Category Archives: Active Investment

Individual Stocks, October 2017

The equity portion in my active strategy are all in individual stocks. For the sake of transparency, here is the list. Please note that this not intended as investment advice and you are urged to always do your own research and make your own decisions. I may conduct transactions with any securities without writing about them prior to or after the fact. No obligation to disclose is implied.

Right now are 30 stocks total. In my old nomenclature I referred to all dividend-paying stocks my “DGI portfolio” and the others as “growth stocks”. I no longer make that distinction since moving all of them to my taxable accounts and reducing current dividend payout became a consideration. Together these stocks account for over 60% of my active strategy or 33-35% of the total portfolio, its single largest component. They are mostly US large caps. Three (Baidu, Tencent, and BYD) are Chinese, while Silicon Labs ($SLAB) is the only mid cap.

In the table, gain/Loss is for price only, based on the cumulative sum paid on all lots. Dividends are not counted. The holding periods vary. Some like Aqua America ($WTR) which is my wife’s and the first lot was acquired in 2003, others a few months ago. Gain/loss information is provided as an illustration that I don’t tolerate deep losses without some conviction in the stock. The overall dividend rate is under 1.5%, less than that of SPY and VTI (about 1.9%).

Many stocks are colored red which is used to indicate strong conviction or “tax handcuff” such that they are not candidates for near term trades. As stated previously in other posts, the only stocks that I more or less made up my mind to sell are in energy. They happen to be in an up-swing so I’ll wait for that momentum to wane.

The relative weights are quite random at this time. There are two schemes under consideration: one is equal weight (1/N); the other is to have two groups, equal weight within each group but one group at a higher level to reflect a greater conviction or expected return. Currently all but three stocks are in round lots. It makes option trading easier but strict conformation to to a weighting scheme more difficult. Overall this is not something that I lose sleep over.

I monitor the sector weights but do not set a target. The overweight to tech and to a lessor extent, financial, is consistent with my overall market view. As the market cycle evolves that will change, but we’re talking about a time frame of years. There are plenty of other tools in my arsenal.

I have only been tracking the individual stocks as a whole since April so there isn’t enough of a track record to make any conclusions. So far they are +2% vs. SPY. My target is to simply match SPY so I’m quite pleased with that. Owning individual stocks allows the lowest cost of ownership (< 1 basis point per transaction at InteractiveBrokers vs. ~5 basis points per annum through index funds), opportunity for TLH, and greater income generation potential by selling option premium. However, I have no edge outside of US large cap so in index funds are a cheap way go get exposure there. In the passive accounts I'm 50/50 US/International and tilting small and EM. Arguably I could use even greater tilts than what I currently have.

So there it is, all my individual stocks. Please note again that None of the above is investment advice, and the standard disclaimer applies.

Decision Time

This is another market commentary following my post on March 23rd, A Correction May Be Upon Us; and 29th, Lightly Held Opinions. The prediction was a drop then bounce in April, then a deeper drop in May that could potentially last into July. The bounce in April was flagged to have the potential to make a new high in the 2nd post. So what has happened so far?

The chart is of the S&P where the low of 2322 was reached on the 27th. There was a retest of the low on Apr 13th as concerns with North Korea reached a fevered pitch. The bounce up to 2398 was just shy of the 2400 peak on March 1st. The other indices behaved slightly differently: the DOW made a lower low whereas both Nasdaq and Russell 2000 made new highs on the bounce. Overall, I’d say things played out as predicted. The bigger question is, will the deeper correction come?

I’m leaning towards “yes” on that one, although I would temper the probability for the most severe scenarios — retesting of the election or even the Brexit lows. If you take a look at the Fibonacci levels in the first post, 2280 would be the first target, the breaking of which will put into question the 2240 level which is also the current 200 DMA. I would expect the next support at 2200 to hold in most cases. In terms of near term catalysts there is plenty: the FOMC meeting, April employment report and the French election all within a week’s time, not to mention North Korea. That said I always view external events as excuses for releasing the internal pressure: in this case there being too many people along for the ride, and the market never makes it easy for everyone to make money.

