Monday, May 18, 2015

Gambles and Sure Things

  I won two of my three second round NBA series picks to take my mythical NBA playoff bankroll from -10 to +90 heading into the third round. Every series I picked could have gone either way. After an impressive game one win, the Wizards (who I picked to take the Hawks in an upset) lost four of the next five games after all-star guard John Wall missed three games with five non-displaced fractures in his left wrist. I don't know how Wall came back for the last two games since even thinking about five non-displaced fractures in my left wrist makes me want to get the biggest cast I can find. The Cavaliers (who I picked to easily defeat the Bulls) found themselves in a battle of attrition with the Chicago Bulls as Cavs all-star guard Kyrie Irving and Bulls center Pau Gasol sat out large portions of games with injuries before LeBron James asserted his will and the Cavs won the series in six games. The Houston Rockets (who I picked to win in seven games) should have been able to take advantage of Clippers all-star guard Chris Paul’s absence from the first two games with a pulled hamstring but instead were nearly blown out of the series without showing any of the toughness I thought would carry them through. The Rockets righted the ship in game five and won game six in a miraculous comeback before taking game seven on Sunday to complete a historic Clippers collapse and make me look like an astute basketball predictor.

  I’m only gambling mythical dollars on my playoff predictions and giving serious thought to resurrecting my 30 year old regular season prediction program and gambling for real next season. I'll write the 21st century version of my program this August if I'm still motivated. Until then I'll stick to placing my bets on sure things and one of the surest things I know to gamble on is the stock market since it is sure to go up and it is sure to go down.

  I've written about my previous encounters with workplace keepers of the 401K plans in the various companies I've worked for and how 5 years ago I transferred these 401K plans into a Fidelity self-directed IRA and accumulate Intel stock by buying on dips and selling when it goes up enough to allow me to break even on my initial buy while keeping five shares as a profit. A big winner in this is Fidelity since they get $7.95 commission on each buy and sell. I don't begrudge Fidelity their commission – their website is top-notch, they have a great mobile app for my amazing iPod, and whenever I've had a question about the website or how trades work I have gotten timely and correct answers from their online chat service.

  My Intel buys and sells have been working very well. The stock goes up and down around 10 times a year and I've accumulated over 200 shares of their stock in that time solely from the ebb and flow of the markets. When I started this exercise in 2010 Intel was giving a 16 cent dividend which has increased each year and now they provide a 24 cent dividend so not only do I have 200 shares of Intel stock as profit - the company gives me almost $50 every three months just to own it.

  I've dabbled in other stocks. I don’t use a system like I do with Intel - I just follow my gut. I prefer name brand companies that pay a dividend but I will make exceptions. In December 2010 I bought 15 shares of Apple stock that wasn't paying a dividend for $320. When Apple stock went up to $450 in January of 2012, I sold 11 shares to recoup my initial investment and felt very smart indeed. I felt much less smart in August of 2012 when the stock was up to $700. I'm only kidding about feeling less smart – I was happy to have recouped my initial investment and have four shares of Apple risk free. In June of 2014 Apple split their stock 7 to 1 to give me 28 shares which currently sells for about $125 a share and even offers a dividend of .52 cents per share per quarter.

  My stock market adventures include some misadventures as well as the successful outcomes I've detailed as I've continued looking for ways to minimize risks and maximize profits. I had always thought of stock options as a risky idea where you either pay for the option to purchase a stock at a set price until an expiration date or where you collect money to sell the option to purchase a stock that you don’t own at a set price until an expiration date and either grab a quick profit, lose your investment, or take a huge loss as you scramble to buy stock you don't own at a premium price to fulfill your obligation to sell. There are dozens of trading strategies for options (you can see some here). There is the Long Straddle, Long Strangle, Iron Condor, and for ‘In-A-Gadda-Da-Vida’ fans there is even an Iron Butterfly.

  Last August I read an article about options that explained in detail the ‘covered call’ option. A covered call is selling an option on stock that is already owned. It reminds me a little bit of ‘rent-to-own’ stores where people can have a brand new $1,000 TV now and pay ONLY $50 a week for a year or more. It is a great deal for the rent-to-own stores since they get over $2,600 for a $1,000 TV that probably only cost them $500 in the first place and if a renter doesn't pay the TV can be repossessed and sold at a discount. As applied to stocks investors will pay me today for the option to purchase my stock at an agreed upon price in the future. If the renter doesn't exercise the option, the stock is still mine and if they exercise the option I sell the stock but in either case the rental fee is mine.

  Options in general and covered calls in particular can be pretty confusing. I used Fidelity’s excellent customer service and had a live chat with an agent until I felt like I had all the information I needed. An option (also known as a contract) counts for 100 shares of a stock but the price of the option is listed as a single share. That means if the listed price of an option is .40 cents you get $40 (less commissions) for every option you sell. If the option is exercised then you sell the stock for the agreed on price and have to pay another commission. From my research the only downside to selling options was that if the stock shot up in price I would have to sell the stock at the agreed on lower price and wouldn't make as much profit. This didn't seem like too much of a drawback since I'm more of a bird in the hand guy and wouldn't likely be kicking myself over some opportunity cost just like I don’t kick myself over taking my profit on the Apple stock 2 years ago where I surely could have played it better and I could have also surely played it worse.

  By October I felt informed enough and was ready to make some moves. I bought 300 shares of Intel (INTC) at $32.24 on the 9th while the stock was in the middle of a dip of more than $2 a share. I then sold three options to sell the 300 shares for $33 a share, collecting 64 cents a share for the options. The option expired on the 18th. This put $182 in my account (300 * .64 less the $10 commission to Fidelity.). Intel kept sliding down and was priced at $31.38 at the close of business on October 17th so my option expired and I had the stock and the $182 dollars.

