Wednesday, June 3, 2020

Rolling Covered Calls - Seniors should stop saving for a rainy day

Investors are either retired or not.  When you're retired, there are stages that guide how you employ your money.  In the latter stages a fresh approach is appropriate. Let's look at income from your brokerage accounts.
  • It's time to stop saving for a rainy day and take some risk.  Equities are the only place to get income from your brokerage accounts.
  • Remove emotion related to owning your favorite stock and view your stocks as blocks of money to invest to create income.  
  • Rolling calls depend on the investor realizing when you are called away, there is always another stock for income opportunity.
  • In order to roll your calls you need concentration in a stock. It is better to sell five calls on one stock than one call on five stocks.  
  • Call selling on dividend stocks provides for income during periods when the options market is weak.
This entire strategy is based on the thesis that adequate current income must come from equities as every other tool in your brokerage account delivers very little income. 

Many seniors who were self employed or had professional careers do not have a traditional pension.  Even corporate retirees may have to manage their own pension money after the corporation gives them the sum of their retirement savings such as 401k's.  This post targets seniors who are managing all or some of their brokerage accounts to create income.  I hope you will embrace using rolling covered calls to create income.

Image result for free photos "saving for a rainy day"

Saving for a rainy day is prudent behavior for most of your life.  But when you enter the very mature years, you need to realize the rainy days are here.    Pursue your constitutional right of the pursuit of happiness. Quality of life when one ages depends upon spending money on stuff and experiences and help . You need  income to fund those expenditures.  And because those of you who have saved for rainy days are by nature conservative, you don't want to sell stocks just to have fun. You can use your money to create income and a lot of income.

Rolling covered calls uses options on stocks.  Building the inventory of stocks is as fundamental as pouring the foundation for your home.  Look for stocks that pay dividends, have solid balance sheets, and have some upside potential, and  an active options market.  

Which stocks to put into this basket.

The number of stocks in a portfolio of about $1,000,000 should be about 30 - 35 names.  But the universe of stocks you use for your strategy will not be the same 30 - 35 stocks all the time.  The common elements among these stocks are:

  • Solid Balance Sheet - I use D/E ratio when I write posts.  If you understand how to read a balance sheet and can evaluate interest coverage ratios and other metrics, you have an advantage when picking a stock with a solid balance sheet.
  • Dividend Yield - Every stock in this basket pays a dividend.  Should you get stuck in a down market trend and there are no buyers of your options, you want to make sure you are collecting a dividend to pay for some of your fun.  Icing on the cake is to find a stock with reliable dividend growth over time.  This will help to offset the cost of inflation over the next 10 years.  We are old but we expect to live 10-20 more years and the cost of everything doubles every 20 years. Yet we are committed to take more risk and buying a stock like COP referenced below, we can compromise on dividend aristocrat status.
  • EPS or Free Cash Flow has to be greater than the dividend paid out.  How much above the dividend will determine how safe that dividend is.  You may go through periods of time when a stock's EPS looks less than the dividend payout and you have to determine if that is a passing event when the company took a charge for something special versus a complete change in the company's out making the dividend in jeopardy.  We are not always right in our picks.  I have and you will be wrong once in a while. 
  • P/E (price earnings) ratio should be reasonable for the stock.  Lower yielding stocks with growth potential may carry a higher P/E ratio than you find palatable and you have to weigh that against the value of the income you can get from selling a call.

Concentrate on 30-35 names

When you have concentration in a given stock such as owning 500 shares, you can sell rolling calls.  These calls can be spread out over weeks or even months and over several strike prices.

For instance, in May I had 44 calls working on 24 different names.  Seven of the calls were assigned. One stock, Las Vegas Sands $LVS, suspended the dividend prior to expiration and one stock, Royal Dutch Shell $RDS reduced the dividend.  

 May 13 calls    all expired
 May 86 calls  2 assigned
 May 1527 calls  17 stocks 2 assigned
 May 225 calls 4 stocks 3 assigned
 May 29 3 calls  all expired

When you buy a stock for the first time, you determine your exit strategy.  If the stock price increases, you can often times find call buyers.  I like to make sure I pick a strike price above my basis.  It is important to realize that I may add to my position and the new lot will have a different cost basis.  If that basis is lower than my original buy, I do not fret provided the fundamentals of the stock stay solid.  

When you sell a call on the new lot that has a lower basis, you  may pick a strike price above that basis but below the basis of your original buy.   I do not use "average" cost basis.  I sell calls on specific lots.

The expiration date is important.  When possible you want to capture the next quarterly dividend.  However, some times the call premiums are big enough to sell a call without capturing the dividend.  If your new shares are called away.  There is always another stock to buy or perhaps you add again to this position at a higher basis.  Again these new shares will be a chunk of money to invest for income.  Look for a call that provides at least a 1% yield and some capital gain.  Some days you will find nothing.  On other days you may be amazed at how many calls you can sell.

