Nice Covered Call Example

I don't do much option trading, but I'd like to start writing covered calls and puts on certain stocks.  Stocks trading at high valuations, or trading sideways for long periods tend to be good candidates for covered calls;  where someone pays you a few bucks for the option to buy your shares in the future at a higher price than today.  The risk to the me is that I will sell my shares at a higher price than today; thus, I'll part with my dividend producing asset.

Here is a nice example from Dr. Paul Price:

New post on MarketShadows

A Covered Call Concept by Dr. Paul Price A Covered Call Concept Everyone loves to get something for nothing. When covered calls end up expiring worthless that is exactly what happens. The writer (seller) received money for the call premium. An option that goes unused means the  seller ‘won’  without giving up anything.  Many people think that seeing short calls expire is the ‘best case’ result. They are wrong. To understand why simply do the math. Assume we own 100 XYZ Corporation  which now  trades at $45 per share.  Pretend the bid on the October $50 calls is $2. Selling one covered call contract at that price brings in $2 x 100 shares = $200. If XYZ finishes at $45, unchanged from its inception date price, on expiration Friday:                         We started with 100 XYZ shares worth $4,500. When the trade concluded we finished holding the original 100 XYZ shares, still worth $4,500, plus the $200 from the call premium = $4,700 in total value. If the underlying shares had declined in price by anything greater than the $2 per share our position would have less total value than we started with as of the trade inception date. The call money received was 100% profit. Did that really represent the maximum possible profit? Consider the result achieved if XYZ ends at $50 or above on the option’s expiration date.   The call writer would be forced to deliver 100 XYZ shares when the option is exercised. The option owner would then pay him $50 x 100 shares = $5,000.  The call seller would also have the $200 from the call premium received. Final position = No shares + $5,200 of cash. Total Value = $5,200. Which would you rather have on the option expiration date… $4,700 or $5,200? Sure, it rankles if the underlying shock shoots to well above the chosen strike. Call sellers have capped their upside.  They will miss out on pocketing the full  move. Do not sell covered calls at strike prices lower than where you would be willing to part with your shares. The ‘risk’ in covered call writing is exactly the same one you take whenever you sell any stock. There is always a chance that those shares could go higher afterwards. The key concept is simple. Once you have sold covered calls … seeing the option exercised always delivers your best-case result. Dr. Paul Price | July 23, 2013 at 7:11 am | Categories: Education, Options, Value Investing | URL:http://wp.me/p2soa2-7TkY

Halliburton Notes

HAL announced EPS a penny above expectations, and revenue slightly ahead of expectations.  Both are down vs. same quarter last year, but that's true throughout the natural gas industry.  Decent report card.  I'm holding, hoping for a nice dividend increase.

Analyst Actions: Halliburton Keeps Outperform, Target Lifted $2 at Credit Suisse; Shares Up Near 2%, Nearer 52 Week Highs

BY Midnight Trader
— 2:22 PM ET 07/23/2013

02:22 PM EDT, 07/23/2013 (MidnightTrader) -- Credit Suisse says: "No Good Performance Goes Unpunished. HAL did well this quarter and delivered on its promises, but this did not show up in the stock price-a buying opportunity. Activity is strong-frac stages are on par with 3Q12, the latest peak in Oilfield Service activity. Growth in North America (NAM) is the primary investor concern. Recovery in Canada and the Gulf Of Mexico (GoM) will drive NAM revenues higher in 3Q13, with service intensity and rig efficiency aiding onshore; but given a record frac stage run rate, significant upside will depend on pricing which should kick-in sometime next year. The outlook on fundamentals remains strong and we are raising 2013 EPS to $3.22 from$3.21 and 2014 to $4.26 from $4.08, and TP to $55 (from $53)."

Not Just a NAM OFS Company. "HAL delivered leading YoY international revenue growth for the 5th consecutive quarter (+14% YoY). 2Q13 international op income was 48% of EBIT. Eastern Hemisphere also grew at the top of the peer group, YoY revenue and EBIT were +16% and +23%, respectively, which even outpaced SLB's impressive Eastern Hemisphere performance of +12% revs and +18% EBIT and BHI's +12% rev and +9% EBIT YoY. HAL mentioned a few recent wins that will help propel its strength in the region including a $500mm fluids contract in Malaysia, an offshore cementing contract, and a $100mm five year contract in the North Sea. We project Eastern Hemisphere YoY growth to be 20% for sales and 27% for EBIT in 3Q13."

