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A question about “How to use derivatives as a source of added income”

On June 21, from J. G., Ontario, Canada

Thanks for yesterday’s post “How to use derivatives as a source of added income”. I like the thought of options trading, but I’m a little afraid to jump back in because of the volatility of NVAX. I have one NVVAX contract at $159.00. Have you found any other stocks/ETF’s that are more stable?

Our answer

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How to use derivatives as a source of added income. June 21, 2021

This is our weekly post dealing with derivatives (calls and puts). Over 80% of our members are interested in the subject. 

When the market opens at 9:30 AM today, June 21, Rosi and I plan to sell 18 just out-of-the-money covered call contracts on the 1,800 shares of Novavax (NVAX), which we hold in our “fun” portfolio. (Value about $314,000.00)

Based on the final sale at the closing bell last Friday, June 18, we should get about $6.00 per share, or, $6,000 per contract for a total of $10,800.00 for the week. A bird in the hand, money in the bank! I never netted that much money in one week practising dentistry.

Percentage return for the week?  $10,800.00 divided by $314,000.00 and multiplied by 100 equals 4.44%!

We bought the 1,800 shares of Novavax (NVAX)in our “fun” portfolio at an average price of $225.01. Last Friday, July 18, NVAX closed at $174.41. So, we lost $91,467.99. Not much fun.

This year to date, we have made $38,509.81 selling NVAX covered calls in our “fun” portfolio. We sold just out-of-the-money contracts and further out-of-the-money contracts to benefit from any growth if there was any. The $38,509.81 offsets our losses somewhat, but the losses are still significant.

Maybe the title of this post should be: “How to use derivatives as a source of subtracted income.”

But… “To succeed, make more mistakes” is sound advice.

What were our mistakes? What can we learn?

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Drive faster, get there sooner, face greater risk of accident!

As soon as you find a way to journey through life risk-free, please call me, and I promise to do the same for you.

The stock market is especially good at highlighting the relationship between risk and reward.

Here is a statement which you have heard before. “Look around the poker table; if you can’t see the sucker, you are the sucker.”

It is no secret that the average investor, professional or not, significantly underperforms the market over an extended period.

Professionals who manage other people’s money, certainly know how to equal the market but they do have to buy groceries and pay the rent. After subtracting their fees from portfolio performance, few equal the market.

Who is the sucker?

Retail investors (amateurs) jump into the market when it is high and expensive, and run from the market when it is low, and bargains abound.

Who is the sucker?

Feeling insecure, many investors buy mutual funds so that professionals manage their savings.

From 1983 to 2013, the stock market as represented by S&P 500, earned over 1,102% after expenses. The average mutual fund investor earned 239%! The results for any 30 year period would be comparable.

Who is the sucker?

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When investing, as in life, we should stack the odds in our favor.

The chart above shows that over a five-year term, 24.73% of US funds and 1.37% of Canadian funds outperformed their respective indexes. These percentages suggest future results.

Some odds!

About one year ago, Forbes magazine published an article titled The Hidden Dangers Of Passive Investing

The author wrote: “If every investor only engages in passive strategies, then large active management opportunities would emerge. I believe that passive investing has become a sufficiently crowded trade that indexers will see lower returns than fundamentally rigorous active investors over the next few years, at least. Passive investors are in the Danger Zone.”

The Monday Morning Program supports the “Danger Zone” passive investing by buying an exchange -traded fund which tracks the S&P 500. 

Simply stated (again), our investment philosophy says over the long term, properly selected US market index exchange-traded funds, held in tax-advantaged accounts, in an appropriate asset allocation, have been the investor’s best way for growing savings and are likely to remain so for many years.

The two tables below show the record.

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Joe Biden’s impact on our investing. Survey results

Greetings everyone,

Again, a sincere thank you to all those who took the time to respond!

On Friday, June 11, 2021, we asked our members and subscribers: “What impact will Joe Biden as U.S. president, have on our investing?”

You can see the results below.

Choice
Percentage

Good

24.1%

Bad

17.2%

Neutral

37.9%

I don’t know.

20.7%

At this point, the market has done better than during any other president’s term since Dwight Eisenhower, over 70 years ago!

The massive stimulus which was underway before Biden took office, has a lot to do with the market growth. Biden’s pending tax policy could put an end to that.

Monday Morning members who have the habits which we encourage, do not need to have any concerns, regardless of what happens.

You can see our readers’ comments below.

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How to use derivatives as a source of added income. June 14, 2021

According to a recent survey, 83.3% of our members and subscribers are either involved with derivatives (calls and puts) or would like to be. Accordingly, we will deal with the subject on a regular basis, usually on Mondays.

