Overall Market Meter Rating Remains "Slightly Bullish"

Each month during expiration week, the Covered Calls Advisor re-calculates each of the current values for the nine factors used to determine the "Overall Market Meter" rating. As shown in the chart below, the new Overall Market Meter Average rating (blue bar at the bottom of the chart) remains unchanged at "Slightly Bullish":
















The current Market Meter Average of 4.22 is greater than the 3.89 of last month, but as such remains at Slightly Bullish (Note: the range for Slightly Bullish is from 3.5 to 4.5) for establishing covered calls investing positions for the upcoming options expiration month of October 2010. Of the nine factors used, six remained unchanged from last month and three changed. The three that changed were:
- Baltic Dry Index improved from Neutral to Bullish
- Price Trend improved from Neutral to Bullish
- P/E Ratios deteriorated from Slightly Bullish to Neutral

As shown in the right sidebar, the covered calls investing strategy corresponding to this overall Slightly Bullish sentiment is to "on-average sell 2% out-of-the-money covered calls for the nearest expiration month." So with the September 2010 options expiration this week, new positions for Oct2010 expiration will be established in accordance with this guideline.

The Slightly Bullish sentiment as described above is also consistent with the Covered Calls Advisor's perception of where we are on the "Investor's Sentiment Cycle" shown here on the left. This is a very interesting and useful chart because it recognizes both the cyclical and emotional nature of the stock market. Where are we located on this chart now? To this advisor, the credit crisis induced dramatic market decline in 2008 and early 2009 hit bottom in March 2009 ("bear market ends" trough on the chart below corresponding to emotional "despair"). It seems to this advisor that we have progressed to the "hope" stage along this cyclical roller coaster curve and that we might move upward to "relief" over the next several months if the dreaded (and highly unlikely in this advisor's opinion) double-dip recession is avoided. Being anywhere along the green line on the chart signifies periods of relative bullishness for the stock market, while the red line denotes relative bearishness. Here is an interesting survey conducted of 100 investing professionals who explained where they think we are now on the curve: link. So, if what I believe to be true is correct and we are now in the "hope" phase, then this chart would tend to confirm the current "Overall Market Meter" investing posture of "Slightly Bullish".

For a more detailed explanation of each of the Covered Calls Advisor's nine indicators, please refer to this prior blog post on that topic -- link.

Your comments or questions regarding this post are welcomed. Please click on the "comments" link below or email me at the address shown in the upper-right sidebar.

Regards and Godspeed,
Jeff

Exploiting Our Covered Calls Investing "Edges"

For any given investing strategy, the investor should try to identify any and all discernible advantages that particular strategy has when compared against a basic buy-and-hold approach. Once these potential advantages are identified, it is important to establish an investing process that attempts to exploit these advantages. The term that this Covered Calls Advisor prefers for the specific advantages identified is our investing "edges". Identifying and then establishing a disciplined investing process to exploit these "edges" is what enables us to attain additional profit beyond that which would otherwise be obtained through a passive buy-and-hold strategy.

So what are our "edges" as covered calls investors? It is this advisor's belief that there are six edges, each of which provides an opportunity to achieve excess returns:

1. Specialize in Covered Calls Investing -- Here is the introduction to one of my prior blog posts: "One of the most important investing lessons I've learned is to select an investing strategy that you are most comfortable with and stay with it. That is, do not try to be "a jack-of-all-trades and a master of none." Instead, try to continually increase your knowledge related to the strategy you are using and seek to become an expert at it." This fundamental belief in combination with the performance results achieved is what has sustained my commitment to covered calls investing during the past three decades -- thus this Covered Calls Advisor's investing motto of "Stick with Covered Calls."
I was recently reminded of my uncommon commitment to covered calls (and the investing edge it provides) while reading this article: (See "7 Things To Do To Improve"). Charles Kirk concludes in item #7 titled "Become a specialist, not a jack of all trades", by saying "So, find something that interests you more than anything else and concentrate all of your time and focus on that one thing. That path will lead you to developing a clear edge that will provide huge profits to you down the line." I hope you agree with me and will consider making covered calls investing "that one thing" you will "focus on" to achieve a "clear edge".

2. Active Management -- The typical buy-and-hold investing strategy is a passive investing approach since stocks or mutual funds are normally purchased and held for a period of years. Likewise, covered calls investing can also be deployed passively, and passive covered-calls-related indices (for example BXM, BXY, and PUT) have been developed. Research has shown that the long-term returns performance of these indices are approximately equivalent to that of a comparable buy-and-hold investment. But as individual investors, we have the opportunity to be "active" (contrasted with "passive") managers of our covered calls portfolios. As active managers, an associated "edge" comes from making timely adjustments (i.e. rolling decisions) related to our existing covered calls positions.

