SNDK - Adjustment

The following adjustment was made today on SNDK:

27-Apr-07 - Interim Trade - STO 2 May07 45/00 Call @ 0.84 -

I could have made this adjustment on Monday and gotten about $1.10-$1.15 on the call option but I decided to until after SNDK announced earnings on Thursday. You never know how a stock is going to react to an earnings announcement so, IMHO, it's better to wait until after the announce before establishing or adjusting a covered call position.

Note that this position will be almost a year old by May expiration. In that time I generated about 23% in option premium. Also note that this is an Interim trade. This usually means the call option is below the cost basis, which would result in a loss if called. In this case though, the call option is above the cost basis and will result in a small gain. I really don't want to let this stock get called away and give back most of the option premium I generated, so I flagged this as an Interim trade and will roll it out and up to avoid assignment if the call option goes ITM.

Current Position Summary:

Stock Investment: $10,854.00
Income Generated: $2,543.00
Percent Income Generated: 23.43%
Net Profit If Called: $689.00
Percent Return If Called: 6.35%
Annualized Return If Called: 5.96%
Days to Expiration: 361 days

Trade History:

24-Apr-06 - Initial Stock Position - BTO 100 SNDK @ 59.56 -
24-Apr-06 - Initial Call Option - STO 1 Jul06 57.50 Call @ 7.09 - Closed
06-Jul-06 - Buy Back & Roll Out/Down - BTC 1 Jul06 57.50 Call @ -0.16 -
06-Jul-06 - Dollar Cost Averaging - BTO 100 SNDK @ 48.98 -
06-Jul-06 - Combined Cost Basis - $10,854.00 200 @ 54.27 -
06-Jul-06 - Continued Trade - STO 2 Oct06 55.00 Call @ 3.39 - Expired
23-Oct-06 - Continued Trade - STO 2 Jan07 55.00 Call @ 2.14 - Closed
19-Dec-06 - Buy Back & Roll Out/Down - BTC 2 Jan07 55.00 Call @ -0.16 -
19-Dec-06 - Continued Trade - STO 2 Feb07 50.00 Call @ 1.69 - Closed
06-Feb-07 - Buy Back & Roll Out/Down - BTC 2 Feb07 50.00 Call @ -0.06 -
06-Feb-07 - Interim Trade - STO 2 Apr07 45.00 Call @ 1.39 - Expired
27-Apr-07 - Interim Trade - STO 2 May07 45/00 Call @ 0.84 -

UPS - New VICC Position

A new VICC position was established today on UPS. The following is the trade information, including IB commissions:

26-Apr-07 - Initial Stock Position - BTO 100 UPS @ 71.93
26-Apr-07 - Initial Call Option - STO 1 May07 75.00 Call @ 0.10

Stock Investment: $7,193.00
Income Generated: $10.00
Percent Income Generated: 0.14%
Net Profit If Called: $317.00
Percent Return If Called: 4.41%
Annualized Return If Called: 73.12%
Days to Expiration: 22 days

Note that as a VICC position the primary objective is capital appreciation. The stock will be held long term until it reaches or surpasses it's fair value. Front month OTM call options are sold to bring in a small amount of income while waiting for the stock to appreciate. The calls are sold far enough OTM to avoid assignment and the need to make any mid-month adjustments.

WMT - New VICC Position

A new VICC position was established today on WMT. The following is the trade information, including IB commissions:

23-Apr-07 - Initial Stock Position - BTO 100 WMT @ 49.26
23-Apr-07 - Initial Call Option - STO 1 May07 52.50 Call @ 0.10

Stock Investment: $4,926.00
Income Generated: $10.00
Percent Income Generated: 0.20%
Net Profit If Called: $334.00
Percent Return If Called: 6.78%
Annualized Return If Called: 98.99%
Days to Expiration: 25 days

Note that as a VICC position the primary objective is capital appreciation. The stock will be held long term until it reaches or surpasses it's fair value. Front month OTM call options are sold to bring in a small amount of income while waiting for the stock to appreciate. The calls are sold far enough OTM to avoid assignment and the need to make any mid-month adjustments.

WFMI - New VICC Position

A new VICC position was established today on WFMI. The following is the trade information, including IB commissions:

23-Apr-07 - Initial Stock Position - BTO 100 WFMI @ 47.19
23-Apr-07 - Initial Call Option - STO 1 May07 50.00 Call @ 0.83

Stock Investment: $4,719.00
Income Generated: $83.00
Percent Income Generated: 1.76%
Net Profit If Called: $364.00
Percent Return If Called: 7.71%
Annualized Return If Called: 112.62%
Days to Expiration: 25 days

Note that as a VICC position the primary objective is capital appreciation. The stock will be held long term until it reaches or surpasses it's fair value. Front month OTM call options are sold to bring in a small amount of income while waiting for the stock to appreciate. The calls are sold far enough OTM to avoid assignment and the need to make any mid-month adjustments.

