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”
On May 24, the expiry date for the ASX’s May exchange traded options, NAB closed at $23.48 which is below the strike price of our NAB May $24.50 put options. The 12 put option contracts were “exercised” and we were “assigned” 1200 shares of NAB at $24.50 each. We are quite happy to own the shares as we will be able to collect the 90 cent fully franked dividend which will be paid out to NAB shareholders on July 16. We can also use our NAB shares as collateral (instead of cash) to cover the margins required for the other put option contracts that we sell.
Trade Transactions This Week
This week we will sell our first covered call since we started this model portfolio on April11. We will sell call options over our newly acquired NAB shares.
National Australian Bank: NAB September 24.01 CALL
From the chart of NAB below, we can see that the price of NAB tends to fall immediately after the shares go ex-dividend. This is a fairly common occurrence with high dividend shares. NAB shares will go ex-dividend on the May 31 and it is very likely that the share price will fall after that happens.
As we are expecting the share price to fall, we will sell ATM call options to get more premium to help offset any capital loss. As we must hold the shares for at least 45 days in order to claim franking credits, we will look to sell options that expire in July or beyond. We will also sell European style options to avoid losing our stock prematurely due to early exercise of our call options.
From the options chain below, we can get a premium of 76 cents for NAB September $24.01 calls. As we own 1200 NAB shares, we can sell up to 12 call option contracts. These would be considered “covered calls” as the calls are covered by our NAB shares. We will receive $912 ($0.76 x 1200 shares) for our commitment to sell our NAB shares at $24.01 in September.
My primary exit for this trade is for the call options to expire worthless. This will be the case if NAB shares are trading below $24.01 as I expect. We will simply get to keep the income of $912 from selling the calls but there will be some unrealised capital loss in our NAB shares. We can sell another call on NAB if this happens and continue to generate more income, while waiting for the next dividend payment.
My secondary exit for this trade is for the call options to expire ITM and for our NAB shares to get called away. This would be the case if NAB’s share price goes above $24.01 when the options expire in September. The total income from our NAB trades by then would be:
|Option premium from May $24.50 puts||$0.63|
|Option premium from Sept $24.01 calls||$0.76|
|Total income received||$2.67|
As we will be selling the shares at below our purchase price, we will also have a realised capital loss of $0.49 ($24.01 – $24.50) from our shares. Our net income is $2.18 ($2.67 – $0.49) or 8.9% in just over 5 months or an annualised return of $19.2%. Once our shares are sold, we can start selling more cash secured puts.
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 but recovered a little since last week. Today RIO is trading at $57.33 which is still well below our strike price. Our put options are now deep ITM and in real life, they may get exercised anytime which means we have to buy RIO shares at $64.00. However, to keep things simple for the model portfolio, we will assume that our option contracts will only get exercised on the option expiry date which in this case is July 26.
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 $28.76 and our put options have increased in price to $0.91.
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 $24.78. Although the stock price has not changed much, our put options have decreased in price to $1.05 due to time decay and a decrease 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 $13.35. Although the stock price has not changed much, our put options have decreased in price to $0.70 due to time decay and a decrease 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 NAB May $24.50 put position has disappeared as the option has already expired. Because the put options were ITM, they were exercised and we now own 1200 NAB shares, and we have added a new covered call position for NAB.
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.
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.