3. Value-Oriented Stock Selection -- Good stock selection is Job #1 for the covered calls investor. Unlike broad-based indices such as the S&P 500 or BXM, we seek to purchase only value-oriented individual equities, which are likely to continue in the future (as they have historically), to outperform the broader indices (such as the S&P 500).

4. Adjust Moneyness of Strike Prices -- As active covered calls investors, we have the flexibility to sell out-of-the-money covered calls when our outlook is more bullish and in-the-money when bearish; whereas the mechanical indices sell the same moneyness every month (for example, only at-the-money calls in the case of BXM). With even modest success at adjusting moneyness to coincide with our overall market outlook, incremental return results are achieved.

5. Sell Higher-Than-Average Volatility -- Because of the large cap nature and the diversification inherent in the S&P 500 index, its Volatility Index(VIX) is lower than most individual stocks. Selling options on individual equities (with somewhat higher implied volatility than VIX) provides covered calls investors with somewhat higher options income (and thus somewhat higher overall portfolio returns) than would be achieved by either (1) buy-and-hold investing directly in the S&P 500; or (2) selling S&P 500 options (such as is done with the BXM, BXY, and PUT indices).

6. Exploiting the Volatility Risk Premium -- Academic research has demonstrated that the implied volatility of option prices is, on average, higher than the actual realized volatility. Thus, by selling options to establish our covered calls positions (NOT buying options), we covered calls investors exploit this effect (another "edge" versus buy-and-hold investors) and profit from it.

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From my experience, my best estimate is that over a long-term investing horizon (say 10+ years), a disciplined covered calls investor that is cognizant of the six "edges" described above, and works to take advantage of them might expect (on average over the years), to outperform a buy-and-hold benchmark by about 3% to 5% per year. This extra return might not sound especially impressive, but the power of compounding investment returns is substantial. Suppose that over the next decade a buy-and-hold S&P 500 investor averages an 8% annualized return; and a covered calls investor averages a 12% return. Then, an initial $100,000 portfolio would grow (excluding taxes) over the next 10 years, to about $215,900 for a buy-and-hold portfolio; but to $310,600 for the covered calls portfolio. Whereas individually, each of the six "edges" described above provides only a small advantage, together they can provide a very significant advantage for covered calls investors.
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"We believe that while investors need to focus great attention on the fundamentals, they must simultaneously answer the question: What's your edge? To succeed in today's overcrowded environment, investors need an edge, an advantage over the competition, to help them allocate their scarce time. Since most everyone has access to complete and accurate databases, powerful computers, and well-trained analytical talent, these resource provide less and less of a competitive edge; they are necessary but not sufficient. You cannot have an edge doing what everyone else is doing; to add value you must stand apart from the crowd. And when you do, you benefit from watching the competition at work." -- Seth Klarman

If you have any comments or questions on this article or on any of the six "edges" presented, please email me at the address shown in the top-right sidebar of this blog. Your comments are always welcomed.

Regards and Godspeed,
Jeff

Establish Guess? Inc. Covered Calls

A new covered calls position was established in the Covered Calls Advisor Portfolio(CCAP) with the purchase of Guess? Inc.(GES) covered calls. GES was one of the covered calls positions that was called away last Friday at Sep2010 options expiration and today it was decided to re-establish a new position for Oct2010 expiration as follows:

Established Guess? Inc.(GES) Covered Calls for Oct2010:
09/22/2010 Bought 300 GES @ $37.75
09/22/2010 Sold 3 GES Oct2010 $40.00 Calls @ $.55

Guess?, Inc. designs, markets, distributes and licenses its lifestyle collections of contemporary apparel and accessories for a style-conscious 18-to-32-year-old target audience of men and women around the world. In addition to wholesale and retail distribution channels, GES operates in 67 countries via its licensing and distributor partnerships. Apparel and accessories design teams are located in California in the U.S., and in Florence and Bologna, Italy. It offers collections of denim and cotton clothing, including jeans, pants, overalls, skirts, dresses, shorts, blouses, shirts, jackets, and knitwear. The company also grants licenses to manufacture and distribute a range of products that include eyewear, watches, handbags, footwear, kids' and infants' apparel, leather apparel, swimwear, fragrance, jewelry, intimate apparel, and other fashion accessories. Guess , Inc. markets its apparel under various trademarks, including GUESS, GUESS , GUESS U.S.A., GUESS Jeans, GUESS and Triangle Design, MARCIANO, Question Mark and Triangle Design, a stylized G and a stylized M, GUESS Kids, Baby GUESS, YES, G by GUESS, GUESS by MARCIANO, and Gc. The company sells its products through retail, wholesale, e-commerce, and licensing distribution channels. Guess operates 425 stores in North America and 96 stores abroad; licensees and distributors operated another 594 non-North American stores.

