Your Reading List

How To Gauge Returns With A Phantom Portfolio

Name and symbol

Encana (ECA)

Talisman (TLM)

Hudbay (HBM)

Yamana (YRI)

(I forget the stock)

Tech Resources (TCK. B)

Osisko (OSK)

TOTALS

No. of shares

500

1000

1000

1000

1000

500

1000

Seven STOCKS

Cost

$15,000

$18,000

$13,000

$10,000

$13,000

$21,000

$8,500

$98,500

April Premium

$400

$460

$150

$170

$250

$700

$150

$2,280 (one month)

Next month’s Premium

$850

$880

$550

$540

$800

$1100

$550

$5,270

Would-be investors often ask me: “Just how much money can we make selling covered calls?” I take them to the Montreal Exchange (www.m-x.ca)and choose a random amount of money to work with, and then follow a phantom portfolio along for a few months to show them how it works. I’ll do the same in this column, to give you an idea of what this might look like using imaginary money with real-world examples.

To help readers/new investors decide if they want to manage some of their money, I suggest they test run part of their money in a Tax Free Savings Account (TFSA) or trading account and figure out how much money that account can make per month if they sell covered calls on some favourite stocks. I should point out that if you have a financial adviser who has done a decent job for you, there’s no need to fire them and suddenly start managing all your money; it might pay to leave some with the adviser or broker while you learn how to run part of your portfolio.

We don’t know what the future will bring — our head might go bananas or we might get busy on a new project or you might find managing your money is not your cup of tea. But I do think more people should learn the skill of making money with money, just wade in, don’t dive in.

HOW TO BUILD A PHA NTOM PORTFOLIO

There are about 120 stocks in Canada that we can sell covered calls on, but we only need maybe 10 stocks. It depends on how much money we plan to work with. Let’s start with say $10,000 in a TFSA.

I’m only going to tell you what I would look at with our two TFSAs. First of all, with $10,000 I think I only want to deal with one stock. For many farmers, $10,000 is only a small part of their overall net worth so I don’t think it will pay to own say three stocks of $3,300 each in a TFSA. When it’s worth $30,000 to $40,000, it might be time to split the money among two or three stocks.

I want to use money efficiently so I usually look at stocks that cost under $20 so we could buy up to 500 shares for $10,000. But as it happened, last year we had several decent stocks that cost under $10 so two fit in our $5,000 TFSAs quite nicely.

My choice of stocks at this time include a couple Yamana (YRI) and Osisko (OSK), Finning (FTT), Silver Wheaton (SLW), Pan American Silver (PAA), Dryships (DRYS) and there are others.

As of today, May 12, 2010 I would fill one TFSA with CLM because it has 640 million tonnes of good-quality iron ore, no bank debt, a Chinese company owns 20 per cent of it so there is a customer and the infrastructure was almost built when I found this company. I started to buy that stock at $5.20 long before I set up the TFSA.

The stock dropped in early May to under $8 and now is around $8.80. I would not sell calls on this stock at this time because it is just changing from a developer to a producer and I think it has upside. But some readers do sell calls on this stock.

For the other account I would choose OSK or YRI. OSK has around something close to 10 million ounces of gold in its reserves in a rich, rocky area of northern Quebec. That rock stretches into Ontario and a mine called Detour is on the Ontario side of the border. This stock trades for around $11 these days so $10,000 could buy 900 shares. As of May 12, we could sell a covered call on those shares for strike price $11 for June and collect around $450. That’s 4.5 per cent for five weeks.

I know there are no guarantees but from what I could see of both companies the shares have the potential to rise 50 per cent to 100 per cent and both have options so I could sell covered calls on them.

A $100,000 PORTFOLIO

When I recently visited with a group of farmers in Teulon, Man., we took a pretend amount of $100,000 and I asked people to give me their favourite stocks and we pretended to sell calls on them two ways. One way was to sell calls near the price of the day for the nearby month, which was April at the time. The other was to sell calls into the next nearby month near the price of the day. These amounts would be different almost day by day but this will give you an idea of how much money that group of stocks would have brought in if we had sold calls on them that day.

As you can see in the chart above for one month these stocks would have brought in over $2,280 and if we had sold some calls for May, one or two for June and one for July the premiums brought in would have been $5,270. We didn’t consider the commissions.

With the nearby monthly amount it would be quite easy to collect the $2,289 10 times a year and maybe 12 times for a total of around $23,000. With the next month, if we assumed we could sell calls four times a year, the total would be something around $21,000.

The dollars would change with the months and the stocks we chose but this does give you some idea of the income $100,000 worth of good stocks could bring. This is cash in a trading account the day or the next day we sell the calls and it would be taxed as capital gain.

The only stock I chose was TCK. B because we own 3,000 shares and I know this stock quite well. We also own YRI and OSK.

If we were dealing with a $50,000 bag of money I would drop some of the stocks, not cut the numbers except for TCK. B which I might cut to 400 shares that cost around $18,000 at that time. I likely would keep TLM and OSK. I’d then fill in with a stock with whatever money was left over. The premiums would be more or less half of what you see.

All of this information is free on the Montreal Exchange at www.m-x.ca.If you go to Google and type in that site and then click on something related to options you should come to the site. Scroll down until you find the words “most active options,” click on one and then click on the top OK. Next you need to click on the menu arrow to the left of the top OK and up will come a list of the 120 Canadian stocks that have options. Choose one, click on it and then click on the top OK again, and you will come to an option chain for the stock you chose.

If the words come out in French and you want English on the top right click on the word English. If you still have problems call me before you kick or punch out your computer.

THE DIFFERENCE BETWEEN A STEER AND A MILK COW

Some people fear selling covered calls because they think it will limit their gains if their stock goes up rapidly. Yes, that could happen, but here’s how I finally figured out how to manage this strategy.

Take for example TCK. B from February 2009 to the end of December 2009. If you look at a chart of that stock it was going up nicely. Then come 2010 the chart leveled off. So, in cattle talk, from February 2009 to the end of December 2009 I would call TCK. B a growing steer or heifer. I did not sell covered calls on most of the shares most of the year. The stock went from $4 to around $40 and we owned 3,000 shares from $9.50 and I gave the stock room to run or grow.

Come 2010, the chart has levelled off and the odds of the stock doubling in the next 12 months are quite slim and even if they did, that is slower growth than when the stock went up nine or 10 times in nine months.

So now it might make sense to sell covered calls a bit above the price of the day and just bring in cash just like a milk cow does. Most stocks are not growing steers for long. Stocks go sideways 68 per cent of the time which is why “milking” a stock can make us good money most months of the year. A little judgment helps.

That way we can bring in some cash and yet give the stock some room to go up in price. We don’t have to be perfect to make good money.

Andy Sirski is more or less retired. He manages his investments and publishes a newsletter called StocksTalk where he tells what he does day by day. If you want to read it free for a month go to Google, type in StocksTalk.net,click on free month, click on go to forms, fill out four lines and submit.

About the author

Freelance Writer

Andy was a former Grainews editor and long-time Grainews columnist. He passed away in February 2017.

Andy Sirski's recent articles

Comments

explore

Stories from our other publications