which is yielding 4.70%, comes in Ranked at #3 on the weighted superlist, and shows a Delta Ratio Reading of "Buy!", which is pretty good, considering how many stocks on the superlist are Reading "Too High" or even "Screaming!" (the latter of which being what MDT is currently Reading).

A few months ago I added a section to the MyMM spreadsheet where I keep the superlist to help me sort out what next to buy, and why. One of the things in this portion of the superlist's worksheet is a column where I evaluate a number of other criteria in this section and, based on the results for each stock in the superlist, display either nothing, or one of the words "Definitely!", "Possible!" or "Later". I'll write more about this "Rating" process soon in a future article, but for now what you need to know is, based on its Ranking, Delta Ratio Reading and ability to generate enough dividends to satisfy my 3.00% minimum, COP is one of only two stocks on the superlist that have earned a "Definitely!" Rating at this time.

The other stock currently on the weighted superlist that is also generating a "Definitely!" Rating is a stock that I wrote about in the Finale to August's "What Next To Buy, And Why?" series: my most recent purchase, Staples, Inc. (NASDAQ:SPLS). SPLS comes in ranked #10 on the weighted superlist, and boasts a Reading of "Holy Cow!". I'd been planning to buy more SPLS anyway, when I'd accumulated enough dividends by the end of September to make the $1.00 commissions I'd have to pay worthwhile, so it was a pleasant surprise to see it flashing "Definitely!" in the new Rating column, too. And with a current yield of 4.00%, SPLS also beats out MDT in that category, and would boost the overall yield of my portfolio as well.

But Wait...

Getting back to MDT, as of the close of this past Tuesday, the October 42 put for MDT has a bid price of $1.79, and the October 41 put has a bid price of $1.25. Those will undoubtedly change between now and September 24th, when I could sell cash-secured puts in an attempt to get my MDT shares back (assuming my shares get called away by the July contract, which at this point looks very likely).

The November 42 puts currently have a premium of $2.21, and the November 43 puts have a premium of $2.82 currently, but I'd prefer to shoot for the October 42 puts because a) I don't like having cash sitting around "idle" for too long, and b) the way things have been going for MDT recently, the 42 strike might end up OTM, and while I would have collected a premium, I would have to start the process over again in order to get the shares back into my portfolio, and so see "a" above.

In addition, the way the market has been behaving, I'm not comfortable going that far ITM to get the November premium; I don't want to end up being assigned the MDT shares at $43 per share when [if] the price has dropped well below $42 per share.

However, for lack of better information and a crystal ball, if we assume that MDT stays just below $42 and use the 42 strike with the $1.79 premium, that would make my cost basis for getting my MDT shares back a little over $40.14 (once you factor in commissions), which is lower than my current cost basis for them of $40.2646.

On the other hand, if I choose to get my MDT shares back and don't repurchase them in time to meet MDT's October 3rd ex-dividend date, I'll lose out on those dividends, which would cut into the benefit I would receive from whatever premium I could get for selling October puts. Hmmmmm…

Time To Decide

So if (or rather, when) my Medtronic shares get called away, my choices at this point in time are:

  1. Turn right around and re-purchase the MDT shares at the current price, making sure I get them in time to receive the next dividend.
  2. Set a limit order at a lower price and wait for a dip in MDT to buy back the shares that got called away.
  3. Sell just ITM October cash-secured puts, collect the premium, and hope I get assigned the shares in October without the share price dropping so far that it offsets the benefit from the premium (and if I don't get assigned in October, then Wash, Rinse, Repeat until I do).
  4. Take the proceeds from the MDT shares being called away, plus the other cash that I will have accumulated from other dividends and distributions by September 24th, and purchase approximately equal positions in COP and SPLS with that money, improving the yield on those proceeds by almost 52%.

Well, what would you do? I have time to decide, and will ponder the matter and do some more due diligence on all three companies in question between now and September 24th., which is the earliest I could do any of the choices above. But I would appreciate any and all feedback that y'all want and can provide on this matter; just use the Comments section below. Thanks in advance!

Disclosure: I am long SPLS. 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: In addition, I am short (MDT) via covered calls. Disclaimer: I am not a professional investment advisor or financial analyst; I’m just a guy who likes to crunch numbers and can make an Excel spreadsheet do pretty much whatever I want it to do, and I’m doing my best to manage my own portfolio. This article is in no way an endorsement of any of the stocks discussed in it, and as always, you need to do your own research and due diligence before you decide to trade any securities or other products.