The Buy Alerts spreadsheet below shows that GES is an attractive value at this time since the total points rating of 16.40 is above the Covered Calls Advisor's desired "Buy" threshold of 16.0. Also very importantly, at its current price, the growth potential of the Guess brand seems under-appreciated by investors based on its potential growth drivers related to: (1) rapid expansion in Asia; (2) expanding new product categories; and (3) potential new store formats.




















Note: For expanded view, left click on the spreadsheet above.

Some possible overall performance results(including commissions) for the Guess? Inc.(GES) transactions would be as follows:
Stock Purchase Cost: $11,333.95
= ($37.75*300+$8.95 commission)

Net Profit:
(a) Options Income: +$153.80
= (300*$.55 - $11.20 commissions)
(b) Dividend Income: $0.00
(c) Capital Appreciation (If stock price unchanged at $37.75):
-$8.95 = ($37.75-$37.75)*300 - $8.95 commissions
(c) Capital Appreciation (If exercised at $40.00): +$666.05
= ($40.00-$37.75)*300 - $8.95 commissions

Total Net Profit(If stock price unchanged at $37.75): +$144.85
= (+$153.80 +$0.00 -$8.95)
Total Net Profit(If stock price exercised at $40.00): +$819.85
= (+$153.80 +$0.00 +$666.05)

Absolute Return if Unchanged at $37.75: +1.3%
= +$144.85/$11,333.95
Annualized Return If Unchanged (ARIU) +19.4%
= (+$144.85/$11,333.95)*(365/24 days)

Absolute Return if Exercised at $40.00: +7.2%
= +$819.85/$11,333.95
Annualized Return If Exercised (ARIE) +110.0%
= (+$819.85/$11,333.95)*(365/24 days)

Continuation Transactions -- Bank of America Corp., Intel Corp., and Microsoft Corp.

Today, shares in Bank of America Corp.(BAC), Intel Corp.(INTC), and Microsoft Corp.(MSFT) were retained and call options were sold to establish Oct2010 covered calls positions. Normally, the Covered Calls Advisor establishes near-month (in this case that would be Sep2010) covered calls. But the Sep2010 slightly-out-of-the-money strike price call option premiums were less than the minimum desired value of $.30, so the positions were extended to Oct2010 expirations. The transactions history as well as some possible results for these positions are detailed below:

1. Bank of America Corp.(BAC) -- Continuation Transaction

The transactions history to date for Bank of America Corp.(BAC) is as follows:
06/21/2010 Bought 400 BAC @ $16.04
06/21/2010 Sold 4 BAC Jul2010 $16.00 Calls @ $.58
07/17/2010 Jul2010 Options Expired
Note: The closing price of BAC was $13.98 on expiration Friday.
07/22/2010 Sold 4 BAC Aug2010 $14.00 Calls @ $.50
Note: The price of BAC was $13.87 today when this option was sold.
08/21/2010 Aug2010 Option Expired
Note: The closing price of BAC was $12.86 on expiration Friday.
09/01/2010 Ex-Dividend $4.00 = $.01*400 shares
09/03/2010 Sold 4 BAC Oct2010 $14.00 Call Options @ $.38
Note: The price of BAC was $13.41 today when these options were sold.

Two possible overall performance results(including commissions) for the Bank of America Corp.(BAC) transactions would be as follows:
Stock Purchase Cost: $6,424.95
= ($16.04*400+$8.95 commission)

Net Profit:
(a) Options Income: +$548.15
= (400*($.58+$.50+$.38) - 3*$11.95 commissions)
(b) Dividend Income: +$4.00 ($.01*400 shares)
(c) Capital Appreciation (If stock price unchanged at $13.41): -$1,043.05
= ($16.04-$13.41)*400 - $8.95 commissions
(c) Capital Appreciation (If stock assigned at $14.00): -$824.95
= ($14.00-$16.04)*400 - $8.95 commissions

Total Net Profit(If stock price unchanged at $13.41): -$490.90
= (+$548.15 +$4.00 -$1,043.05)
Total Net Profit(If stock assigned at $14.00): -$272.80
= (+$548.15 +$4.00 -$824.95)

Absolute Return (If Stock unchanged at $13.41): -7.6%
= -$490.90/$6,424.95
Annualized Return If Unchanged (ARIU) -23.8%
= (-$490.90/$6,424.95)*(365/117 days)

