Good week. Good decisions.

Options trading is a risky business in that one can take highly leveraged positions in hopes those positions will move in your favor and produce higher than normal payoffs due to the leverage.  Of course if one takes positions where the market moves against you the opposite is true in that you can lose bigger than normal.  The point is that good decisions make for good weeks or good months. 

We took some serious positions about a month ago in Apple and Facebook.  We had Apple shares at $380 and $400.  Facebook at $20 per share.  Apple reported good earnings this week relieving investors and moved up nicely to end the week at $441 per share.  Facebook put good earnings on the board as well and ended the week at  $34 per share.  In the instance of Facebook we got paid 35 cents per share for our insurance position and sold out our position at 1 cent per share.  As you can see a highly leveraged position can produce good income over a short period.   35 to 1 in about a month is serious jack in our universe.    Apple produced similar results.   

Our portfolio has 13 position of that size monthly and so the goal is produce likewise profits each month without committing huge amounts of real capital, but by using other people's money to leverage our positions.  The key as noted is do one's homework and not be forced to use other people's REAL money unless needed.  One gets to take million dollar positions without having the actual million dollars in the bank so to speak. 

Since the early spring this year we changed our approach to a more simplified trading policy since the current political environment in Washington DC makes it much harder to take positions that administration policy could make mute with executive orders.  So far it seems to have worked since we are firmly in the black for the year and have no underwater positions currently.   We patiently wait for blood in street on good securities and ponce when opportunity arises.  It makes for less trades, more homework, less risk, and now more profits.  Once we make our money we exit and find other opportunities. 

This week we will add positions in BCE an old favorite and likely KO a new name for us.  

                

General Obligation bonds no longer as safe as Revenue bonds.

For those of us who invest in Municipal bonds the bankruptcy in Detroit brings the point home that I have been making for years that GO's or not as safe as Revenue Bonds anymore.  For years the opposite was true.  There is no longer such a thing as the "full faith and credit" of any government institution since activist courts and even the President of the United States have now completely overturned the rule of law that held that bond holders had first call on any assets of a government that defaults. 

GO's backed by school buildings, water and sewer lines, fire department buildings, and such were solid real estate that could in the past be taken back by bond holders if a government defaulted on bond payments.  But when Obama changed the rules in 2008 by allowing bond holders for GM to take a full loss in their lawful first in line for payback when a company defaults the world was turned upside down for bond holders.   In several city bankruptcies of late union pension holders again were moved in front of bondholders in municipal bankruptcies thereby making the law meaningless. Detroit I fully expect will continue this practice of bondholders losing full principal. 

The concept now is that bondholders are a bunch of rich bond funds or rich bondholders who screwed over governments with their buying of bonds and need to lose their money in bankruptcies. In almost all cases bondholders tend to be middle class individuals or people just holding bond funds in their retirement assets.   Thereby the idea that only rich people hold bonds is untrue. 

Revenue bonds backed by airport, hospital, or power agency revenue in my opinion or now a better bet on municipal finances than General Obligation bonds since they depend on a revenue stream from an asset that can raise rates to cover the cost of operating.  There is also the lack of worry regarding bankruptcy since these entities tend to have separate governing boards and little pressure from pension obligations.  

The municipal world has changed and those who do not take this into account when buying municipals could pay the price down the line.  Municipals still make a good case for investing in individual bonds since the principal is guaranteed for the most part and the interest remains triple tax free if bought in your state of residence.  Higher tax rates make bonds that can now be bought at par for 4.5% or better look good when comparing other income alternatives.   

Lastly when considering municipal bonds take into account not only the tax free interest, but also how they lower income level on your annual tax return effects the taxation of other income you might have.  The lack of reportable income from municipal interest can keep one from going over the 15% federal tax bracket keeping other dividend income from taxation for example.

             

Current Trading Portfolio July 8, 2012

Our current trading portfolio.  At this time we have positive positions in all these securities.  Note that we trade these stocks as options and they might not be good long term holdings.  However we believe at our strike prices noted below they represent good entry point values. 

AAPL..... Continues as our largest holding at just over $150k.   Apple has had such bad press of late we see $390 as a bottom now.  Yields about 3% at the current price.  Nice premiums on options and little downsize risk. 

AFL... We like this insurance carrier that is near the bottom of it's price range.  Insurance benefits from rising rates since they the can produce additional income from asset holdings.  We use a strike price of $50. 

BP.. Sooner or later BP will break free of the lawsuit agony.  The current price near $40 is most favorable long term in our opinion.  We might even like it better at around $37. 5% yield make the wait worthwhile. 

CTL..The one legacy telecom that has begun to grow and gain market share.  Not to mention the nice 6% plus yield.  Our strike price is $33, but we might back it off to $32 shortly for additional safety. 

FB.... Remains a company in limbo.  If they can figure out how to convert all those Facebook accounts to some advertising revenue they could grow quickly.  Strike price of $20. 

HFC....Continues to prosper from the lack of a pipeline for mid continent oil which keeps the price below the world price.  So they get to resell refined crude at the market price with the nice cushion of additional profit. Do not overlook the special quarterly dividend.  Strike price $35. 

LO...The only cigarette maker we like currently due to the growth factor in the US.  Nice dividend too.  Strike price of $37.50. 