MDT - New VICC Position

A new VICC position was established today on MDT. The following is the trade information, including IB commissions:

23-Apr-07 - Initial Stock Position - BTO 100 MDT @ 52.72
23-Apr-07 - Initial Call Option - STO 1 May07 55.00 Call @ 0.19

Stock Investment: $5,272.00
Income Generated: $19.00
Percent Income Generated: 0.36%
Net Profit If Called: $247.00
Percent Return If Called: 4.69%
Annualized Return If Called: 68.40%
Days to Expiration: 25 days

Note that as a VICC position the primary objective is capital appreciation. The stock will be held long term until it reaches or surpasses it's fair value. Front month OTM call options are sold to bring in a small amount of income while waiting for the stock to appreciate. The calls are sold far enough OTM to avoid assignment and the need to make any mid-month adjustments.

WGO - Adjustment

The following adjustment was made today on WGO:

23-Apr-07 - Continued Trade - STO 2 May07 35.00 Call @ 0.54 -

Current Position Summary:

Stock Investment: $6,455.00
Income Generated: $914.50
Percent Income Generated: 14.17%
Net Profit If Called: $1,459.50
Percent Return If Called: 22.61%
Annualized Return If Called: 12.35%
Days to Expiration: 668 days

Trade History:

19-Jul-05 - Initial Stock Position - BTO 100 WGO @ 34.92 -
19-Jul-05 - Initial Call Option - STO 1 Aug05 35.00 Call @ 1.09 - Expired
22-Aug-05 - Continued Trade - STO 1 Sep05 35.00 Call @ 0.44 - Closed
01-Sep-05 - Buy Back & Roll Out - BTC 1 Sep05 35.00 Call @ -0.06 -
19-Sep-05 - Continued Trade - STO 1 Nov05 35.00 Call @ 0.34 - Closed
03-Oct-05 - Dividend Received - DIV 100 Dividend @ 0.09 -
21-Oct-05 - Buy Back & Roll Down - BTC 1 Nov05 35.00 Call @ -0.06 -
24-Oct-05 - Interim Trade - STO 1 Nov05 30.00 Call @ 0.24 - Closed
14-Nov-05 - Buy Back & Roll Up - BTC 1 Nov05 30.00 Call @ -2.66 -
21-Nov-05 - Continued Trade - STO 1 Jan06 35.00 Call @ 0.99 - Expired
09-Jan-06 - Dividend Received - DIV 100 Dividend @ 0.09 -
23-Jan-06 - Continued Trade - STO 1 Mar06 35.00 Call @ 0.44 - Expired
20-Mar-06 - Dollar Cost Averaging - BTO 100 WGO @ 29.63 -
20-Mar-06 - Combined Cost Basis - $6,455.00 200 @ 32.28 -
20-Mar-06 - Continued Trade - STO 2 Jul05 35.00 Call @ 0.69 - Expired
03-Apr-06 - Dividend Received - DIV 100 Dividend @ 0.09 -
10-Jul-06 - Dividend Received - DIV 200 Dividend @ 0.09 -
24-Jul-06 - Continued Trade - STO 2 Jan07 35.00 Call @ 1.39 - Closed
09-Oct-06 - Dividend Received - DIV 200 Dividend @ 0.10 -
22-Dec-06 - Buy Back & Roll Out - BTC 2 Jan07 35.00 Call @ -0.16 -
22-Dec-06 - Continued Trade - STO 2 Apr07 35.00 Call @ 1.19 - Expired
08-Jan-07 - Dividend Received - DIV 200 Dividend @ 0.10 -
09-Apr-07 - Dividend Received - DIV 200 Dividend @ 0.10 -
23-Apr-07 - Continued Trade - STO 2 May07 35.00 Call @ 0.54 -

NTES - Adjustment

The following adjustment was made today on NTES:

23-Apr-07 - Interim Trade - STO 4 May07 20.00 Call @ 0.19 -

Current Position Summary:

Stock Investment: $9,694.00
Income Generated: $3,408.00
Percent Income Generated: 35.16%
Net Profit If Called: $1,714.00
Percent Return If Called: 17.68%
Annualized Return If Called: 15.22%
Days to Expiration: 424 days

Trade History:

