Monday, November 4, 2019

Maximize yield with capital gain potential MPC CVX or XOM

The goal of every income investor is income followed closely by capital preservation.  Next on our list of goals is to maximize income and retain the opportunity for capital gains.

  • The goal of the trades discussed in this post are to achieve 8% annualized cash flow from a combination of dividends and covered call premiums and to keep an opportunity for capital gains.
  • My analysis illustrates how to determine how much premium from a covered call you need to meet your goal.
  • In this article I present three stocks to consider with only one of these stocks that meets my 8% hurdle. 
In reality this is just a math exercise.  You start with either your basis on a stock or the target price at which you want to buy a stock.  For me I want 8% annual income yield on these stocks.  I will discuss why I set 8% for these stocks later in the post.   Once you have that number in hand, subtract the annual dividend.   After subtracting the dividend from the desired total income, you can determine how much you want in call premiums.

Since you want to capture the dividend with each call expiration date, you can expect to sell no more than 3 calls per year.    Assuming you actually can sell three calls per year, you simply divide the total income you want from the call premiums by three and that determines the premium you need per call to meet your goal.  Let's look at an example then we can apply this theory to real trades.

EXAMPLE XYZ STOCK











For XYZ stock we need $2.50 of additional income from premiums on covered calls.  If we get lucky you might get the whole $2.50 on the first call.  However, it is more highly likely that you will end up selling, also known as writing, calls three times during a year at an average of $.83 per contract.  One contract is 100 shares.

SCREEN BY PREMIUM FIRST

In this situation, once I target a stock, I start by looking for premiums rather than strike price.  In most of my covered call trades, I look for a strike price no less than 8% above my basis and usually, I like 10% or more.  I want a strike price high enough that it is not likely to be called away.

On a potful of stocks, however, I will start by looking for a premium and then determine which expiration date is after the next ex-dividend date.  In other words you do not want to sell a call with an expiration date before an upcoming ex-dividend date.  The last value I look at is strike price.

These are good stocks and I know I risk losing my shares if the strike price is too low.  If the best premium comes from an expiration date in fewer than 30 days, I am more willing to risk losing the shares to the call buyer but never, ever at below my basis.   I always want a capital gain if the shares are assigned to the call buyer.

How much capital gain I want is different with each and every stock.  Stocks like Broadcom, symbol AVGO, are very volatile.  Tweet, tariff and headline news can hammer these stocks providing an entry point and these same factors can send it soaring which makes the calls create more income for us.  Picking a high strike price is appropriate.  If you get hit, you'll likely have another chance to get in.

Other stocks are not so volatile and you are at less risk of losing your shares even when you pick a strike price only 5% or so above your basis. Let's get to specifics.

CVX (Chevron), MPC (Marathon Petroleum) and XOM (Exxon Mobil)

Below are tables of the calls available when I did my search today. November 4, 2019.

Remember, I want to add one or more of these stocks and am looking for an annual combined (dividend plus call premium) yield of 8%.  

The eight percent comes from the idea that this group of stocks needs to create enough income to fund a specific project.  For me it is an annual charitable contribution but you might think of the idea when you are trying to create the income you need for your required minimal distribution from an IRA.    You don't have to use 8%.  If your hurdle is 5% simply change the parameters in the calculation.

Chevron CVX


All three stocks have good balance sheets.  Chevron carries a D/E (debt to equity ratio of only .20.)    They all have good dividend yields, Chevron's is over 4%.  And they all have revenue growth.  They earn more than they pay out in dividends as measured by EPS and free cash flow.









You can see from the table above, the concept that I can get 8% annual return on this stock by using dividends and calls is not encouraging.  I will pass on the single call available with the premium I
need.

Marathon Petroleum MPC


MPC has the highest D/E ratio at .91 and that it is still acceptable.  It has the lowest dividend yield of 3.19% but that too is acceptable because MPC has the most robust revenue growth.  Revenue growth stimulates the juices of the call buyers.  Moreover, there has been speculation that MPC may split up to provide more shareholder value.















You can see from the table above, we have more than one option to consider.  Note the first call after the ex dividend date is November 22, 2019.    You cannot go out too long on the expiration date or you will not be able to sell three calls in a year.   Within 90 days, MPC provides two calls worth consideration.

December 20, 2019 $72.50 call for a premium of $1.18 and the January 17, 2020 calls for a premium of $1.32.

Exxon Mobil XOM


XOM pays the best dividend of the group with a yield of 5%.  XOM also has a good balance sheet with a D/E ratio of .24.  Revenue growth is the slowest of the group.  XOM calls are interesting.












Notice the only call for me that has interest is the January 17, 2020.  You could sell this call and receive two of the three call premiums you need to receive an 8% combined income yield.  However, the capital gain opportunity is weak at only 1.16%.    You could very easily lose your shares to the call buyer.