May was a pretty typical month for me.  The stocks I still own from this basket are:

SYMBOL Div Yld D/e Ratio P/e Ratio
CAT 3.34% 2.61 12.7
MS 3.07% 2.52 9.2
VZ 4.36% 2.31 12.6
LVS - 2.74 17.4
MSFT 1.10% 0.65 30.5
INTC 2.12% 0.52 12
CVS 2.99% 1.42 11.9
BAC 2.90% 1.19 10.1
GILD 3.71% 1.09 19.3
QCOM 3.07% 5.24 23.6
UL 3.29% 2.11 22.3
WSO 3.99% 0.27 28.3
WHR 3.94% 2.54 9.1
WMT 1.74% 1.11 23.6
IBM 5.17% 3.47 12.4
BCE 5.73% 1.56 16.5
AEP 3.26% 1.69 23.2
EXC 3.93% 1.23 14.3
SWKS 1.48% 0.04 25.7
PRU 7.22% 0.4 8.4
UPS 3.99% 7.3 20.1
COP 3.80% 0.48 13.5
IP 5.82% 2.45 20.9

This is an interesting list.  Of the dividend paying stocks, the yield range is 1.10% from MSFT and 7.22% from PRU.  The only worrisome D/E ratio is UPS.  In this basket the highest P/E ratio is SWKS at 25.7.  These are not all the stocks in my basket, just those that were on call in May but are now available to sell more calls.  

And indeed in June I have sold calls on twelve of these names.

Rolling Call Guidelines

Selling multiple calls with multiple expiration dates allows you to stay in the game with a block of money in a given security that is increasing in value.  When the stock is below the stock option strike price, your call will expire and if you still like the position, you can sell more calls on that lot.

When that stock is valued above the call option strike price, you will lose it.  If you follow the rules of selling calls for income you will have booked a capital gain, the call premium and hopefully the most recent quarterly dividend.  Touche.  Well done.

When your stock is called away you have to find a replacement.  Put your blocks of money to work. Your first choice is buy a name already in your portfolio so you can build a base in that stock.  It has to pay a dividend and it may be a laggard.  Check the balance sheet and other fundamentals, news, earnings announcements then look at call potential.  

Rolling Calls and time value of money

I calculate the standard outcomes from selling a call.  If I can sell a call for a capital gain and an amount equal to the quarterly dividend or 1% of the stock price, in one day of course I would do that.  I have never had that experience.  I do not trade options.  I only sell covered calls on dividend stocks.  Note that I have a covered call calculator on this blog to help you determine the potential outcome.

Below are two calls on COP that demonstrate rolling calls by both expiration date and strike price.  One expires and one is called away.

This call expired and I have more calls working on this lot.  This equates to receiving both a $.42 dividend plus the call premium of $1.05.  On about $3900.00 I received a net 3.77% in 2 weeks.  

    Call Expiration 
COP Call sold on 5/1/2020 5/15/2020
Cost Basis:   5/1/2020 $38.98
Strike Price:   $41.00
Call Premium:    $1.05
Dividend  Ex-Div 5/8/2020 $0.420
Call Yield on Basis   2.69%
Call + Dividend Yield on Basis   3.77%
$ Gain if Assigned   $3.49
Max Return if Assigned   8.95%

This call sold on the same day but with an expiration date two weeks later and a strike price $.50 more was called away.  Now I have $4,150 to put to use after having netted over 11% in 30 days. That buys a lot of pursuit of happiness. 

    Call Expiration 
COP Call sold on 5/1/2020 5/29/2020
Cost Basis:   5/1/2020 $38.98
Strike Price:   $41.50
Call Premium:    $1.50
Dividend  Ex-Div 5/8/2020 $0.420
Call Yield on Basis   3.85%
Call + Dividend Yield on Basis   4.93%
$ Gain if Assigned   $4.44
Max Return if Assigned   11.39%

Where do I put the proceeds.  Here is the trade I made on June 2, 2020.

    Call Expiration 
RTX Call sold on 6/2/2020 8/21/2020
Cost Basis:   6/2/2020 $62.74
Strike Price:   $75.00
Call Premium:    $1.05
Dividend  Expected 8/14/2020 $0.475
Call Yield on Basis   1.67%
Call + Dividend Yield on Basis   2.43%
$ Gain if Assigned   $13.79
Max Return if Assigned   21.97%

I elected to add to RTX which is the newly combined Raytheon and United Technologies.  I started in RTX when the merger was complete and got very lucky to buy in the low $50's.  That first lot will be called away as I sold a $55 call.  This call is very different from the COP call and illustrates the how time, duration of the call, can provide a juicy income if the stock performs.  If not, we have to live with what I believe is a solid income stock just by virtue of the dividend.

Time to live, make money and take more risk.


* Long all positions

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