Year End Cashflow Report – Paper Income during 2011

Welcome to the Investing for Cashflow Report – 2011 Edition!

Last month, this blog passed the one year mark, so it was only fitting that we have a cashflow report for 2011. If you have your own 2011 year-in-review, please post a link in my comments section so that we can all learn about your successes and failures. As you’ll see below, there is always room for improvement.

As always, I will use this report to:

  1. Help me track my progress towards financial independence
  2. Maintain my focus on increasing paper income and meeting my goals each month
  3. Provide an example of creating an income from investing/trading (actually making money)
  4. Get your feedback on ways to improve

Enjoy!

2011 Overview

2011 Price Performance of NYSE

2011 NYSE Price Chart with 50 day EMA

As an overall gauge of the US equity markets, I follow the NYSE (NYA). It the broadest of the indexes, and all the ETFs I use for covered calls follow components of this market (more or less). Therefore, it is a great baseline for investing performance and provides a good backdrop for my goals and any trading successes/failures encountered through the year.

The NYSE kicked off 2011 at 8,044 on Jan. 03 and hit a high of 8,671 on May 02 (+7.8%). From there, it proceeded to drop to a low of 6,574 on Oct 03 (-24.2% from the high). We ended the year at 7,477 on Dec. 30 (up 13.7% from the low, down 13.8% from the high, and -7.0% from where we started).

For comparison, over the same period of time, the the Dow Jones Industrial Average (DJIA) was up 4.6%, the SP500 (SPX) was unchanged, and the NASDAQ Composite (COMP) was down 3.2%.

2011 Goal Review

Overall, my goal at the start of last year was to make $36,000 by December. As I’ve learned, goals with long time frames (more than a month) need to be broken down into manageable, shorter-term steps so I don’t lose focus. That is how I arrived at a goal of $3,000 per month.

In March, I reached the $3,000 per month target for the first time. By May, I had hit three months in a row, which gave me the green light to raise my goal. For the year, I broke the $3,000 level 8 times.

In June, I increased my goal (per month) to $3,600 and subsequently hit that target 3 months in a row. For the year, I met this target 5 times.

After a disastrous August, I added another condition to my goal of $3,600 per month in cashflow; the withdrawal of $3,600 each month. I met the cashflow goal in 2 of the past 3 months, while depositing $3,600 into an expense account for 3 months straight to close out the year. As an end result of my trading in 2011, I generated $37,755.68 from selling call options.

Even though my definition of success looks different today than it did a year ago, I see that as a sign of personal growth and adaptation. I achieved my trading goals for 2011, and became a smarter investor and trader in the process. All in all, I have to conclude that last year was a success.

Investing for Cashflow - Performance in 2011

2011 Investing for Cashflow – Cashflow from Premiums

*ROI = Cashflow/Capital Invested

Premiums ROI
Jan $2,279 8.8%
Feb $2,879 5.8%
Mar $3,154 6.5%
Apr $3,488 5.7%
May $3,037 4.7%
Jun $3,556 6.4%
Jul $4,025 6.6%
Aug $4,452 18.1%
Sept $0 0.0%
Oct $3,168 11.7%
Nov $3,934 9.6%
Dec $3,784 9.8%

GOAL ACHIEVED: Create cashflow greater than or equal to $3,000 USD per month for 3 months straight
GOAL ACHIEVED: Create cashflow greater than or equal to $3,600 USD per month for 3 months straight.
GOAL ACHIEVED: Execute a covered call trading strategy to create $36,000 USD in paper income
GOAL ACHIEVED*: Create cashflow greater than $3,600 USD per month AND deposit $3,600 USD per month into an expense account, for 3 months straight.
*2 out of 3 isn’t bad!

Lessons Learned in 2011

Searching through a bookWe all know that there is a big difference between paper trading and live trading. Emotions can get the better of us, and that is why the mechanical trading system exists. This year I saw that the difference between paper trading and live trading is actually fairly small…when compared to the ginormous difference between live trading and trading for a living.

Some say that you must practice money management in order to become a successful trader. I think that statement doesn’t go far enough; you must practice trading money management in order to trade successfully. But it is not only applied on a per trade or portfolio level. In order to trade for a living, you must also practice personal money management within your trading account! There is the short term impact of reducing the money you have to trade the following month. But the major issue is long term. Removing money every month is very similar to having a loan; each month, you have a guaranteed loss.

In October, I started removing money from my account each month and by December the impact of capital gains exploded in my face. Basically, I had a capital loss of $10,800 in three months before I even started trading!

