Seagate Technology (STX) is one of the stocks that I am holding in my retirement account. I purchased it as part of my focus on dividends since it had a 4% yield at the time. The stock increased in price and I ended up selling it in late June for a 23% annualized profit. But I immediately repurchased it again and instituted my hedging strategy since I still fell like the stock had some decent potential for further gains.
Well this week, STX reported earnings. It seemed at first like investors were going to be disappointed as the stock had opened down over 5% from above $30 per share to the mid-$28 range. But gradually, the stock began to improve and closed right at $30 per share even though the broader market was down for the day.
Why the Strength?
Well in addition to reporting earnings and giving a somewhat disappointing outlook, Seagate announced that they were increasing their dividend from $0.25 per share to $0.32 per share! Assuming that the dividend remains at that level for the next year, the yield on the stock at $30 per share is just over 4.2%. I think that investors may have figured that out and realized that maybe it is worth the investment to get a decent return with the potential for some capital gains.
Now if you are like me, then you can have your dividends and hedge the stock also. Right now, I am sitting on protective puts at $25 and $27 per share with outstanding calls at $28 and $30. My basis for all the shares I own are $27.16. If STX remains above $30 per share for the next eleven trading days, then they will all be called away at an average of $29 giving me a $1.84 profit. Plus I will get the dividend since the ex-dividend day is August 10th.
It is possible that my $28 strike calls could get exercised before then if someone wants to try and capture the dividend. However, they would have to make sure that it is worth it when compared with the price paid for the option and the amount of capital required to exercise. Even so, I would still have a profit at that price.
I was encouraged to see that the dividend seemed to help stabilize the stock and provide a floor for the shares. Of course, it isn’t that surprising since a significant portion of historical stock market return can be attributed to dividends. It only makes sense that stocks of companies that return money to shareholders would be in demand and perform well over time.
You may have heard that Green Mountain Coffee Roasters stock took a big hit earlier this week when they missed earnings and put out a disappointing forcast for the remainder of the year. In fact, the stock lost almost 48% of its value in one single trading day. Ouch! Now if you have been long the stock, that is a major hit to that portion of the portfolio. Granted GMCR has been a momentum stock for some time now, so it isn’t unexpected that the gains would slow at some point. However, it can still make for some sleepness nights knowing that one day could wipe out so much value.
Sleep Better At Night–Buy Some Protective Puts
If you are investing in the stock market (and especially in individual stocks), you need to have some plan for these events when they occur. There are many ways to do this from not buying individual stocks and going only with indexes, to diversifying across several stocks and sectors, to using stop losses, to buying put options. I would like to address the concept of risk management from the perspective of put options and share what I do with my retirement account.
If you have been reading this blog for a while, you know that I invest my retirement account in some individual stocks many of which might be considered risking (ironically, GMCR only shows a beta of 0.8). Take for example, my investment in Onyx Pharmaceuticals (ONXX). This is a stock that I bought after selling Imclone which was bought out several years back. I purchased ONXX as a potential buyout candidate for which there is still potential. The most recent run up is due to buyout rumors again.
Over the past year, ONXX (with a beta of 1.2) has traded from $27.17 to $47.80 per share. With this most recent pop, I decided to buy some protective puts at a strike of $46 expiring in the month of May in two weeks. So far, that looks like a good decision since ONXX is now back down under $43 per share. Since my overall cost in the stock is $43.57 even after the purchase of the puts, I have guaranteed myself a profit.
Then, I will be able to purchase back the same stock for less and either sit on the cash or purchase even more shares of ONXX in preparation for the next pop. I will usually pay for the put options by selling some covered calls creating a collar.
I have found the technique of buying puts, selling calls or selling stock when it pops and buying back calls, exercising puts, and buying more stock to be fairly effective in mitigating losses and decreasing volatility in my retirement portfolio.
Hopefully, I won’t one day discover that the stock that I am holding has dropped by almost 50% in one day. But if it does happen, I know that I will sleep well because I would have owned some protective puts.
Oh, and by the way, a stop loss order would not have helped with GMCR this week. If you don’t know why, be sure to ask.
Readers: I am guessing that most of you use indexes for your risk management, but for those who do pick individual stocks, what do you do?
Yesterday, the stock market dropped the most since November 2011. So, what was your take? Did it bother you that the value of your stocks dropped significantly or did you consider it an opportunity to buy stocks on sale? Matt makes a great contrast between the attitude of declining prices when it comes to stocks versus the response to declining prices with gasoline.
I look at the fact that my investment horizon is over 25 years. I figure that trying to pick up some shares on a down day is better for me in the long run. I bought several shares of STX last week for $25.82 on average when it was down over 8% in a day due to some poor guidance. I figured that the stock pays a dividend which should help create a floor under any sort of decline. I also figured that I could always sell some covered calls to decrease my basis if need be.
Yesterday Bought More AKS
Yesterday, I was able to purchase another 100 shares of AK Steel for $6.95. The plan is to sell some covered calls with the $7 strike and a May expiration. I put in the order today to do so at $0.65 per share. It hasn’t sold, but I wouldn’t be surprised if it did over the next two days before the weekend.
If it doesn’t happen and the stock ends up dropping again, I can pick up some more shares below $7. It is not a big deal and will lower the overall basis of the stock. The biggest risk is that AKS has financial difficulties and stops paying a dividend or even goes bankrupt. I don’t think that will happen over the next few months, but I do have to consider that if I increase my position too much, I will want to buy some protective puts.
I had some put options when my position was bigger. They paid off for me as the stock slid from the teens down into single digits. But now my overall exposure hasn’t been that large so I let the puts fall by the wayside. I figured I would save the cost and simply work with selling calls. However, it may be worth reconsidering if I want to purchase more shares over the next few days.
The other consideration is the fact that earnings will be coming out later this month. That can always be a big trigger for volatility and moves one way or the other. A big move down is bad and could hurt. The May $6 strike puts cost $0.15 each. It is probably worth it to buy some tomorrow and prepare to sell some calls as well.
Overall, the market has made a decent run over the past few months. I am not surprised that it is time for a breather. Summer is coming and earnings season is expected to be disappointing. Even though yesterday was a big down day and today saw a bit of a rebound, I would probably use the down days to add to positions but only a little bit at a time. That is what I will be doing.
So, are you buying any stocks?