Note to new readers: This is a regular update on the status of our Low Risk Income Model Portfolio which is built using the income strategy described in our e-book “A Low Risk Income Strategy for All Economic Conditions”

Last week, we made a commitment to buy an undervalued gold stock. Global markets continue to be jittery over the situation in Europe and it looks like the stock market correction could continue. My initial plan was to stay on the sidelines and not put on any new trades this week but one stock on my watch list is already at such an attractive price so I decided to go ahead and enter a partial position on this stock this week.

Trade Transactions This Week

Iluka Resources: ILU July $13 PUT

As you can see from the chart below, ILU took a big dive last week because the earnings announced disappointed the shareholders. However, ILU is still a very profitable company. The current value for ILU according to Vector Vest is $31.71 so the stock is very undervalued at the current price of $13.07. Even though it is undervalued, ILU could fall further but looking at ILU’s 3 year chart I can see that there is strong support at $12 so I am comfortable with taking a half position on ILU at $13.

Furthermore, although ILU is also a mining stock, it principally produces zircon; titanium dioxide products of rutile and synthetic rutile; and ilmenite, which are quite different from the products mined by RIO or NCM, the other two mining stocks which we have open positions on.  Hence, we are still maintaining diversification even though the stocks are from the same sector.

As you can also see from the options chain below, I can sell a July $13 put option for $0.78 per share. If my put options get exercised in July, I will get to buy ILU shares at $12.22 ($13 strike – $0.78 option premium received).

Source: CommSec (click on the chart to enlarge)

As our allocation for each stock position is $30,000, we can sell up to 23 contracts of ILU July $13 puts. However, as this is a very volatile stock and mining stocks in general are still trending down, so I prefer to enter a half size position today. We can add to our position if ILU falls further so we will only sell 11 contracts today. This means that I am making a commitment to buy 1100 (11 contracts x 100 shares per contract) shares of ILU at $13 per share, and I need to set aside $14,300 of my cash to purchase the shares in case my put options get exercised in July. A portion of this cash will be required to cover margins but most of the cash will continue to earn interest in my Cash Investment account for the next two months while waiting for the puts to expire. I will receive $858 ($0.78 x 1100 shares) for making this commitment.

My primary exit for this trade is for my put options to expire worthless. This would be the case if ILU’s share price is above $13 (which is what I expect) when the options expire in July. This means I simply get to keep the $858 of premium income which is a 6% return in just over two months or an annualised return of  30.85%. As you can see, the option premiums are very high when there is strong volatility.

My secondary exit for this trade is for my put options to get exercised so I will have to buy ILU shares. This would be the case if ILU stays below $13 when the put options expire on July 26. Unlike most mining stocks, ILU has paid rather high fully franked dividends as shown in the table below. However, there is no certainty that these dividends will be paid regularly and I certainly do not think of ILU as a dividend stock like Telstra. The option premiums we can get for selling options on this type of volatile stocks can also be very high so we should be able to sell a few covered calls to generate extra income to help us achieve our target return of 15% even without income from dividends.

Source: CommSec (click on the chart to enlarge)

Model Portfolio Update

National Australian Bank: NAB May 24.50 PUT

On April 11, I sold to open NAB May $24.50 put options for $0.62 when NAB was trading at $24.42.  Today NAB is trading at $24.50 and my put options are now only worth $0.29.  Although the stock is trading at around the same price, the time value of the option has decreased resulting in a lower price option. This put option will expire next Thursday and we will find out soon if we will be buying NAB shares at our strike price of $24.50.

For more information about this trade set up, read my April 11 model portfolio update.

Rio Tinto: RIO July $64.00 PUT

On April 18, I sold to open RIO July $64.00 put options for $2.04 when RIO was trading at $66.08.  Since then RIO shares have gone down in price. Today RIO is trading at $58.33 and my put options are now worth $6.34.

For more information about this trade set up, read my April 18 model portfolio update.

Wesfarmers: WES June $29.50 PUT

On April 24, I sold to open WES June $29.50 put options for $0.59 when WES was trading at $29.64.  Since then WES shares have gone up in price. Today WES is trading at $30.72 and my put options are now worth $0.26.

For more information about this trade set up, read my April 25 model portfolio update.

Newcrest Mining: NCM July $24 PUT

On May 9, I sold to open NCM July $24 put options for $1.24 when NCM was trading at $24.24. Today NCM is trading at $24.17 and our put options are now worth $1.43.

For more information about this trade set up, read my May 9 model portfolio update.

Current Open Position Snapshot

I will be providing a weekly update on this model portfolio on this blog. If you are intrigued by our income strategy but have trouble following the discussions in this post, you will need to first download and read our e-book in order to understand the strategy and do some basic options education (found on our Resources page) to familiarise yourself with option terminology.

Stay tuned!

Disclaimer: This post is for educational purposes only and should not be treated as investment advice. This strategy would not be suitable for stock investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek investment advice if required.

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