Some Changes Coming for 2008

After 3 weeks of a much needed vacation I'm back in the saddle. 2007 wasn't a very good year for my covered call portfolio. My average monthly income dropped from about 2%/month the previous 2 years to below 1%/month. I ended the year below my minimum goal of 12% income for the year but my account value still increased by about 3%, although it was below the benchmark index.

2008 isn't starting out too good either. The market took a beating today and so did my positions. I plan to spend this rainy weekend reviewing my portfolio and planning adjustments to make next week. I've got several positions that are currently uncovered, since I didn't have a chance to do any trading after the Dec options expired.

I plan on making some changes to my trading plan and stock selection criteria in 2008. I just finished reading a great book on value investing that I received as a Christmas gift (Thanks Jeff!). The book is titled Active Value Investing: Making Money in Range-Bound Markets by Vitaliy Katsenelson, and I highly recommend it. Vitaliy makes a good case for the markets to be range-bound for the next several years and describes a process for analyzing companies based on quality, valuation, and growth. He also describes a total return approach, which includes capital appreciation and dividend yield. Although this book doesn't discuss covered calls, I believe that they could enhance the total return by providing a third source of income.

My current stock selection criteria already includes measures for quality, valuation, and growth, and these will be refined further, especially the growth measure which I haven't really paid enough attention to. I also plan on taking a more total return approach, incorporating more dividend paying companies and looking for more capital appreciation (e.g. selling more ATM or OTM calls on dividend paying stocks).

Another book I plan to read is The Ultimate Dividend Playbook: Income, Insight and Independence for Today's Investor by Josh Peters. Josh is the editor of Morningstar DividendInvestor, which I subscribed to last month. I like Josh's approach to dividend investing. His dividend drill is something I'll look to incorporate into my trading plan as well.

I'm also going to investigate using a dividend capture strategy, establishing covered call positions before ex-dividend date to capture both the dividend and the option premium, and possibly some capital appreciation. I may even sell cash secured puts on these CC positions to capture even more option premium and interest on the cash, which would be a fourth and fifth source of income.

I'm also kicking around the idea of limiting the number of positions I hold by allocating a fixed amount of capital to each position, like 4% of total capital. Then putting on an initial position of 1-2% and leaving the rest in the account to collect interest and be available to either sell cash secured puts or average down. Currently I maintain about 10-20% cash reserves, so this change would most likely increase my cash reserves and reduce the amount invested. It may reduce my returns but it would also provide more cash to recover from declining positions. So as always, there's a trade off. Limiting the number of positions would also make it easier to track. I've found that with too many positions I just don't have the time to properly analyze them each month. Having a limited number of high quality positions would be more manageable. I may even spread the expirations out to various months so I don't have so many adjustments to make each month.

Since I started this covered call portfolio I'm moving further and further into the value investing camp. Value investing makes sense to me and there's empirical evidence to support it (e.g. various market studies and actual results from investors like Warren Buffett and several other value fund managers). So, naturally my trading plan will continue to evolve in that direction. I have several ideas I plan to investigate, and possibly implement, this year and will post any changes to my trading plan on this blog.

Hopefully 2008 will be more profitable than 2007 was.