There has been a lot of option activity in my retirement accounts recently so I wanted to take some time and explain how to calculate the return on investment (ROI) using a real example of a trade that I did yesterday.  As you know, I am working on increasing the exposure that my portfolio has to dividend paying stocks.  Well, one of the stocks that I was looking at was Nucor (NUE).  I was able to purchase some shares using the proceeds that resulted from the exercise of ONXX $46 puts last week.

My goal is to get a 1% return per month on my retirement account on average.  Part of this should come from the increased focus on dividends while the rest will come from capital gains and covered call premiums.  I believe that this is an achievable goal on average, although there will be times when the value will fluctuate above or below that target.

Nucor Trade

So, here is what I did yesterday.  I started by purchasing the June $32 strike put options for $0.49 per share.  Then I picked up the stock itself for $34.70 and put in an order to sell the June $35 strike calls at $1.10.  This was about 5 cents above the ask at the time, but I figured that given the normal daily volatility, it would get filled if NUE approached $34.90.  This did occur so at the end of the day, this is what my basis looked like before commissions:

$34.70 for the stock + $0.49 for the puts – $1.10 for the calls = $34.09

So, $34.09 per share is the amount that I have in the stock.  Now commissions can have a big impact upon return, and I always hate it when those aren’t figured into the equation.  I keep an Excel spreadsheet and add them in automatically based upon cash in and cash of the account.  When I add in commissions for trading, my basis becomes $34.15322 ($34.16) per share.  This is the number I will use for the calculations, but it is a little cleaner to look at the numbers without when you are learning.

Return on Investment If Called

If NUE is at or above $35 per share on June 16, 2012, it will get called away.  If that is the case, let’s calculate the ROI for these four weeks.  The general formula is the amount of profit divided by the amount invested (basis) multiplied by 100 to express in a percentage and would look like this:

($35.00 – $34.16) (profit)/ $34.16 (amount invested) * 100 = 2.459%

This meets my criteria of gaining 1% in a month.  But what if the stock does not increase and does not get called out?

ROI if Not Called

This is a little more difficult situation to calculate because you really don’t know if there will ultimately be any profit.  This is where the 1% monthly criteria comes into play for me.  I want the premium income itself to equal 1% of the basis.  So in this case, I use the amount of price reduction of the stock price for my “profit” and the basis as the amount invested to make the equation look like this:

$34.70 (purchase price) – $34.16/ $34.16 * 100 = 1.58%

The Nucor trade meets my criteria for 1% monthly.

Capital Losses

Now what happens if the stock drops like a rock.  Obviously, these percentages mean nothing.  But this is where tracking a basis over time becomes useful.  Ultimately, if the stock drops below $32 rapidly, I will not be in any additional danger of loss since I own the put options.  I can add additional shares to the position each time meeting the above criteria.  Eventually, the stock will stabilize and the ‘ROI if called’ will get realized.

By managing the position and adding shares at lower prices, it is possible to not lose money on a declining stock and break even.

So, if one-third of my stock picks fall into each category, the overall net impact is that the 1% monthly target will be met on a portfolio wide basis.  The fact that I am starting to work with dividend stocks should help to minimize the volatility.  That is the goal anyway.

Related articles

• Protecting Your Portfolio When Selling Put Options (grandpermonth.com)
• How to Make $1000 Per Month Selling Put Options (grandpermonth.com)

Well, the past two weeks have been incredibly busy and it feels like I am doing all I can to keep my head above water, but it feels like it isn’t working.  Last week, I put in 75 hours and work.  This week, I was out of town yesterday and today and was very busy during the day with minimal internet access.  Now, it is 11 pm in the hotel so I will be making this short so that I can get some sleep.

Options Expired Today

Today was options expiration which will end up being a good thing for me since I have some puts that will be exercised.  The most important one for me is the ONXX $46 strike puts which I purchased a few weeks back when ONXX was making a spike in price (back when the DOW was over 13,000).  I did this because I could lock in a profit compared to my basis.