20-Mar-06 - Initial Stock Position - BTO 100 NTES @ 96.94 - 4-1 Split
20-Mar-06 - Initial Call Option - STO 1 Jun06 85.00 Call @ 15.29 - 4-1 Split
28-Mar-06 - Split Stock Position - SPLT 400 NTES @ 24.24 -
28-Mar-06 - Split Call Option - SPLT 4 Jun06 21.25 Call @ 3.82 - Expired
26-Jun-06 - Continued Trade - STO 4 Jan07 22.50 Call @ 3.19 - Closed
23-Oct-06 - Buy Back & Roll Out/Down - BTC 4 Jan07 22.50 Call @ -0.16 -
23-Oct-06 - Continued Trade - STO 4 Jan07 18.75 Call @ 0.69 - Closed
17-Jan-07 - Buy Back & Roll Out/Up - BTC 4 Jan07 18.75 Call @ -0.41 -
17-Jan-07 - Continued Trade - STO 4 Mar07 20.00 Call @ 0.99 - Expired
19-Mar-07 - Interim Trade - STO 4 Apr07 20.00 Call @ 0.19 - Expired
23-Apr-07 - Interim Trade - STO 4 May07 20.00 Call @ 0.19 -

CLHB - Adjustment

The following adjustment was made today on CLHB:

23-Apr-07 - Continued Trade - STO 1 May07 50.00 Call @ 0.34 -

Current Position Summary:

Stock Investment: $5,350.00
Income Generated: $566.00
Percent Income Generated: 10.58%
Net Profit If Called: $216.00
Percent Return If Called: 4.04%
Annualized Return If Called: 17.14%
Days to Expiration: 86 days

Trade History:

21-Feb-07 - Initial Stock Position - BTO 100 CLHB @ 53.50 -
21-Feb-07 - Initial Call Option - STO 1 Apr07 50.00 Call @ 5.32 - Expired
23-Apr-07 - Continued Trade - STO 1 May07 50.00 Call @ 0.34 -

MA - Closed Position

The MA Apr07 95.00 Call was exercised and the stock was called away for a profit. The following is the trade history and returns, including IB commissions.

Covered Call Results

Stock Investment: $9,527.00
Income Generated: $1,174.00
Net Profit: $1,147.00
Percent Return: 12.04%
Annualized Return: 29.10%
Duration of Trade: 151 days

Buy & Hold Comparison

Opening Price: $95.27
Closing Price: $110.09
P/L per Share: $14.82
Shares: 100
Dividends: $24.00
Net Profit: $1,506.00
Percent Return: 15.81%
Annualized Return: 38.21%
Duration of Trade: 151 days

Trade History:

20-Nov-06 - Initial Stock Position - BTO 100 MA @ 95.27
20-Nov-06 - Initial Call Option - STO 1 Apr07 95.00 Call @ 11.50
09-Feb-07 - Dividend Received - DIV 100 Dividend @ 0.09
20-Apr-07 - Option Exercised - EX 1 Apr07 95.00 Call @ 95.00
10-May-07 - Dividend Received - DIV 100 Dividend @0.15

ISE - Closed Position

The ISE Apr07 50.00 Call was exercised and the stock was called away for a profit. The following is the trade history and returns, including IB commissions.

Covered Call Results

Stock Investment: $5,181.00
Income Generated: $769.00
Net Profit: $588.00
Percent Return: 11.35%
Annualized Return: 27.43%
Duration of Trade: 151 days

Buy & Hold Comparison

Opening Price: $51.81
Closing Price: $50.40
P/L per Share: -$1.41
Shares: 100
Dividends: $10.00
Net Profit: -$131.00
Percent Return: -2.53%
Annualized Return: -6.111%
Duration of Trade: 151 days

Trade History:

20-Nov-06 - Initial Stock Position - BTO 100 ISE @ 51.81
20-Nov-06 - Initial Call Option - STO 1 Apr07 50.00 Call @ 7.59
29-Dec-06 - Dividend Received - DIV 100 Dividend @ 0.05
30-Mar-07 - Dividend Received - DIV 100 Dividend @ 0.05
20-Apr-07 - Option Exercised - EX 1 Apr07 50.00 Call @ 50.00

Position Sizing and Stop Losses

There are at least a couple of ways to manage risk using position sizing and stop losses.

For example, say I wanted to limit my maximum loss to 1% of total capital. I could use either of the following methods:

1. Using position sizing, I could limit the position to 1% of total capital.

2. Using position sizing and a stop loss, I could limit the position to 4% of total capital and set a 25% stop loss.

With method #1, I'd have less money invested in the position and therefore my return, in dollar terms, would be less. The position would have to lose 100% of it's value to reach the maximum loss, which is pretty unlikely unless the company goes out of business.

With method #2, I'd have more money invested in the position and therefore my return, in dollar terms, would be more. The position would only have to lose 25% of it's value to reach the maximum loss, which is more likely if the company missed earnings or the market as a whole was going down.

There are pros and cons to using either method. For my covered call positions I use method #1 and for my buy & hold positions I use method #2. One reason for the difference is that I can lower my cost basis in CC positions by selling call options, but with my buy & hold positions I can't. My new VICC positions are kind of a hybrid. They're buy and hold positions with covered calls, so I chose to use method #1.