END RESULT

Today I added MPC and sold two calls.  I sold the December 20, 2019 $72.50 call and the January 17, 2020 $75.00 call.

We will just have to see what happens.  This is an exercise in working calls in a market with an upside bias.  It is a conservative approach because in the end if the market tanks 'ala 2009, we will still have a stock with steady income and a solid balance sheet.

Good income investing.

M* MoneyMadam
Disclosure:  Long CVX, MPC, XOM with calls on MPC











Monday, October 21, 2019

NVDA and AVGO two calls with different purposes

We income investors are struggling to keep the cash flow up.   Quality dividend stocks are expensive and value stocks have value for reasons that make ordinary investors nervous.

  • No commissions help  you be more creative to work call option income
  • Know your income goals and be flexible with strike prices and expiration dates
  • Stick with stocks that have good fundamentals but don't eliminate a stock just because it is not perfect

We have to employ our cash to earn income and hold our noses when all the numbers are not perfect.

Below are two calls, both executed today.  They are designed to deliver income yet each is quite different from the other.  One call expires in 12 days and the other call in 89 days.

AVGO - Broadcom


I own Broadcom and sell calls as often as I can.  Broadcom is not perfect.  The D/E (debt to equity ratio) is higher than other chip stocks such as Intel.  AVGO D/E = 1.75 whereas INTC carries a D/E of only .38 and Skyworks (SWKS) has no debt.

Moreover, AVGO has earnings per share slightly less than the dividend payout.  However, their cash flow per share is more than double their dividend.  EPS = $7.42, Cash Flow = $23.39 with dividend payout of $ 10.60.

I am putting more money to work in Broadcom and selling a call designed to deliver at least 10% in capital gain should the call be assigned (the call buyer actually buys my shares at the strike price.)  Another goal for this call is to received call premium greater than the quarter dividend.  Finally, I picked a strike price that captures the dividend provided the call buyer does not take my shares before the ex-dividend date.

One of the biggest benefits from owning Broadcom is the prodigious dividend growth.  Over the past 3 years the quarterly dividend increased from $ .51 to $2.65.   When you realize that your expenses will double in 20 years and if you expect to live for 20 more years,  you need your income to grow.  Broadcom, in my opinion is worth the risk.

See the two tables below:


AVGO Dividend Machine Fundamentals










AVGO January Covered Call Option


















NVDA - Nvidia


I also own Nvidia and I added a little today.  With this stock I am looking to cash a nice check quickly.   I have less interest in holding NVDA for the long haul because the dividend is low and their dividend increases are adequate but nothing like AVGO.

I am risking new capital but for only 12 days.  I picked a call that will deliver more in the premium than I can get in dividends when holding the stock for an entire year.   The risk is that NVDA is very volatile (52 weeks price range is between $124.46 and $235.32;  this means NVDA could be worth less than what I paid in just 12 days.




I picked a strike price that is very close to my cost  basis.   I get a little gain and I get to pocket a juicy call premium.  And the entire commitment is only 12 days.

Risk is an interesting issue.  Look at NVDA's fundamentals below and you can see that the share price may be volatile and prone to headline news and trade tweets, but NVDA has a solid balance sheet and cash flow that far exceeds dividend paid out.  I think 12 days of risk is ok.  Let's see what happens.

See the two tables below:


NVDA Dividend Machine Fundamentals










NVDA November Covered Call Option



















It is not easy to work your portfolio in this stock market environment.  No commissions helps me be more creative.  Know what your goals are so when you do execute your trades, you are confident your income goals can be realized.   When your proceeds are not eroded by costs, you can do a little more active call selling.

M* MoneyMadam

Disclosure:  Long NVDA and AVGO with calls

Friday, October 4, 2019

Simple conservative income investing: Call opportunities on CAT and WSO

Today, the market is up and I take advantage of those moves by looking for additional income from covered calls.  I am not an options trader.  I use call options to boost my income because there are few sources of good yield at a reasonable price.

WSO is a good dividend stock that moves up and down with international news, tariff news, exchange rate news.  The company likes to share income with investors through dividends.  And they increase the dividend routinely.

You may not want to risk selling a call on WSO but I do sell calls on some of my position and have benefited from that strategy.   Here is a call I sold today on shares I added in February



















I like to keep things simple and you can clearly see how using calls can boost income.  The call premium is equal to the quarterly dividend.  It is like getting five dividends this year.


Caterpillar is even more volatile than WSO.  Lately it is an unloved stock.  I buy and sell calls on it and I do not worry about losing it because it seems CAT's price always goes down after it is called away and I buy it back, cash the dividend check and sell a call to someone who thinks the price will go up.  Quite often they are right but I do not care as I do this for income.  



















Again you can see the advantage of selling a call that pays you a juicy premium but also captures the next dividend.  In this case the call premium is greater than the quarter dividend.