Properly carried out, derivatives can be a source of added income in a portfolio. Buffett himself uses them in a major way.

On Tuesday, June 1 (Monday, May 31 was a holiday) in our “fun” portfolio, Rosi and I sold  15 contracts of  Novavax (NVAX) expiry date June 11, strike price of $150           (C 11JUN21 150). Our purchase price was $US145.40 per share.

We made $US10,320.00 on the deal, still allowing $US5,550 for growth if there was to be any.

Well…

Growth there was — NVAX closed at $US209.68 last Friday, June 11!

So yes, we made $US15,870.00 ($US10,320.00 plus $US5,550.00) on this transaction but…

…had we held NVAX we would have made $US96,420.00 ($US209.68 minus $US145.40 multiplied by 1,500)!

Does that hurt?

Well, it should not. I needed two weeks in dental practice to net $US15,870.00.

Two points here–

  1. There will always be better investments and than the one we just made.
  2. If we had to do it over again, we frequently would have done things differently.

To stay in the game, we now need to buy NVAX at the significantly higher price of $US209.68 per share.

Does that hurt?

Investors writing covered calls generally do not like to be assigned. But if the compound annual growth rate (CAGR) is good, we should be happy to put in more money, should we not?

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About aging in an unparalleled, successful way. Happy birthday, DJI!

Our member John Kershman DDS, recently sent the following email:

“Hi Milan,

“This video proves your point about investing in the index.”

https://www.reddit.com/r/dataisbeautiful/comments/nn2gir/oc_the_dow_jones_turns_125_years_old_in_its_honor/?utm_source=share&utm_medium=ios_app&utm_name=iossmf

You will find the video fascinating!

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About how to prepare a market crash if your are retired or close to it.

A significant number of our members are either retired or close to retirement.

Investors with the Monday Morning investing philosophy will welcome the inevitable market collapse, which we will face one of these days. For them, the collapse will be a bargain buying opportunity.

People approaching retirement who have not prepared for a market collapse might have to work longer or cut back on their lifestyle or both.

Can investors prepare for market collapse? If so, how?

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Effective, evidence-based management of what intelligent investors can control. Article 2. ASSET ALLOCATION

Stock-picking is a much better choice for interesting cocktail party conversation but index investing and asset allocation have always been the most important factors for worry-free, effective investing.

Writing in his justly renowned book The Battle for Investment Survival, published over 80 years ago, Gerald Loeb says: “It is far better to let cash lie idle than to buy just to “keep invested” or for “income.” In fact, it is really vital—and just this one point, in my opinion, represents one of the widest differences between the successful professional and the loss-taking amateur.”

Echoing Loeb, the late, greatly respected David Swensen, chief investment officer at Yale University, states in his book Unconventional Success:

“…asset allocation accounts for the largest share of portfolio returns.”

Searching for “asset allocation” on the Internet will produce a large number of hits. Almost all of them will recommend a balance between stocks, bonds and cash. Such a balance was effective in the past, but this time is different.

Commenting in their extensively documented book This Time Is Different, Reinhart and Rogoff state that it almost never is. Financial crises have been common over the centuries. Remarkable similarities exist among them.

However, interest rates have never been as low as they now are. When they ultimately rise as they must, bond values will drop — a mathematical certainty. This time could be different.Bonds are no longer a useful aspect of asset allocation.

To balance their asset allocation, investors can choose between stocks and cash or near-cash, such as a money market fund.

And how can investors select stocks effectively? What is the right balance?

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Derivatives are financial weapons of mass destruction. Could it be worse?

  • Resulting from its involvement in derivatives, in 1994, California’s Orange County declared bankruptcy.
  • Resulting from its involvement in derivatives, in 1998, Long Term Capital Management needed a $3.6 billion bailout from 14 financial institutions in order to prevent market panic and collapse of the entire financial system.
  • Gambling with derivatives, many individual investors keep losing 100% of their money.

However, properly carried out, derivatives can be a source of added income in a portfolio. Buffett himself uses them in a major way.

According to a recent survey, 83.3% of our members and subscribers are either involved with derivatives (calls and puts) or would like to be. Accordingly, we will deal with the subject on a regular basis.

Rosi’s and my core portfolios are 50% in exchange-traded funds which track the S&P 500 (SPY) and 50% in a money market fund (TDB166). When volatility is high, we write covered calls on our SPY holdings. Otherwise, we leave things alone, buying more SPY  at bargain rates with the market drops and taking profits when the market rises.

But in our fun portfolio, often not much fun, we write covered calls on Mondays (unless it is a holiday) with expiry dates on Fridays of the same week.

Monday, May 31 was a holiday so here is what we did on Tuesday, June 1.

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