Well, ONXX closed today at $41.82 so I will be selling those shares for $46!  Yippee!  Now I plan on picking up some Nucor shares next week since that is part of my dividend plan.  I will still have a few ONXX shares left so I purchased some additional June $38 puts today.  I will have to let you know what the new basis becomes, but it will likely be close to $42 per share.  Then I could sell the June $42 calls and end up with a profit if called.

I will also sell some DRYS and SLW shares as well when their puts get exercised.  I will be replacing those shares at a cheaper price so will be able to profit by the price differential.  This is what the summer will likely be about.  Hopefully, it won’t be a repeat of 2008, but you just never know so it helps to have a plan.

Carnivals

Here are some carnivals that have featured my three blogs:

Carnival of Financial Camaraderie #30 - PT

Plus a few more:

I recently ran across a video at Kitco’s Video News page that featured an interview with Kevin O’Leary who is a Canadian entrepreneur who founded SoftKey, a software company that eventually acquired The Learning Company before selling out to Mattel.  Apparently, he is also on the show Shark Tank on ABC which I have heard about but never bothered to watch.

I don’t think it is important to watch the full video, but I do think that he made one very important point which I will share with you and which I am working on implementing:

• Never buy a stock that doesn’t pay a dividend!

It is really quite simple and makes a lot of sense.  He doesn’t look at earnings when evaluating a stock.  He looks at free cash flow and wants to make sure that some of that cash is being returned to the owners (the shareholders) of the company.

A Transition in Thinking

I am starting to see from where he is coming.  Much of the market’s return has been the result of dividends.  Just take a look at the following graph which I found at The Market Oracle:

If this graph doesn’t convince you of the importance of dividends, which account for over half of the S&P 500′s, then how about I show you another graph that looks at the performance of the Dogs of the Dow vs the S&P 500.  In case you didn’t realize it, the Dogs of the Dow are those stocks in the 30 from the DJIA that have gotten so beat up in terms of price, that their dividend yield is among the top 10 of those 30 stocks.

No Lost Decade for Dividends

So had you been holding stocks that paid dividends, there really would not have been a lost decade.  You would have received consistent payments of cash to add to your portfolio enabling it to grow and make money.  You can just look at the graph and see that the S&P 500 lost money during the decade that saw two major shocks.  And yet, stocks that paid dividends (namely, the Dogs of the Dow) actually made money.

Fortunately, it is possible to teach this old dog some new tricks.  That is why I am simply working on changing all the stocks in my retirement accounts to dividend paying stocks and tracking my dividend income this year.  I did manage to hit my goal for the 1st quarter.  Over the next 25 years, I will allow those accounts to grow and reinvest those dividends into more stocks.

In fact, I will probably buy some more STX and INTC this week since they have been holding up quite nicely during this recent market decline.  I will also watch the ONXX $46 puts get exercised on Friday so I can start my purchase of Nucor (NUE) next week.  I won’t get the dividend for this quarter, but should be in a position to pick it up in the third quarter.  The same holds true for INTC and STX since the ex-dividend date has passed.  Nevertheless, adding to these positions is just a good idea.

Obviously, I will continue to publish the quarterly update on the dividend progress and see if it continues to grow.  According to the charts above, it should be a great plan!

Regular readers of this blog may or may not know that I follow the gold market fairly closely.  I am not a gold bug per se, but I do feel that gold is a decent store of wealth as opposed to the greatest investment as some would have you believe.  On the other hand, I don’t think that it should be dismissed entirely since it can have some purpose in a broad investment portfolio.

If you have been watching the gold market recently, you have probably noticed that the price has dipped below $1600 per ounce.  The gold market has historically been one that has been responsive to inflation expectations due to money supply or geopolitical concerns or even financial crises and a loss of confidence in fiat currency.