This post documents how simple, conservative income investing can work for the ordinary investor.

M* MoneyMadam

Disclosure:  Long WSO and CAT with calls

Tuesday, September 24, 2019

Discount Bonds a tale of woe.

High Yield Bonds were enticing for income investors, including me, while we were in a low interest rate environment.  Safe bonds just didn't pay enough.

  • High Yield Bonds are not for beginners
  • Pay a steep discount
  • Risk is high

Since I started writing this blog about income investing,  I invested $81,670 in high yield bonds.  Each buy was for 10 bonds.  Eight different bonds make up the portfolio.

TheMoneyMadam's High Yield Bond Portfolio


The table below lists the bonds I bought with CUSIP, coupon rate, and maturity date.  The portfolio holds only one of the eight bonds.  The others defaulted, were redeemed or tendered.




It was a rocky and mostly unsuccessful venture.  My $81,670 turned into $72,949 not including income.  That is a 12% loss.  When adjusted for income the loss is cut to 4% but I don't like losing money.

The most painful rub is that quality bonds continued on a bull run during this time.  Those quality bonds gained more than my high yield bonds.  

If you read the dividend ideas on this blog you will see over the same time frame, I bought $875,687 worth of stocks.  The high yield bonds make up about 9% of the investments that I track in my portfolios. That alone is a good lesson. If you are going to take risk, you must keep it to a minimum.

It is a tricky business that requires even more due diligence than buying a dividend stock. Bonds are distressed for a reason and that is risk.

When will be enter a Bond Bear?


As we continue the 35 year bond bull market and enter what I had hoped to be a 20 year bond bear market, high yield bonds would not be as necessary even though they can be very rewarding (see Noble Energy Bond above.).

In 2019 the turning tide of interest rates has not yet revealed itself. 

I intend to ride the new cycle of increasing interest rates should it ever come true.  For average risk bonds I would like 5% for five years.  When bond prices decrease enough that I can get 5% for five years, I may change my mind and want more.  We will see.

As I find bonds I like, I will write them up.  

M* MoneyMadam

Disclosure:  Long Cinemark Bond However since the price is above par, I am tempted to sell soon.


HCI Exceptional Call


HCI Group, symbol HCI is a dividend stock I have owned for about two years.  I bought it based on the yield and dividend growth.  It also has reasonable debt, but revenues are not growing.  



The stock price has ranged between $36.72 and $59.32.  I would like to get rid of HCI through calls.  I sell calls and they have never been assigned.  



Today, I sold a call that does not capture the next dividend but the total return for me if they take my shares by exercising their right to buy is quite good – 13.8%. 



HCI $45 call expires October 18, 2019.





With this call I have income in mind.  The premium I received is over 1%.  I like that.  Moreover, the duration of the call is very short.  If HCI is assigned that is okay with me and if I keep it, I will continue to sell calls.   If the fundamentals deteriorate such as no longer increasing the dividend, I will sell it all.



M* MoneyMadam

Monday, September 23, 2019

Best call today was WHR Whirlpool

Last Friday, September 20, 2019 was quarterly expiration of stock options.  As an active income investor, I use covered calls to create income.  I certainly cannot get adequate income from the usual sources for safe money like bonds.

I had 25 calls on 12 different stocks expire last Friday.  Five calls on two stocks were taken.  Four of the calls that were exercised were on Novocure, symbol NVCR.  Novocure does not qualify as an income stock.  I do not want to risk losing the rest of my position on NVCR.  Therefore, I did not even tempt myself by looking at potential calls on this growth stock.

The other call that was taken, also known as exercised, or assigned was J.P Morgan, symbol JPM.  All the other calls expired.  I got to keep the premium paid and now I am looking for additional calls on those stocks.

Listed below are the calls I sold today:

IBM:  $150 strike expired on 9/20/19







You will notice, I am underwater on IBM.  But I like the dividend yield of over 4.5% and I have sold 4 calls on IBM since I bought eighteen months ago.   I don't like it enough to buy more shares but I do like the call premiums.

In this call I created an additional 1.1% on my basis.  I am willing to live with the unrealized loss as long as I cash those dividend and call premium checks.







Whirlpool (WHR): $160 strike expired on 9/20/2019


Whirlpool is quite volatile.  It responds to a lot of "headline risk."  Tariffs and international sales of washing machines is more exciting than you think.  



Again I like the yield of 3.19% but I would like more than 3.19% and calls are a way to boost the income.  I have sold calls many times on WHR that have been exercised.  This time my calls expired and I was able to sell more calls today.

In this call alone, I was able to capture a yield of 4.53% just from the premium.  






Without a doubt Whirlpool was the covered call of the day.  This is good income investing.  If any other calls come available, I will write them up.  Stay tuned.

M* MoneyMadam

Disclosure:  Long IBM and WHR with calls