Absolute Return if Assigned at $14.00: -4.2%
= -$272.80/$6,424.95
Annualized Return If Exercised (ARIE) -13.2%
= (-$416.85/$6,424.95)*(365/117 days)


2. Intel Corporation (INTC) -- Continuation Transaction

The transactions history to date for Intel Corp (INTC) is as follows:
05/21/2010 Bought 300 INTC @ $20.30
05/21/2010 Sold 3 INTC Jun2010 $22.00 Call Options @ $.52
06/21/2010 Sold 3 INTC Jul2010 $22.00 Call Options @$.46
Note: The price of INTC was $21.60 when these options were sold.
7/17/2010 Jul2010 Options Expired
Note: The closing price of INTC was $21.02 on expiration Friday.
07/22/2010 Sold 3 INTC Aug2010 $22.00 Calls @ $.42
Note: The price of INTC was $21.70 today when these options were sold.
08/04/2010 Ex-Dividend $4.00 = $.1575*300 shares
08/21/2010 Aug2010 Option Expired
Note: The closing price of INTC was $18.91 on expiration Friday.
09/03/2010 Sold 3 INTC Oct2010 $19.00 Call Options @ $.43
Note: The price of INTC was $18.24 today when these options were sold.

Two possible overall performance results(including commissions) for the Intel Corp(INTC) transactions would be as follows:
Stock Purchase Cost: $6,098.95
= ($20.30*300+$8.95 commission)

Net Profit:
(a) Options Income: +$504.20
= 300*($.52+$.46+$.42+$.43) - 4*$11.20 commissions
(b) Dividend Income: +$47.25 ($.1575 * 300 shares)
(c) Capital Appreciation (If stock price unchanged at $18.24):
-$626.95 = ($18.24-$20.30)*300 - $8.95 commissions
(c) Capital Appreciation (If exercised at $19.00): -$398.95
= ($19.00-$20.30)*300 - $8.95 commissions

Total Net Profit(If stock price unchanged at $18.24): -$75.50
= (+$504.20 +$47.25 -$626.95)
Total Net Profit(If stock price exercised at $19.00): +$152.50
= (+$504.20 +$47.25 -$398.95)

Absolute Return (If Stock Unchanged at $18.24): -1.2%
= -$75.50/$6,098.95
Annualized Return If Unchanged (ARIU): -3.1%
= (+$844.70/$6,098.95)*(365/148 days)

Absolute Return if Exercised at $19.00: +2.5%
= +$152.50/$6,098.95
Annualized Return If Exercised (ARIE): +6.2%
= (+$152.50/$6,098.95)*(365/148 days)


3. Microsoft Corporation (MSFT) -- Continuation Transaction

The transactions history to date for Microsoft Corporation (MSFT) is as follows:
07/23/2010 Bought 500 MSFT @ $25.47
07/23/2010 Sold 5 MSFT Aug2010 $26.00 Calls @ $.44
08/17/2010 Ex-Dividend $65.00 = $.13 * 500 shares
08/21/2010 Aug2010 Option Expired
Note: The closing price of MSFT was $24.23 on expiration Friday.
09/03/2010 Sold 5 MSFT Oct2010 $25.00 Call Options @ $.49
Note: The price of MSFT was $24.31 today when these options were sold.

Two possible overall performance results(including commissions) for the Microsoft Corp.(MSFT) transactions would be as follows:
Stock Purchase Cost: $12,743.95
= ($25.47*500+$8.95 commission)

Net Profit:
(a) Options Income: +$439.60
= (500*($.44+$.49) - 2*$12.70 commissions)
(b) Dividend Income: +$65.00 =($.13 * 500 shares)
(c) Capital Appreciation (If stock price unchanged at $24.31):
-$588.95 = ($24.31-$25.47)*500 - $8.95 commissions
(c) Capital Appreciation (If exercised at $25.00): -$243.95
= ($25.00-$25.47)*500 - $8.95 commissions

Total Net Profit(If stock price unchanged at $24.31): -$84.35
= (+$439.60 +$65.00 -$588.95)
Total Net Profit(If stock price exercised at $25.00): +$260.65
= (+$439.60 +$65.00 -$243.95)

Absolute Return if Unchanged at $24.31: -0.7%
= -$84.35/$12,743.95
Annualized Return If Unchanged (ARIU) -2.8%
= (-$84.35/$12,743.95)*(365/85 days)

Absolute Return if Exercised at $25.00: +2.0%
= +$260.65/$12,743.95
Annualized Return If Exercised (ARIE) +8.8%
= (+$260.65/$12,743.95)*(365/85 days)