options for portfolio building

I think they call this market "range bound". It goes up a bit, down a bit, some good news, some not so good news. Corporations have cut overhead, cut inventoray, are increasingly looking profitable at the same time that unemployment stays high, housing prices drift, foreclosures continue to increase. The government has engaged in massive deficit spending, may need to do some more, in spite of an increasingly toxic political environment for big spending.

So how do I behave in this situation? I have always believed in staying invested, as one never knows when the market is going to turn. On the other hand, smarter investors then me are saying one should keep one's cash position sizable, so that one is in a position to buy when the market bottoms out. Hmmm...where's a guy to settle when that kind of conflict is raging inside.

I've been reading about options. They are complex, and at their highest sophistication, look like a form of gambling.
It seems, however, that if one wants to boost returns in a stagnant market, selling calls and puts is an opportunity to boost cash earnings and also position cash to be deployed at lower than market prices for equities.

The covered call is a means to wring some cash out of those optimists who are sure that a stock will rise and they will want to purchase it at a discount. As the call seller, you get the price of the stock at your strike price, plus the value of the call premium you sold as your return for selling the call. If you really want to hold that equity, you may be forced to buy your call back at closer to the expiration date, but you can then sell another call at a higher strike price if the equities value is rising.

The cash-covered put is another way to keep your and purchase an equity at lower than current price. If the put buyer forces you to purchase as the equity falls below your strike price, your cost is the strike price mminus the value of the put you sold, assuring you of a lower entry point for the stock than you would have achieved, had you purchased the stock outright, rather than selling the put and reserving cash to cover the placement of that put. What you miss the put is collecting dividends on the stock you are hoping to purchase at that lower price. I guess it makes sense to sell the put, hope to be assigned the stock if the price drops below the strike price, then look to purchase the issue just before the next ex-dividend date if the put you sold is not assigned. Your purchase price will be the list price minus the value of the put you sold.

If you are using these tools to actually build a portfolio of dividend paying stocks, rather than simply betting on the movement of stock prices in an attempt to earn cash on the options for equities you don't own, you are reducing risk in your portfolio. You collect a premium for selling options on equities you own when most of those options will never be excercised (i.e. your stock will seldom be called away from you) and you earn a premium for agreeing to purchase a stock at a lower price than it's current price, and your price is even lower than the strike price when you figure in the value of the premium.

So, I'm looking to sell short-term puts in equities I'd like to own, taking care to avoid missing dividend payments by keeping the option terms short and I'm looking to sell calls on stocks I own, but would be willing to see called away at a higher price plus the premium value of selling the call.

What I won't do is sell un-covered calls or sell puts when I don't have the cash to cover a potential placement of stock in my hands, or don't wish to own the stock in the first place.

My portfolio tracking tool isn't sophisiticated enough to actually track my earnings on this strategy, but as long as I'm careful in my selling, I should always either end up with a bit of extra cash, or a new equity position that I wanted anyway.

we'll see where this leads.

breaking the anxiety over portfolio value

Part of my evolution in thinking has been in the quest to understand the link between my future security and my portfolio value at any one time. Like many unsophisticated, amateur investors, I started out feeling good when the portfolio value was rising and feeling bad when it fell. Interestingly, when it rose, my fear of falling also rose, so there wasn't any true sense of security or satisfaction attached to watching valuation. However, as I migrated from the growth to the income/value side of the investment universe, I learned a simple fact; companies tend to be consistent in their approach to the owner/stockholder. They continue dividend payments regardless of the markets view of their share price. And when the share price decreases, they often buy back more shares, which has the effect of boosting share value. If their earnings are growing, the dividend tends to grow. All this, somewhat independent of share price at any time.
This is another way of saying 'buy the company, not the stock'.
If management is mature and skilled at growing the business, staying profitable and respecting the interests of the owners, then cash flow in the form of dividends, as well as share value, will increase over time.
So, I periodically check the monthly income of my portfolio in the form of dividends and interest. I also look at the overall value of the position, since I'm a DRIP fan as well, and my positions grow organically with reinvestment of dividends

Inflation-adjusted yield-on-cost would be a more precise way of watching growth in passive income. When I come across an adequately sophisticated portfolio management tool, I'll try to build that into my monitoring of the portfolio.

Market driven changes in valuation of my holdings certainly have an effect on the total portfolio value, but the dips are cushioned by dividends, and the rising monthly income demonstrates the rising "purchasing power" of my holdings. It certainly relieves me of the anxiety of chasing the next 'growth story', as long as I see that monthly passive income rising.

til next time...

what's a dividend seeking value-based investor to do....

So what about this incredible sustained rally? For the dividend-hungry, bargain-basement shopper like me, deals are hard to find.

I'm keeping myself occupied looking to re-enter sectors I had exited previously; I'm cautiously slipping back into banking, with some carefully selected regional banks; one's without large portfolios of non-performing mortgages, or a bunch of 'counter-party risk' from trading in credit default swaps, derivitives of mortgage backed securities and the like.

I like banks who loaned carefully, maintained control of their mortgage portfolio, continue to have steady earnings and pay their owners in the form of capital appreciation (single digits are fine!) and a history of rising dividends ( I can live just fine with 3-5% in that category, thank you).