Long Term View Intact; Buy It. "We reiterate our Outperform rating and are increasing our TP to $55 from $53; our target continues to be based on 6.5x our 2014 EBITDA estimate (which is now $8.1B). HAL continues to trade at a discount to its closest peer: 29% and 24% on EV/Ebitda and P/E respectively, a discount we do not believe is justifiable given HAL's superior returns and international revenue growth."

Price: 45.90, Change: +0.82, Percent Change: +1.8

http://www.midnighttrader.com

Johnson & Johnson in the WSJ Today - Good Quarter

New Drugs Lift J&J's Quarter

Earnings More Than Double for the Quarter

By 

JONATHAN D. ROCKOFF

Johnson & Johnson JNJ -0.02% said Tuesday that its second-quarter earnings more than doubled to $3.8 billion, as the health-products company benefited from fewer special charges and surging sales for new prescription drugs that the company is starting to roll out.

The $17.9 billion in sales that the New Brunswick, N.J., company reported during the quarter, an 8.5% increase over the period a year earlier, was driven partly by the growth of new medicines, such as prostate-cancer treatment Zytiga and hepatitis C treatment Incivo. J&J has launched 11 new drugs since 2009, and says it expects to seek approval of 10 more by 2017.

"The year is off to a strong start," J&J Chief Executive Alex Gorsky said.

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J&J's medical-devices business, the company's largest segment by sales, benefited from the $21 billion acquisition last year of trauma-device maker Synthes. The device unit's sales grew 9.6% to $7.19 billion, though executives acknowledged that the business faced pricing pressures and other challenges in the U.S.

Charges amounting to $2.2 billion related to the integration of Synthes, as well as funds reserved for litigation expenses, weighed down J&J's results for the second quarter last year.

J&J's $3.8 billion profit in the current second quarter, or $1.33 a share, was up from $1.41 billion, or 50 cents a share, a year earlier. Excluding certain items—such as a gain related to the sale of Elan Corp.'s DRX.DB -1.07% American depositary shares, acquisition-related costs and litigation impacts—adjusted per-share earnings rose to $1.48 from $1.30.

Analysts polled by Thomson Reuters had projected earnings of $1.39 a share on revenue of $17.71 billion.

Shares of J&J rose 16 cents to $90.56 in late morning trading Tuesday. The stock is up about 29% this year.

J&J has been struggling with the recall of iconic products like Tylenol pain and cold medicines, and the company announced more recalls in the quarter. Yet the company began returning recalled products to store shelves in the U.S., notching $290 million in over-the-counter sales in the U.S., a 17% increase from the year-earlier period.

"We're making good progress restoring our over-the-counter products to store shelves," said Sandra Peterson, the J&J executive who oversees the company's consumer group. Overall, sales in the company's consumer unit grew 1.1% to $3.7 billion.

Like its rivals, J&J has sought to move beyond the onset of generic competition for top-selling prescription drugs by restocking its portfolio. In the quarter, J&J reported $7 billion in pharmaceutical sales, a 12% jump from the year-earlier period.

Executives said new drug launches made J&J the fastest-growing drug maker in the U.S., though the company has encountered setbacks, notably the failure of an infused version of an experimental treatment for Alzheimer's disease. J&J and partner PfizerInc. PFE +0.09% discontinued development of the remaining, injectable version of that therapy, bapineuzumab, J&J said Tuesday.

Among the new drugs that J&J is counting on to drive further growth is ibrutinib, an experimental blood-cancer treatment that last week was submitted for U.S. approval. In an effort to complement Zytiga, J&J said last month that it would pay $650 million upfront to buy privately held Aragon Pharmaceuticals Inc. and its experimental prostate-cancer treatment in midstage development.

—Tess Stynes contributed to this article.