What I’ve done in the mean time

I added to a couple names on weakness. I sold puts on Apr 13th when there was well over 1% premium on 2-week OTM puts. They have expired worthless. I also sold some covered calls and 1 stock in the last two days. Not a whole lot different if I was just DCA in the absence of any directional views. The biggest portfolio change was deciding to trim my emergency fund allocation. I sold a CD and moved that money to the active accounts such that its cash position is now 14%.

What if I’m wrong and the market goes straight up from here?

First of all, I don’t see a bear market developing, and if that’s your view you should examine your information sources and your logic. If the correction doesn’t come, I’ll continue to DCA into the names I already picked out. Fortunately we should know the answer soon. One thing is for sure: I’ll not leave cash on the sidelines when this bull market takes off.

So why pay so much attention to this particular intermediate low when my stated approach to market timing is to avoid the real nasty bear markets and hold through the shorter gyrations? First, to constantly validate our hypothesis against the market is how we learn and improve. Second, there are leveraged bets that require a margin of safety that comes when “there’s blood on the street”. The flip side to avoiding the bear market is to fully take advantage of the bull market, both require accurate reading of the situation.

Lightly Held Opinions

The last post was about my then view of an on-going intermediate correction. I went at length explaining why even have an opinion and the extent of my conviction. I felt I need to further clarify given the recent market actions and my own activities.

The market proved more stubborn than the technical indicators or at least my interpretations led me to believe. In fairness any projections are inherently probabilistic in nature. The refusal to break down and the bounce yesterday have led me to consider the possibility that the “April bounce” originally framed within the context of the intermediate decline may instead produce a new high. Though I still see the decline in May-July bringing us below where we’re currently.

As mentioned, my timing moves to the extent of a 12.7% cash position in the active accounts were “incidental” to the portfolio realignment due to tax considerations. It’s never my plan to trade around an intermediate decline of weeks to several months in duration, especially in the larger context of what I believe will be a memorable bull market. The fact that I’m buying individual stocks rather than the whole market gives more flexibility. As such today I added to BAC, and existing position; and opened a position in MO. Both are at or below their 50 DMA due to recent weakness. The purchases were short of the final intended size.

I hope I have illustrated the nature of my market predictions: they are opinions with a rationale basis that I can defend, but I’m not married to them. I fully accept that I’ll be wrong as often as right; and when the market proves me wrong, I change my mind. There’s nothing to prove, no intellectual battle to be won. My ego won’t provide for my family. In the end, I rather be making money than being right.

A Correction May Be Upon Us

The long waited correction may be finally upon us. The 1%+ drop in the S&P on Mar 21st was the first in over 100 days. The bounce on the 22nd was anemic and accompanied by low volume. Most of today (23rd) was spent in positive territory but sellers took over in the last two hours — a very tell-tale sign. As in the chart below, we have broken below the trend line from the November election. Given this evidence, I’m of the opinion that an intermediate correction of months in duration has started.

I’ll go out on a limb again in trying to forecast a duration and depth of this correction. My model is signaling a bounce in April and a resumption of decline in May with a hard drop and bottom into July. I have little confidence in the exact path but a correction of 4+ months in duration will match that of the rise, a symmetry that would be appealing. The Fibonacci levels for this “Trump rally” aligns nicely with regions of minor support/resistance. I don’t trade at those time intervals but it’s interesting nonetheless. Given the nature of the in-flows of this rally, and that the market is never kind to Johnny-came-latelies, there is a high probability we’ll retrace all the way to the November bottom and more. I would go so far as saying that the “Brexit” bottom of 1991.68 is also in play.