Hope this makes sense.

A New Strategy

I decided to experiment with a new strategy for trading covered calls on what I call "pure" value stocks. These are stocks in solid companies selling at a discount to their fair value.

For this strategy I developed a new trading plan, which I call the Value Investing Covered Call (VICC) Trading Plan (see next post).

The main objective of this plan will be capital appreciation with a secondary objective of current income. I'll allocate about 10% of my current covered call portfolio to VICC positions.

In my regular covered call trading plan, I look for covered calls that provide 10-12% downside protection and a 20-24% annualized return if called. That plan has a primary objective of income.

VICC positions will have different requirements. Since I'll be buying stocks, with a margin of safety below their fair value, to hold for the long-term, I'm not looking for any downside protection. I'm also not looking for too much income either, since the objective is capital appreciation.

This is basically a buy & hold strategy except I'll be selling OTM call options to bring in a small premium, like a monthly dividend, while waiting for the stocks to appreciate. Speaking of dividends, all of the stocks selected will be dividend paying stocks where I'll try to double the dividend yield by selling call options. So, again, I shouldn't need much in the way of monthly option premium to achieve that (i.e. any premium above .10/month).

After option expiration this Friday, I'll see how much cash I have available and select 1 or more VICC positions, in addition to any new covered calls positions. As always, all trades will be posted here.

What Has Worked in Investing

As I've said in past postings, I'm not a fan of Efficient Market Hypothesis. I have a great deal of respect for the scholars, such as Eugene Fama, who came up with the theory, but I believe it doesn't explain what happens in the real world. I have yet to see the investment returns of any of these scholars.

While I believe markets are efficient when it comes to arbitrage opportunities, in the sense that prices adjust quickly to eliminate arbitrage, I don't believe that everything that is known about a company is priced into the stock. I believe that stock prices are influenced by the irrational actions of the market participants.

I also believe, with the right investment approach, one can beat the market, as evidenced by the students of Benjamin Graham, such as Warren Buffett, and several others. They have proven that they can and do beat the market over the long term, despite the claims of EMH.

An interesting booklet titled "What Has Worked in Investing" is available at Tweedy, Browne, an investment firm that follows the principles of Benjamin Graham.

This booklet describes 44 academic studies of certain investment criteria that have produced high rates of return. In the 44 studies exceptional returns were found for stocks with one or more of the following investment characteristics: low stock price in relation to book value, net current assets, earnings, cash flow, dividends or previous share price; small market capitalization; and a significant pattern of stock purchases by one or more insiders (officers and directors), or by the company itself. The study periods ranged from 1 to 55 years; indicated annual returns ranged from 12.1% to 49.6% and indicated annual returns in excess of the market index used in the studies ranged from 2.7% to 33.5% for the various characteristics and historical periods that were examined. Approximately one-half of the studies examined in the booklet focused on U.S. stocks and the balance focused on mature foreign stock markets. Many of the investment characteristics explained in this booklet, which are "value" oriented characteristics, have been the core of Tweedy, Browne's investment philosophy and stock selection decision making process since 1959, and are the basis for the management of their funds.

Some of these studies show similar results to the studies found in David Dreman's book Contrarian Investment Strategies in the Next Generation. Dreman also follows the principles of Benjamin Graham.

I'm sure you'll find this booklet very interesting reading.

Warren Buffett at the University of Florida

Here's a great video of Warren Buffett speaking to MBA students at the University of Florida. The entire video is about 1 hour and 30 minutes long, but I highly recommend it, particularly if you have never actually seen or heard Buffett speak.

What is Risk?

I'm reading David Dreman's book Contrarian Investment Strategies in the Next Generationand Chapter 14 is titled "What is Risk?". According to the Efficient Market Hypothesis (EMH) and Modern Portfolio Theory (MPT), risk is measured by volatility or beta. The greater the volatility or beta, the higher the risk.

However, one of the main advocates of EMH & MPT, Eugene Fama, subsequent to his 1992 paper, famously declared "beta as the sole variable in explaining returns on stocks...is dead...Knowing the volatility of an equity doesn't tell you much about the stock's return."

David Dreman published this article in Forbes Magazine in 2001.

A more comprehensive criticism may be found in here.

And of course, there's Warren Buffett's take on EMH and MPT:

"To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About Market Prices."

As Dreman says, "sometimes even the bluest of blue chips tumble sharply and become very volatile for a while. This volatility is not something to shy away from, it's a gift of opportunity. For value buyers, the more a stock is driven down by panic selling, the better. People warned away from this volatility lost enormous potential profits".

I tend to agree with this thinking, which is why I don't use volatility to measure risk. I believe, as David Dreman and Warren Buffett does, that risk is measured by the companies financial strength and it's stock price in relation to the fundamentals (i.e. intrinsic value vs stock price).