Cashflow Report – Paper Income during July 2011

Welcome to my cashflow report for July 2011!

Every month, I review the cashflow (paper income) I’ve created from trading covered calls. I do this for many reasons, but these 4 are a good summary:

  1. To help me track my progress towards financial independence
  2. To maintain my focus on increasing paper income and meeting my goals each month
  3. To provide an example of creating an income from investing/trading
  4. To get your perspective

Enjoy!

July 2011

Last month, I was concerned that DRN and EDC would increase in price so much that after my options exercised, the new purchase price for both ETFs would be much higher than previous months. This would require a larger amount of capital to achieve the same position size (in terms of number of shares)…which is an increase in risk. Instead, prices returned to approximately the same level they were at for June’s cashflow report.

The story on DRN has not changed much; the October uptrend is still intact, yet it is range bound between the mid-60’s and mid-80’s. EDC is still trading between the mid-30’s and mid-40’s, but is definitely in a shorter term downtrend right now. TMF gaped up at the end of the month and pierced the $40 level, but we’ll have to see how the debt default saga plays out. FAS is clearly trending downward.

What I learned in July

From an effort standpoint, creating $3,000 in a given month is pretty easy. My trades don’t require a lot of attention, and the market has been fairly flat for most of the year. However, living off of $3,000+ of paper income every month requires much more focus on minimizing risk, capital loss, and proper budgeting. So while I’ve reduced the execution of trades to something fairly easy, the process for living off of investments is not even close!

My short term goals are well defined and measurable, and I am enjoying the resulting success. My long term goals are still concrete, but I haven’t expanded my thoughts outside of money making.

For example, I haven’t created the process or mechanisms in place to really live off investments. Profits are recycled back into the trading account for the time being. There are still some topics that need to be addressed before I can start weening myself off of a paycheck, such as:

  1. Level of reserves needed in my trading account in order to survive the worst drawdown possible
  2. Tax burden as a result of dropping employer-paid taxes (social security,etc.)
  3. Funding of retirement accounts
  4. Emergency Fund account size
  5. Logistics of moving money from a trading account to a checking account to pay bills
  6. Updated budget
  7. Personal financial goals
  8. Creation of a corporate entity for trading activities?

I also learned that a few of my assumptions haven’t made their way to this blog yet. Specifically, my current risk level is based on a portfolio size of $300,000. This is the goal that I set for the covered call strategy, and I am building up the proper position sizes along the way. My portfolio isn’t there yet, so risk percentages based on my current account balance would be much higher.

Cashflow Report – Paper Income During July 2011 – Breakdown:

DRN-Direxion Daily Real Estate Bull 3X (ETF)

Premiums = $1566.00
Dividends = $0.00
Commissions/Fees = ($17.49)

EDC-Direxion Daily Emerging Markets Bull 3X (ETF)

Premiums = $1200.00
Dividends = $0.00
Commissions/Fees = ($18.78)

TMF-Direxion Daily 20+ Yr Trsy Bull 3X Shares (ETF)

Premiums = $659.00
Dividends = $0.00
Commissions/Fees = ($12.64)

FAS-Direxion Daily Financial Bull 3X Shares(ETF)

Premiums = $332.00
Dividends = $0.00
Commissions/Fees = ($11.26)

Net Cashflow – July 2011 = $3727.64

GOAL ACHIEVED

Paper Income from Covered Calls
GOAL: Create cashflow greater than or equal to $3,600 USD per month for 3 months straight by executing my covered call strategy.

The Road Ahead

It should be interesting, and that is about all I can say. With the banking crisis continuing in Europe, and our own debt ceiling issues (not to mention the actual deficit), there is no way to know what will happen. Everyone seems to be in a watch and wait mode.

After some thought, I appreciate the impact that leaving an employer will bring. Achieving personal financial goals becomes more complicated without the consistent cashflow from a job. Planning and budgeting properly become much more critical to staying in the black.

I don’t have all the answers today, but stay tuned. These issues will definitely be addressed.

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July Option Investing – FAS Covered Calls

Earlier this week,  I decided to reduce my exposure (i.e. smaller position size) in DRN and EDC, which is driving me into other ETFs in order to meet my cashflow goal.

I want to keep the risk from new trades small, because I do not have enough information on the debt debate to know (with certainty) what price changes will occur over the next few weeks.

With the markets in a correction (see commentary based on IBD from the Invest-Safely Blog), I am also keeping money on the sidelines, reducing my “trading” portfolio size.

I set a limit for my portfolio risk percentage at 5% or less  per trade, and the largest 1 month drawdown for FAS is 75%.  Those two figures work out to a position size of ~$5,000 or less.

After some research, I decided on FAS.   With the current price around $25 per share, it was one of the few leveraged ETFs with the liquidity AND option premiums I need to meet my cashflow goals.

I ended up buying 200 FAS shares at $25.18 and selling 2 August $25 calls for $1.66.

July Option Investing – TMF Covered Calls

I decided to expand my portfolio and initiate a position in TMF.

Since the option volumes are lower than my current entry rules allow, I needed to find a way to protect money.  My last try at expanding my ETF selection (CZM – which now trades under the ticker YINN) was less than successful due to low option volume.