NOV...Supplier of oil drilling equipment and most importantly gas drilling equipment.   Warren Buffet is buying shares.  Strike price of $60. 

O...Since it has sold off back towards $40 we have added this stock back to our portfolio.  We love Realty Income and it's monthly dividend. Strike price of $40. 

SHLD... Lousy retailer. Fabulous real estate portfolio.  Our strike price of $40 seems to be a good value price for this stock.  We might back off to the mid $30 is the stock continues to show weakness here. 

SO...The recent sell off has brought this stock back where it is a value again.  Our strike price of $41 makes for a good entry point. 

T....Stable big telecom company we like at $33.  

            

We took a good sized loss today.

We did something this morning we absolutely hate to do,  take a loss, a nice sized loss at that.  

The scenario was simple we sold an option to buy 2400 shares of Baytex Energy back in March of this year for $816.  The strike price at the time looked quite good at $40 with the stock at that time selling at around $45. The stock has a solid 7% or so dividend backed by a huge oil inventory in the ground and a nice spread in the margin of cost of extracting versus market crude price.  Frankly we figured the option would never get assigned and the $800 premium was safely in our bank account. 

Once again politics reared it's head and Obama instead of approving the Keystone XL pipeline like most figured he would shortly after the election decided to put the decision off again.  This meant for the time being all that oil Baytex is producing will get bottled up in Oklahoma and Illinois until rail cars owned by Warren Buffet,  Obama's cronyism buddy in this case,  can move it to refineries mostly on the Gulf Coast.  The resulting glut of oil and no hope of any long term relief means Baytex can produce all they want but only as much as can be transported will get sold. 

Add in the resulting drop in price due to the glut cut into Baytex's profit margin and you get a drop off in stock value.  The stock price has been as low $35 in the recent month which meant we were sitting on a $12000 loss in capital if we could find no upward move in price.  Fortunately for us the Egyptians decided to have themselves a government overthrow that sent oil futures moving up and Baytex stock price up with it.  Today the stock is selling for just under $38 with options at around $2.50 for the $40 strike price.  Not knowing where this revolution in Egypt is going and sensing a chance to cut our loss in half we bought back the option at just that $2.50.  A $5200 net loss, but it looks good compared to the $12000 we were seeing just a month ago. 

The point here is something you can read back over two years ago in my trading and investing rules.  I call it the "Jefferson Strickland rule".  Many years ago my old car dealer friend told me one of he worst things to deal with is a bad car trade where you sit underwater in a car value.  Each day you come in thinking about the loss to come is like a bad tasting medicine sitting in a bottle on your desk.  

Every day you come is another day you taste the bad medicine even if you do not actually take it.  So the best remedy is to take the bad tasting pill sooner rather than later getting it done and moving on with a brighter outlook and looking for better opportunities.  Therefore today we took the bad medicine and already feel better thinking about using the now open resources for better trades ahead. 

Taking a loss is the hardest thing most investors and people have to do, but it is a must do and something best learned sooner in your life so as not own depreciating assets and missing on better opportunities. This rule can apply to your old car or bad real estate buy as well.  The asset each day depreciates, sell the asset, take the loss, and save your capital.

                

Some current income bargains.

In the last month or so there has been a sell off in dividend paying stocks.  Frankly many of those securities were formally priced significantly above value.   The fear that interest rates are headed up is confirmed in the huge run up in mortgage rates in just the last two weeks.  Mortgage rates are up almost one full percentage point from around 3.5% to 4.5% now.  Note that in the last week they have moderated some back towards 4.25% and we believe they will moderate a bit more before stabilizing around 4%.  The real key here is the 10 year US Treasury that has now moved up strongly to around 2.5%.  That rate was about 1.5% just some over one month ago.  That rate is likely to stabilize here around 2.5% for the near term.  Unlike the mortgage rate that will be affected by lower mortgage activity at a higher rate, treasuries still have significant buying from the Federal Reserve.   All said good dividend stocks look like a good buy here due to the fear of higher rates. Below are some of our favorites. 

Realty Income, symbol O, has always been one of our favorite picks.  Superb management,  shareholder friendly, and a monthly ever increasing dividend.  Current yield of just over 5% is solid long term.   Realty Income is a triple net leaser and like many REITS have lowered their long term cost of capital with significant reissuing of debt.  Buying O here in the $42 range is a nice income producer for most portfolios. 

Southern Company, symbol SO,  is the preeminent electric producer in the country.  Great management and a rock solid dividend.  Add in that they operate in a area that is the best place in the US for a regulated utility.  Like Realty Income this company has done a good bit of reissuing of debt at much lower rates long term.  Here at around $43 per share it yields just under 5%.  This stock is what used to be known as a widows and orphans stock and owning it makes me sleep well at night. 

AT&T, symbol T,  this stock has drifted back down to around $34 now and yields over 5%.  You might not get a lot of capital gains, but with their business model and rock solid finances this one is a good buy at this price for future income. 

All three of these are not big winners if you are looking to make a big gain. However each one beats CD's, US Treasuries, and most bonds at current prices.  Little downside risk, dependable income, and sleep well at night safety make for good investments in current market conditions.