  This revealed a downside of the ‘covered call’ option strategy. The stock price had gone down and the only options I could sell were for low prices that guaranteed a net loss if the option was exercised. Selling an option at a losing price was not an option for me and told me that it was important to use this covered call strategy only with top quality stocks that paid a dividend so if I got stuck holding it there would still be a revenue stream until a price rebound allowed the selling of options at a profitable price. It also told me that while the strategy leads to long-term profits it was a short term gamble so it was perfect for my self-directed 401k that I can’t use until I’m 60.

  On Tuesday the 21st I sold the three options for $33 a share that would expire on the 31st. Since Intel was priced lower than before I only got 15 cents and my net gain was $36.94 (300 * .15 = $45 less commission). Intel performed a major rebound over the next week and a half and when it closed at $34.01 on October 30th the option was exercised and I had to sell my 300 shares for $33.00 (less commission).

  So was I a loser because I sold the stock at a price for a dollar less than the market value? You could make the case but I don’t think so. Let’s look at the numbers:
10/10/2014Buy 300 INTC @ 32.24-9679.92
10/10/2014Sell 3 INTC Options @33 (.48)
Expiring 10/18/2014 (not exercised)
10/18/2014Sell 3 INTC Options @33 (.15)
Expiring 10/31/2014 (exercised)
10/31/2014Sell 300 INTC @ 33+9681.33

  That works out to a 4.45% profit over 21 days which is an annual profit of 77%. I could have made more of a profit by holding the stock and selling at $34.01 but I wasn't trying to buy low and sell high – I was trying to buy low and rent the stock in a low risk fashion and thought it worked quite well. I tried for a similar quick hit in January with AT&T (T) which is a spectacular stock for this exercise because it gives better than a five percent dividend in case options can't be sold at a profitable price and it has frequent up and down swings. On January 14 AT&T stock dropped almost 3 percent in the prior two days. I made a buy at 33.14 and the first thing I did was to collect $36.01 by selling the covered call option at $34 a share to expire on February 20th. AT&T dipped to $32.64 on January 28th and shot up to $35 on February 6th before settling in at $34.08 on February 20th which led to the option I sold being exercised:
1/14/2015Buy 100 T @ 33.13-3320.06
1/14/2015Sell 1 T Option @34 (.44)
Expiring 2/20/2015 (exercised)
2/20/2015Sell 100 T @ 34+3391.98

  Just like the Intel operation, I could have maximized my profits if I had a crystal ball and knew the stock was going to climb to $35 a share but I didn't know that at the time and I didn’t kick myself over it either. I was happy to have made a profit of 3.2% in 5 weeks which is an annualized rate of return of over 29%. Notice how the annual rate of return makes everything sound bigger and better!

  I have been executing this option strategy with Intel on a regular basis since I already have the stock and save on commissions by not having to purchase it. There is definitely an economy of scale involved at this low level since Fidelity charges a $7.95 fee for the first option and 65 cents for each additional option. If I had tripled the AT&T purchase above I would have made a profit of $367 which is 3.6% and not 3.2%. The commissions take a hefty bite when executing options one at a time.

  I've done this strategy with two other high dividend stocks – Exxon (XOM) and Emerson (EMR). Both stocks are highly dependent on oil prices and have gone down over 10 percent since I purchased them months ago which left me on the option sidelines for long periods of time. The saving grace is that both stocks pay at least a 3% dividend so my investment isn't just sitting there like it would be in a non-dividend paying stock. Emerson has rebounded in the past weeks and if I sold it today I’d have a profit even though it is selling for less than I bought it at. I have not been so lucky with Exxon which is still trading more than 8% less than the purchase price but thanks to the dividends and unexercised options I’m down 3% and not 8% (and no I am not going to annualize my loss!).
12/10/2014Buy 100 EMR @ 61.444-6152.35
12/18/2014Sell 1 EMR Option @62.5 (.95)
Expiring 1/27/2015 (not exercised)
3/11/2015Dividend EMR+47.00
5/13/2015Dividend EMR (Payable 6/11/2015)+47.00
5/14/2015Sell 1 EMR Option @62.5 (.65)
Expiring 6/19/2015
Total if sold at 5/15 price of 60.19+96.61+1.57%
Total if 6/19 option is exercised+327.61+5.33%

9/24/2014Buy 100 XOM @ 95-9507.95
10/9/2014Sell 1 XOM Option @97 (.50)
Expiring 10/31/14 (not exercised)
11/7/2014Sell 1 XOM Option @99 (.39)
Expiring 11/22/14 (not exercised)
12/10/2014Dividend XOM+69.00
12/19/2014Sell 1 XOM Option @95 (1.25)
Expiring 1/17/2015 (not exercised)
1/21/2015Sell 1 XOM Option @95 (.47)
Expiring 2/06/2015 (not exercised)
2/13/2015Sell 1 XOM Option @95 (.75)
Expiring 3/13/2015 (not exercised)
3/10/2015Dividend XOM+69.00
5/11/2015Dividend XOM (Payable 6/11/2015)+73.00
Total if sold at 5/15 price of 87.35-273.96-2.88%

  The ‘rent-to-own’ strategy seems perfect for somebody like me with a 401k plan that I can’t touch. I can’t see anything but a minimal risk as long as it is done with quality stocks that can be held if needed. It does require some study although I think it is pretty straight forward and certainly more of a sure thing than picking the winners of basketball or football games. If Exxon or Intel or AT&T or Emerson went out of business I would show a 100% loss. I think if that were to happen I'd have bigger problems than worrying about stock prices. After all, I've never seen the characters in ‘The Walking Dead’ discussing options strategies.