There has been a lot of option activity in my retirement accounts recently so I wanted to take some time and explain how to calculate the return on investment (ROI) using a real example of a trade that I did yesterday. As you know, I am working on increasing the exposure that my portfolio has to dividend paying stocks. Well, one of the stocks that I was looking at was Nucor (NUE). I was able to purchase some shares using the proceeds that resulted from the exercise of ONXX $46 puts last week.
My goal is to get a 1% return per month on my retirement account on average. Part of this should come from the increased focus on dividends while the rest will come from capital gains and covered call premiums. I believe that this is an achievable goal on average, although there will be times when the value will fluctuate above or below that target.
So, here is what I did yesterday. I started by purchasing the June $32 strike put options for $0.49 per share. Then I picked up the stock itself for $34.70 and put in an order to sell the June $35 strike calls at $1.10. This was about 5 cents above the ask at the time, but I figured that given the normal daily volatility, it would get filled if NUE approached $34.90. This did occur so at the end of the day, this is what my basis looked like before commissions:
$34.70 for the stock + $0.49 for the puts – $1.10 for the calls = $34.09
So, $34.09 per share is the amount that I have in the stock. Now commissions can have a big impact upon return, and I always hate it when those aren’t figured into the equation. I keep an Excel spreadsheet and add them in automatically based upon cash in and cash of the account. When I add in commissions for trading, my basis becomes $34.15322 ($34.16) per share. This is the number I will use for the calculations, but it is a little cleaner to look at the numbers without when you are learning.
Return on Investment If Called
If NUE is at or above $35 per share on June 16, 2012, it will get called away. If that is the case, let’s calculate the ROI for these four weeks. The general formula is the amount of profit divided by the amount invested (basis) multiplied by 100 to express in a percentage and would look like this:
($35.00 – $34.16) (profit)/ $34.16 (amount invested) * 100 = 2.459%
This meets my criteria of gaining 1% in a month. But what if the stock does not increase and does not get called out?
ROI if Not Called
This is a little more difficult situation to calculate because you really don’t know if there will ultimately be any profit. This is where the 1% monthly criteria comes into play for me. I want the premium income itself to equal 1% of the basis. So in this case, I use the amount of price reduction of the stock price for my “profit” and the basis as the amount invested to make the equation look like this:
$34.70 (purchase price) – $34.16/ $34.16 * 100 = 1.58%
The Nucor trade meets my criteria for 1% monthly.
Now what happens if the stock drops like a rock. Obviously, these percentages mean nothing. But this is where tracking a basis over time becomes useful. Ultimately, if the stock drops below $32 rapidly, I will not be in any additional danger of loss since I own the put options. I can add additional shares to the position each time meeting the above criteria. Eventually, the stock will stabilize and the ‘ROI if called’ will get realized.
By managing the position and adding shares at lower prices, it is possible to not lose money on a declining stock and break even.
So, if one-third of my stock picks fall into each category, the overall net impact is that the 1% monthly target will be met on a portfolio wide basis. The fact that I am starting to work with dividend stocks should help to minimize the volatility. That is the goal anyway.
- Protecting Your Portfolio When Selling Put Options (grandpermonth.com)
- How to Make $1000 Per Month Selling Put Options (grandpermonth.com)
Well, the past two weeks have been incredibly busy and it feels like I am doing all I can to keep my head above water, but it feels like it isn’t working. Last week, I put in 75 hours and work. This week, I was out of town yesterday and today and was very busy during the day with minimal internet access. Now, it is 11 pm in the hotel so I will be making this short so that I can get some sleep.
Options Expired Today
Today was options expiration which will end up being a good thing for me since I have some puts that will be exercised. The most important one for me is the ONXX $46 strike puts which I purchased a few weeks back when ONXX was making a spike in price (back when the DOW was over 13,000). I did this because I could lock in a profit compared to my basis.
Well, ONXX closed today at $41.82 so I will be selling those shares for $46! Yippee! Now I plan on picking up some Nucor shares next week since that is part of my dividend plan. I will still have a few ONXX shares left so I purchased some additional June $38 puts today. I will have to let you know what the new basis becomes, but it will likely be close to $42 per share. Then I could sell the June $42 calls and end up with a profit if called.
I will also sell some DRYS and SLW shares as well when their puts get exercised. I will be replacing those shares at a cheaper price so will be able to profit by the price differential. This is what the summer will likely be about. Hopefully, it won’t be a repeat of 2008, but you just never know so it helps to have a plan.
Here are some carnivals that have featured my three blogs:
Carnival of Financial Camaraderie #30 – PT
Plus a few more:
I recently ran across a video at Kitco’s Video News page that featured an interview with Kevin O’Leary who is a Canadian entrepreneur who founded SoftKey, a software company that eventually acquired The Learning Company before selling out to Mattel. Apparently, he is also on the show Shark Tank on ABC which I have heard about but never bothered to watch.
I don’t think it is important to watch the full video, but I do think that he made one very important point which I will share with you and which I am working on implementing:
- Never buy a stock that doesn’t pay a dividend!
It is really quite simple and makes a lot of sense. He doesn’t look at earnings when evaluating a stock. He looks at free cash flow and wants to make sure that some of that cash is being returned to the owners (the shareholders) of the company.
A Transition in Thinking
I am starting to see from where he is coming. Much of the market’s return has been the result of dividends. Just take a look at the following graph which I found at The Market Oracle:
If this graph doesn’t convince you of the importance of dividends, which account for over half of the S&P 500’s, then how about I show you another graph that looks at the performance of the Dogs of the Dow vs the S&P 500. In case you didn’t realize it, the Dogs of the Dow are those stocks in the 30 from the DJIA that have gotten so beat up in terms of price, that their dividend yield is among the top 10 of those 30 stocks.
So had you been holding stocks that paid dividends, there really would not have been a lost decade. You would have received consistent payments of cash to add to your portfolio enabling it to grow and make money. You can just look at the graph and see that the S&P 500 lost money during the decade that saw two major shocks. And yet, stocks that paid dividends (namely, the Dogs of the Dow) actually made money.
Fortunately, it is possible to teach this old dog some new tricks. That is why I am simply working on changing all the stocks in my retirement accounts to dividend paying stocks and tracking my dividend income this year. I did manage to hit my goal for the 1st quarter. Over the next 25 years, I will allow those accounts to grow and reinvest those dividends into more stocks.
In fact, I will probably buy some more STX and INTC this week since they have been holding up quite nicely during this recent market decline. I will also watch the ONXX $46 puts get exercised on Friday so I can start my purchase of Nucor (NUE) next week. I won’t get the dividend for this quarter, but should be in a position to pick it up in the third quarter. The same holds true for INTC and STX since the ex-dividend date has passed. Nevertheless, adding to these positions is just a good idea.
Obviously, I will continue to publish the quarterly update on the dividend progress and see if it continues to grow. According to the charts above, it should be a great plan!