Using a buy/write order entry works around the low volume obstacle.  The order will not execute if options are not available.  The downside risk is if the options expire at the end of the month.  If option volume dries up, I either have to sell my shares or sell calls “at market”.  Anyone selling at market become a price-taker, instead of a price-maker, which decreases profitability.  And the lack of liquidity makes profits even worse for the seller.

My TMF buy/write did execute, but there was not enough volume to cover the entire trade in one transaction. You can see the lower volume reflected by the fact that the order executed in 3 segments.

Shares of TMF @ $37.79 with August 38 calls at $1.64
Shares of TMF @ $37.80 with August 38 calls at $1.65
Shares of TMF @ $37.81 with August 38 calls at $1.66

July Option Investing – EDC Covered Calls

My July $33.93 calls were exercised, relieving my of my EDC positions.

Given all of the foreign and domestic uncertainty around debt default, I decided to reduce my exposure (i.e. smaller position size).  This may require investing in another ETF in order to meet my cashflow goal.

EDC’s price is still moving around quite a bit, but the option premiums have remained fairly constant since February.

I ended up buying EDC shares at $35.37 and selling August $35.58 calls for $2.40.

July Option Investing – DRN Covered Calls

My July $70 calls were exercised, leaving me with no position in DRN.  Since DRN is now trading in the mid-70’s, I did lose some purchasing power this month.  Not enough to keep me out of the game, but it is worth keeping an eye on.

DRN option premiums are really high this month, suggesting large price swings.  I purchased DRN at $76.32, and sold $76 Aug calls at $5.22.  Even with the 0.32 loss on the shares, the overall profit of $4.90.share was higher than the premium coming from $77 calls.

July Technical Analysis – TMF

In June’s cashflow post, I mentioned the need to expand my trading in order to meet the updated cashflow goal for 2011. I realized that two things needed to happen.

  1. I needed to review my strategy and decision making process to ensure that it was still consistent with my goals.
  2. I needed to make sure that I wasn’t getting sloppy with regard to trading money management.

And since I’m 100% cash and DRN/EDC are within a few percentage points of my June strike prices, now is the perfect time.

As mentioned in the previous post, the last few months have been “choppy” to say the least and the debt ceiling debate isn’t inspiring any confidence. So I’d really like to diversify a little and get back into some uncorrelated (relatively speaking) ETF’s.

The problem: most of the leveraged ETF’s available for a covered call strategy are based on US equity indexes or a sector of an index (so their correlated to some degree). Which means that my rule for non-equity index based ETF’s may need to “bend” a bit.

TMF


TMF is Direxion’s Daily 30-Year Treasury ETF. The fund tries to replicate 3-times the performance of the NYSE 20-year plus Treasury Bond Index. A few years ago, TMF was one of the ETFs I used to prove out this covered call strategy. The option premiums were always lower than DRN, EDC and others, but price movement is less volatile too.

As you can see in the graph, TMF has been range bound between $35 and $40 since May. It also looks ready to test the February uptrend again (as it did to kick off July’s trading)…looks like the current premium would cover a test of the $35 mark.

The only issue with this fund is the corresponding option volume. During the month of June, only 64 option contacts were traded. Ideally, I want to see 1,000 contacts or more each month. With that level of activity, my trades are less than 1% of the total volume, which is sufficient liquidity to let me enter and exit my trades without influencing prices.


July Technical Analysis – DRN and EDC

It’s that time again…time to make some money!

All of options were exercised over the weekend, so I’m 100% cash.

The last few months have been “choppy” to say the least, which is normal for this stage of a uptrend. According to IBD (as of this morning), the general markets are still under pressure. When I look at the tape, the markets are in a downtrend according to my rules.

Right now, the 50 and 200 day moving averages are very close to each other, so it is best to be on the defensive. The fact that the politicians in Washington are playing roulette with the debt ceiling isn’t smoothing out the ride any either.

DRN


June’s assessment of DRN:

After a brief test of 52 week high’s, DRN fell back to earth and is now testing the uptrend from last October. On the plus side, DRN found some support at the $63.00 level.

What a month! After finding support from the October uptrend, DRN shot back up and hit a new 52-week high (roughly a 30% move). This was one of those moments where I ask myself, “Why did I sell calls?”. But the market intervened, and DRN fell back to the mid-70’s. We’re now back to the 50/200 day moving averages, so it is anyone’s guess where we’ll be headed.

EDC


June’s Commentary:

EDC is approaching lows for the year, after slicing through its 200 day moving average and continuing lower. EDC still hasn’t broken the $32/$33 support levels, but most of the moves to the downside have been on above average volume, which is not a good sign. The downtrend is currently on a ~10% per month pace, so by the end of June/beginning of July, we could see a retest of the upper limit of the downtrend ($36/share or so).

EDC passed through the short-term downtrend at $36, got back above the 50 day moving average, and then tried to take out the $40 per share level. In my opinion, EDC ran into some pretty stiff resistance, falling 15% in 3 days.

Technically, EDC is still range-bound between the low 40’s and low 30’s. Event-wise, the credit issues taking hold in Europe are not helping the emerging markets. If the up/down trend continues we could see a low of 30 before EDC heads north again sometime in late August.


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