I'm gratified to see how my REITs are doing; selected for companies who don't carry a lot of debt, work in industries with stable lessors, such as health care entities, If one doesn't carry a mortgage on a property, the loss of a few lessors isn't nearly as painful as having to handle debt coverage in the face of no income.

Energy costs are on the rise again, making the pipeline MLPs, the exploration companies more attractive. I like the ones who position themselves to collect fees in good times and bad, hedge the prices of their oil/gas production with long term contracts, and continue to buy up properties with proven reserves under them. This avoids the whipsaw valuations, unpredictable payouts. Better to get steady-eddy payouts, reinvest, see the position grow and the rising stream of dividends continue coming in.

I've watched Apple shoot through the stratesphere, love the products and use them, but I'd still rather get paid steadily than make a bet on who will be in vogue one season and who will the next.

Having built a very firm foundation of high-dividend, low payout ratio, modestly growing equities and a generous sprinkling of preferreds, mini-bonds, REITS and partnerships, I'm beginning to develop an interest in equities that promise higher growth in addition to a bit more modest dividend payouts.

I'll see where this takes me as the 401k contributions, employer matching, catch-up contributions and the profit sharing contributions roll in;

Overall I'm looking for 20% growth in the portfolio, from new contributions and dividend/valuation contributions. That would make 2010 a very good year.

What to do when valuations are high...

I've been continuing my reading of all my favorite sites and authors, looking for that thesis that will keep me reinvesting. There's lots of news to process; economy starting to show signs of recovery, wall street bankers as sleazy as we all assumed they are, corporate earnings up.

It's harder to find a divident stock that hasn't already rallied by about 50+ % since last March.

Well; there's DRIPing dividends; doing that...

there's reinvesting mini-bond interest; doing that...

there's shifting sights towards dividedend producing equities with lower payout ratios and ore prospect for both dividend growth as well as capital appreciation;
I have opened positions with MCD and others.

So who do I like to read?...several authors on Seeking Alpha, 3-4 dividend-centric newsletters;

I'm looking for good opportunities in all sectors, inside and outside of the S&P 500. The single catch is...pay me now.

with new money into the retirement portfolio, rising dividends, DRIP and some capital appreciation, I'm looking for about 20% per year in growth in that retirement portfolio.

where are the bargains?

Well, we're on another run; a slight "correction" and the market continues to forge ahead on mixed news. No new jobs, very few housing starts, mean house prices still falling in many markets, another wave of foreclosures on the way, etc. etc.

On the other hand, corporate earnings are up broadly, so business efficiency steps have paid off and stock prices are following the earnings up. This investor still wants to be paid NOW, so I'm looking for those instruments that pay steadily. I'll take the rising value, but show me the money. It means I'm purchasing the next dividend at a bit higher price, but if earnings are rising, I'll hope that shows up in a higher dividend soon. Nonetheless, my new sensibility says I'll take 5-7% payment on a steady basis, reinvest those dividends and any modest rise in price that follows is gravy. I don't need to equal historic stock market gains to be secure. What I need is to avoid losing value. The dividend cushion has paid off nicely over the last 2 years. My losses were significantly less than the market, and I'm out ahead of the S&P 500 on the run-up. now if only my real estate holdings would start to behave that way as well...

My brokerage won't do a DRIP for bonds and etc....

When I bailed out of AG Edwards-Wachovia-Wells Fargo-bankofthemonth and became a self-directed investor at Fidelity, I lost one thing of value in the process. Fidelity won't treat my mini-bonds like an equity and re-invest the monthly/quarterly interest payments for me without brokerage fees. That was one beni of the full service brokerage, but it wasn't worth the brokerage fees on new purchases. I am now forced to watch and wait until adequate interest payments have accumulated and then buy a big enough block of one or another of them to keep the positions growing and keep the cost of investing low. With the DRIP feature, I was blissfully relieved of the requirement of making a conscious decision to purchase an appreciating asset at the higher price in order to keep the position growing. How I miss that drippy thing...

fortunately, for common stocks and preferreds, as well as MLP units, the discount brokerage does DRIPs.

OK, well, it's late and I'm tired, so I'll revisit my new-found mouthpiece again tomorrow or another day...

Should I hold cash, or remain fully invested?

I know what Mr. Buffet said; be greedy when others are fearful and be fearful when others are greedy. That contrarian view requires a firm eye on valuation, and an ability to have ready cash when everyone else has leveraged themselves up to their eyeballs.

My approach to this is as follows: I ask myself whether I'm happy with the price of the earnings and dividends, or the interest earned on each issue when I purchase it. If I am, it doesn't matter whether the market is up or down, hot or cold. I can be fully invested and still feel that I haven't over-paid for the earnings/dividends/interest payments. That doesn't solve the issue of having dry powder when the shooting starts. One wants to pounce on great bargains when they present themselves. The best I can do here is to keep about 5% of my porfolio in an income fund; currently I like DNP. It doesn't fluctuate much in value, throws off about 6% and change every year and is easy to liquidate when I want to buy something that has a higher return on investment. It fulfills my biases on dividend payments, portfolio growth by DRIP, etc.
Perhaps I'm fooling myself, but currently cash IS trash, from a standpoint of interest earnings.