Why do I bother with this kind of predictions and what do I plan to do with that information anyway? First and foremost it’s to develop a feel for the market and secondly to build confidence in the model. I’ve been clear on my approach to market-timing. My main goal is to be able to avoid the “big one” and ensure that my family is provided for. The skills that I’m honing are essential in deciphering the macro trends.

Since the inception of this blog, my most significant market timing move, in terms of duration and amount of capital, was the avoidance of nominal bonds. 35-40% of my passive portfolio has been in stable value funds paying 2 or 3% per annum. It’s been a good move — AGG has lost 3% since Aug’16. Compared with that that my pruning of stocks is rather opportunistic. In full disclosure, my pace of selling picked up in Feb/Mar, but it was not due to my market view. The main reason was the rotation in my fixed income allocation precipitated a desire to limit dividend payouts. This morning I closed out the MCD/DIS option spreads mentioned in this post, along with a couple other positions to give me a 12.7% cash position in my active portfolio. I don’t have plans for more sales; instead there are 7-9 buy candidates. My longer term view remains that we are in a full-blown bull market; but first, we’ll have to wait out this correction.

Anatomy of an Options Trade

Owning individual stocks rather than an index ETF affords many more opportunities to sell option premia as a way to generate some side income. I generally avoid covered calls since most of my holdings are intended for long-term. The implied volatilities are usually higher for puts anyway. My preferred modus operandi is to sell cash-secured (margin-secured really) puts on stocks that I don’t mind owning. That said, the timing and strike are such that the vast majority expire worthless. The position size is so small that I only aim to generate a couple percent per year of the eligible securities in my main trading account. 20-30% returns are not unheard of for those who are serious at it.

This post, however, describes an on-going high-conviction, directional bet the likes of which I increasingly look to as the conviction in my forecast grows. BTW, to put S&P 3400 in Q4’18 into perspective, a 27 handle is implied for the end of 2017.

McDonald’s (MCD) was the underlying stock and the two trade dates were indicated by the blue vertical lines. On 8/23/16, MCD was around 113 after falling from a high of 128 in May. RSI was showing a small negative divergence (lower low but RSI higher), the following option spread was opened:

Two Jan’18 125 strike calls were bought, financed by selling a 110 put of the same expiration. It was a net credit transaction for which I received $80 minus the $2.66 commission. Since MCD had a lot of downside momentum I got a good price on the just out-of-money put. I got the idea for this spread from synthetic equities (buying a call and selling a put at the same price) and synthetic equities with split strike (to ensure a net credit transaction normally). I had to use very wide split strikes (110/125) to get the 2:1 ratio. It was indicative of an extremely bullish bias.

Jan’18 was the furthest expiration available at the time. Since it was a net credit transaction, I was never worried about time decay and I wanted the furthest out options to make the trade work. As MCD continued to drop this trade was underwater until the start of the “Trump rally”. On 2/13/2017, MCD touched 125, the strike price of the calls and I conducted the following trade:

I swapped 3 130 strike calls for the 2 125 strike calls for $30 and moved up the put strike from 110 to 120 for $283 credit. In total, the transactions carried a net credit of $253 minus the $6.20 commission. I’m still long these 3 calls and short 1 put that together have a current market value of $1200+. Not too shabby considering it’s been all credit transactions from the get go. Of course it was not riskless — downside risk being defined by the short put.

I haven’t engaged in many similar trades. There is one with Disney that’s almost a carbon copy. A more recent split strike synthetic equity (non-ratio) position in Gilead is up but losing steam. There was also an earlier trade with Novo Nordisk that was closed with a loss. My conclusion is it’s all about timing. The hope is the favorable market environment will skew the chances to the upside.

Update: The option spreads in both MCD/DIS were closed on 3/23/2017. All were Jan 2018 LEAPs. They were put on as credit transactions so time decay was not a problem initially. However, as the trade started to work and call ratios were increased there were a lot of time premia to lose if there was a correction of several months duration. I kept the synthetic equity position in GILD using Jan 2019 LEAPs.