But with the gold price having backed off from a high of over $1900 per ounce last August and September, is there something that we should be expecting?

Global Industrial Slowdown?

Here is a recently published article that suggests gold is correlated with global industrial production.  That would seem to make sense as inflation, while technically a monetary phenomenon, seems to respond as a result of increased demand as well.  When the labor pool is tight, wages increase leading to a broad increase in prices.  Likewise, when the cost of oil and transportation and all the other goods that use oil in production increases, the gold market seems to respond to those inflation expectations.

If this is the case, one has to wonder whether the gold market is foretelling some global economic slowdown.  Is there another recession on the horizon?  Is China slowing down and are concerns about growth coming from that area of the world?  Is Europe really going to become a major headache?

On the other hand, is it simply the fact that there is no sign of inflation in the near future and that growth will continue albeit at a more moderate pace?  Is this simply a period of consolidation in the gold market?

There is a seasonality to the gold price and summer tends to be a slow time in regards to the price.  Is this a factor in the current pull back?  Will the price for an ounce of gold make another strong run in the fall?

To be perfectly honest, I really don’t have a clue.  So, what am I doing with this information?

Buying More Silver Wheaton Stock

I am buying more Silver Wheaton stock.  Silver typically follows the gold price although with some added volatility.  This has provided me a decent opportunity to purchase some more SLW which should make a nice rebound should seasonal factors be playing a role or should global economic activity improve.

I have already increased my share count by 6.5% this past month and am looking to add some more when I sell some calls and collect the premium.  Hopefully, I will have enough cash to do this during June.  I should be collecting some dividends from Seadrill and AK Steel during the month of June so that should help with the needed cash.

The key will be to maintain patience and add to positions when the stocks are down and pare back when they spike.  I plan on using the same technique with Silver Wheaton and by extension, the price of gold and silver.

What do you think is happening with the gold market?

Well, I managed to make an extra payment on the Discover Card.  I was able to make this extra payment because I took some of the money that I had made from blogging in March and moved it into my personal checking account.  I did let it sit for a little while until I made sure that I was going to have enough money to keep up with my blogging expenses for the month of April and the next few.  The reason is because I actually lost money blogging during the month of April.

However, I do feel confident enough that I can cover expenses for the next few months, so I went ahead and made the extra payment.  It has always been my goal to develop my online opportunities using only my time and not any of my own dollars, and I have been able to do that.  Of course, growth has been somewhat slow as a result, but that doesn’t matter as much to me as being able to bootstrap and create something from nothing.  I am pleased to say that I have been able to make extra payments and pay off some debt as a result of blogging.

Future Discover Card Payments

My main blogging financial goal for this year has been to get the Discover Card paid off.  With recent changes to blogging revenue, I have to wonder from where the funds for this goal might come.  I could hope that things improve later this year, and they may.  I am also working hard to develop my other online income sources, but that will probably simply help to pay for ongoing expenses.  I will just have to see what the next couple of months bring.

I have considered using the money that I have gotten from recycling aluminum cans for making an extra payment.  I have also considered using the change that I periodically roll and redeem for dollars to make an extra payment.  Of course, I have also considered looking at the stuff that I own and having a garage sale.  It would be good to kill two birds with one stone, namely getting rid of household clutter and make some money in the process.  The only catch in this plan would be the time involved.  I will have to see how this works out.

I am still committed to getting that card paid off by the end of the year.  Half of the balance will be covered through the normal monthly payments that I have been making so as long as I can keep up with the extra payments, it should happen.  For now I suppose, I won’t be making any major changes, but will have to monitor the situation to see if blogging income totally disappears or if this is just a slight dry spell.

Carnivals with My Blogs

I do want to take a moment to highlight those carnivals that featured an article from one of my 3 blogs.  CFM = Cash Flow Mantra, GPM = Grand Per Month, and PT = Penny Thots.  Be sure to subscribe to all 3 so you can get lots of great personal financial information.