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”

We finally had a nice little rally in mining shares in the last two weeks. A number of companies including Telstra and Rio Tinto which are in our model portfolio announced earnings this week. More details about this will be discussed below in our update for each of these positions.

Trade Transactions This Week

Rio Tinto: RIO Sept $58 CALL

RIO fell to a low of $50.22 but has since recovered to around $57 but it would be too early to say if the stock has bottomed as its price is still in a downtrend. RIO reported that earnings fell by 34% compared to last year but the company will increase its interim dividend payout by 34% to USD 0.725. While the report was not good, it was better than market expectations so the share price manage to rally a little more on Thursday. The share price is currently almost reaching a short term resistance at $58 as shown in the chart below. Although the stock could continue to rally, there is another strong level of resistance at $60. The stock will also be going ex-dividend soon which could cause the stock price to retreat temporarily.

Rather than hope for more capital gains, I prefer to sell a September $58 call for which I can get a premium of $1.28 today as shown in the option chain below. Stocks rarely move up in a straight line. After a $7 rally, I expect the price to flatten or even retreat when the price reaches a resistance level. However there is a risk of capital loss if our RIO stocks get called away in September at $58 as our cost for RIO is $60.68 ($64 stock – $2.04 put premium – $1.28 call premium). If we prefer not to take this risk, we can always sell a call at a higher strike price. A more conservative trade would be to sell a $60 call for 66 cents of premium and this means we would roughly break even if our stocks get called away in September.

Source: CommSec

As my expectation is for RIO’s price not to exceed $58 in the next two months, I prefer to sell a $58 call and collect more option premium to reduce my cost of owning RIO shares. The new Vector Vest valuation for RIO shares is now $47 which is much lower than what it was when we sold our puts on RIO in April. With the slowdown in China and the rest of the world, the outlook for mining shares is not that good so I am no longer than keen to own RIO shares and do not mind taking a small capital loss.

As we have 500 RIO shares, we can sell 5 call contracts and collect a premium of $640. This will help us get another 2% of income on top of the dividends that we will be getting in September.

My primary exit for this trade is for the call options to expire worthless. This would be the case if RIO’s share price is below $58 (which is what I expect) when the options expire in September. This means we simply get to keep the $640 of premium income which is a 2% return in less than two months or an annualised return of 15.21%.

My secondary exit for this trade is for the call options to get exercised so we will have to sell our RIO shares at $58 per share. This would be the case if RIO is trading above $58 when the call options expire on September 27.

Model Portfolio Update

National Australia Bank: NAB September $24.01 CALL

On May 30, I sold to open NAB September $24.01 call options for $0.76 when NAB was trading at $23.76. NAB shares have rallied and is trading at $25.05 and call options are now worth $1.50.

For more information about this trade set up, read my May 30 model portfolio update.

Woolworth: WOW August $26.00 PUT

On June 6, I sold to open WOW August $26 put options for $0.65 when WOW was trading at $26.24. The share price has shot up and today WOW is trading at $28.15 and our put options are barely worth anything now. I will be looking to close these puts out early, if we want to sell more put options.

For more information about this trade set up, read my June 6 model portfolio update.

Telstra: TLS September $3.51 Call

On June 20, I bought some TLS shares at $3.63 per share and sold to open some TLS Sept $3.51 calls. Since then TLS shares have shot up to as high as $4.09 but the shares have fallen since Telstra announced rather disappointing earnings this week. Today the shares are trading at $3.78 and the call options are worth $0.26. TLS shares are due to go ex-dividend in August and the share price may fall further after that.

For more information about this trade set up, read my June 20 model portfolio update.

Newcrest Mining: NCM Oct $24 CALL

On July 27, I sold to open NCM October $24 call options for $1.27 when NCM was trading at $23.23. Since then the share price has gone up slightly to $24.42 and the call option is now worth $1.72.

For more information about this trade set up, read my July 27 model portfolio update.

Iluka Resources: ILU October $8 PUT

On July 27, I sold to open ILU October $8 put options for $0.56 when ILU was trading at $8.51. Since then the share price has rallied up to $10.27 and the put option is now only worth $0.15.

For more information about this trade set up, read my July 27 model portfolio update.

Current Open Position Snapshot

A summary of our open positions is shown in the table below. We now have 2 open put positions and 4 open covered call positions.

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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