Portfolio Balance

Since the Chump IRA has had a nice run over the past year (1 year performance through May stands at 24.28%), I thought it was time to take a look at balance and diversification.  Here is the portfolio sorted by size of holding, with some additional metrics for consideration:

The number of positions is now at 32, the average size of position is 3.13%, and the current yield for the entire portfolio is 2.87%.  I sorted the holding by position size, coloring all holding above the average size as yellow, and all holding below average green.  17 positions are above average size, 15 are below, with 8 positions above 4%, and four positions below 2%.

I don't feel obligated to keep all my positions the same size.  I tend to add to undervalued positions, and NOT add to overvalued positions.  Sometimes positions get large (AAPL, INTC, AFL) simply because I see a good stock at significant undervaluation.  I see no reason to reduce these positions while the under/or slightly over valuation persists.  Conversely, I also have some small positions that won't grow until they become a better value; KO has been a small holding for the entire last year, it's just too expensive.  Similarly, O is overpriced at these levels, but remains small in the portfolio, so I'll keep it and add to it down the road (perhaps WAY down the road).

Next, I calculated today's "blended" PE and compared it to the PE for the stock over the past 5 years, or the 5 year average PE.   This is a nice simple look at valuation.  A negative number indicates under fair value, a positive is above fair value.  I colored everything 15% or more above fair value yellow (caution), and every stock with a negative/under valuation green.

Using just position size and valuation, I see a couple of large positions that are overvalued;  MDT, JNJ, EMR, MO, ADM.  Next I looked at current yield, and rate of dividend growth for the past 5 years.

MO is okay due to it's nice yield and low beta, I leave it alone for now.  EMR is okay for now with a yield of 2.8%, but I'll keep an eye on valuation.  JNJ and MDT are also worth keeping an eye on, especially JNJ due to valuation.  ADM will also be one I watch closely for continued overvaluation.  I'm hesitant to cut any of these back for two reasons:  1) I like each of these excellent companies, and all are dividend Champions (MO not actually due to spin off of PM, but they have an incredible dividend philosophy).  2)  I don't have any great alternatives for investment at this time.

Looking at this list, HAL jumps out as a stock I'm not crazy about for the long haul.  They have a stingy 1.1% yield, and have very low growth in the dividend.  If it runs further in value, I'll likely trim or sell this name, and use the proceeds to reinvest into my smaller positions that are still at or below fair value.  My target names for additional investment within the portfolio are:

• BBL
• DE
• KSS
• PM (on dips)
• KO (on big dip)

That's all for now,

Chump

Portfolio Update July 10, 2013 - Valuation

Here are the current holdings in the Chump IRA:

I was revisiting one of my first posts for this blog, my "rules" for the portfolio.  They still seem pretty sound after about a year, but I'm not sticking to them rigidly.  One of the rules I wanted to check is about reducing a position once it gets 15% over what I deem to be fair value.  The summary above shows each of my holdings PE today and the average PE for the past 5 years.  

Going through the list, I'm looking for holdings that violate the 15% overvaluation rule:

• ADM is 36% over fair value PE
• GD is 20.6% over fair value PE
• MO is 22.2% over fair value PE
• COP is 19% over fair value PE
• EMR is 16.3% over fair value PE
• JNJ is 25.6% over fair value PE

And of course, O is way over fair value FFO, but was when I bought a small entry position, so I'll ignore that one.

My rule states that once a holding hits these levels of overvaluation, I'll put in a stop loss for the excess $ over my purchase price, or write covered calls, or just trim.  

So, now the big question, do I trim these down?  If so, do I sit on the cash and wait for a correction? For how long?  If I don't have a good replacement for each, then why do it?  Or perhaps I could build the positions of the other holdings that are still slightly undervalued?

I may need another rule about what to do with the funds generated from the liquidation or trimming of a holding.  I'm going to think about this for a few days before I make a decision.

That's all for now, 

Chump

Good Newsletter by Paul Price and Associates

I found this very thoughtful, and well worth the read:

http://marketshadows.com/wp-content/uploads/2013/07/Market-Shadows-Newsletter-7-9-13-final.pdf

Best regards,

Chump