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”

As we can see from the chart of the ASX200 below, we have lost all the gains made in 2012 and we are back where we were at the start of the year.

Mining stocks have been hammered by falling commodity prices due to a slowdown in China and financial stocks have also taken a tumble due to fears of what “Grexit” (a disorderly Greek exit from the Euro) might do credit markets. Some people are expecting a rebound if China announces more stimulus measures and if the European Central Banks promise to lend/print more money. Others are expecting the markets to fall further.

Trade Transactions This Week

As there is much uncertainty in the market, we will stay on the sidelines for a while. Although we still have all of our capital in cash, we have already have made commitments to buy stocks on around two thirds of our capital. We still have one third of our capital available for new trades. It is always good to have available cash so we can take advantage of any good opportunities that may come our way.

We do not have a new trade transaction this week and will do a more thorough review of our Model Portfolio instead.

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.  Like all other banking stocks, NAB was negatively affected by the fear of “Grexit”. Today NAB is trading at around $23.65, which is below our strike price so our put options are ITM. It is very likely that our put options will be exercised and we will have to buy NAB shares at our strike price of $24.50 tomorrow when the May options expire.  This is actually our primary exit for this trade as NAB shares are due to go ex-dividend on May 31. NAB has already announced a fully franked dividend distribution of $0.90 which will include a franking credit of another $0.38. This will reduce our cost basis for our NAB shares to $22.60 ($24.50 strike price – $0.62 put option premium – $1.28 fully franked dividend). If we buy the shares, we will immediately sell some call options over our shares to generate even more income and further reduce our cost base.

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.  RIO shares have taken a big tumble and today RIO is trading at $56.21 which is well below our strike price. Our put options are now deep ITM and they may get exercised anytime which means we have to buy RIO shares at $64.00. However, our cost basis for RIO shares is actually $61.96 ($64 strike price – $2.04 put option premium). If we get assigned RIO shares today, we can sell August $62.00 call options for $1.36 as shown in the options chain below. This is a 2.19% return in just over 3 months. Option premiums for volatile stocks like RIO are very high. Although RIO does not pay a lot of dividends, we can collect good income from selling call options.

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.  WES was also affected by the stock market correction but like most stocks from defensive sectors, they tend to fall a lot less compared to stocks from the volatile mining and financial sectors. Today WES is trading at $29.73. Although the stock price has not changed much, our put options have increased in price to $0.67 due to the increase in volatility.

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 $24.45. Although the stock price has not changed much, our put options have increased in price to $1.30 due to the increase in volatility.

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

Iluka Resources: ILU July $13 PUT

On May 16, I sold to open ILU July $13 put options for $0.78 when ILU was trading at $13.07. Today ILU is trading at $13.40. Although the stock price has not changed much, our put options have increased in price to $0.84 due to the increase in volatility.

For more information about this trade set up, read my May 16 model portfolio update.

Current Open Position Snapshot

As you can see from the table below, the option prices have all increased even when the stock prices have not changed much. Selling put options during market downturns can bring in a lot of income as option premiums are very high. Put options premiums are priced like insurance premiums – the higher the risk, the higher the premium. The risk of capital loss in the stock is also high which is why it is important that you only sell put options only on stocks you are prepared to hold long term. Selling call options will allow you to generate an income while waiting for the stock price to recover.

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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