Lesson Learned: Covering monthly expenses will need to be included in my cashflow analysis

My system for measuring performance is flawed needs to be improved (another personal goal is using positive language).  My singular focus on paper income (premiums from covered calls) left me blind to capital gains and losses. Before I started withdrawing money from my account each month, capital gains were not as important as monthly cashflow levels. I thought that by focusing on the premiums, the income would eventually allow me to stop trading with “my money”. In reality, the income from premiums offset losses the ETF’s incurred, and my overall balance provided a false sense of security.

Then came the weekly FAS option experiment. Not only did it prove my theory on capital gains and losses, it also generated other helpful insights.

Let’s revisit my December cashflow post and the FAS trades:

Dec 05 = $3.40 premium for a Dec. 9 $67.00 Call
Dec 12 = $3.10 premium for a Dec. 17 $62.00 Call
Dec 19 = $2.10 premium for a Dec. 23 $59.00 Call
Dec 27 = $1.32 premium for a Dec. 30 $68.00 Call

The 4 FAS trades for the created a total premium of $9.92 for the month of December. On Dec. 05, a $67 call expiring on Dec. 30 sold for ~8.50. So selling weekly options on FAS did increase cashflow over selling a one month option on FAS. The 4 FAS trades for the created a total premium of $9.92 for the month of December.

But…
I started December’s cashflow trades with FAS shares at $67.53…these shares were not sold until my $59 calls were exercised on Dec. 23rd. ($59.00 – $67.53 = A loss of $8.53 per share = ouch!). I purchased more shares on Dec. 27 for $67.38. Selling those shares at the $68.00 strike price would have created a capital gain of $0.62 ($68.00-$67.38), and an overall capital loss for this set of FAS trades comes to -$7.91.

So…
The total premiums from my 4 FAS in December was $9.92. The total capital loss from my 4 FAS in December was ($7.91). The total net income from FAS in December (properly adjusted for commissions and fees) was $2.01. As mentioned earlier, on Dec. 05, a $67 FAS call expiring Dec. 30 sold for ~$8.50. Had I sold that Dec. 30th call option, I would have generated $8.50 in cashflow and lost $0.53 on the shares I purchased on Dec. 05 ($67.00 – $67.53).

Now, there was no way to know that FAS would end the year around $67. But I don’t need to add commissions and fees to see that trading COVERED CALLS each week created substantially less profit. But the exercise did find an error in tracking commissions. My formulas did not include commissions from buying and selling ETFs. I’m guessing that this is another artifact of my focus on cashflow and not capital gains.

Lesson Learned: Capital gains/losses from trading ETFs will need to be included in the cashflow analysis, including commissions and fees.

– and –

Lesson Learned: The higher premiums achieved from selling weekly COVERED CALL options are offset by capital losses due to price fluctuations in the underlying ETFs.

Why is covered calls in CAPS? Because of something in my August Cashflow report:

…having the ability to trade naked options is extremely important for capital preservation and loss avoidance (mentioned here).

And this post from August:

…in order to generate cashflow with a covered call strategy, I have to be in the market. I don’t have over 100,000 in my trading account, so I can’t trade naked options (brokerage rules). When I reach a 100,000 account balance, my strategy, money management and position sizing rules will be updated to take advantage of the new capabilities. If the market tanks, I can sell naked calls and just sit on the cash (effectively a covered call, just without owning an underlying position). In early August, I would have sold my shares, and sat on the options until they expired.

Lesson Learned: My current strategy and tactics involving covered calls cannot product sufficient income during medium to long term downtrends.

– and –

Lesson Learned: Creating income from investments requires different strategies at different times, and I will need to rely on more than covered calls to meet my goals.

Cashflow Report Revisited – Total Income During 2011 – Breakdown:

I updated my measurement system to account for capital gains and commissions properly, as well as any deposits or withdrawals from my account, and here is where I ended up for 2011. I also thought it would be valuable to revisit the ROI table.

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

Premiums = $17,592.51
Dividends = $398.88
Capital Gains/Losses = ($16,462.69)
Net Gain/Loss = $1,528.70

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

Premiums = $11,440.57
Dividends = $455.98
Capital Gains/Losses = ($11,927.28)
Net Gain/Loss = ($30.73)

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

Premiums = $2,130.82
Dividends = $49.90
Capital Gains/Losses = $62.65
Net Gain/Loss = $2,243.37

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

Premiums = $3,386.23
Dividends = $0.00
Capital Gains/Losses = ($5,506.34)
Net Gain/Loss = ($2,120.11)

ERX-Direxion Daily Energy Bull 3X Shares(ETF)

Premiums = $2,300.79
Dividends = $0.00
Capital Gains/Losses = ($1,896.97)
Net Gain/Loss = $403.82

CZM-Direxion Daily China Bull 3X Shares(ETF)

Premiums = $0.00
Dividends = $0.00
Capital Gains/Losses = ($26.24)
Net Gain/Loss = ($26.24)

Net Gain – 2011 = $1998.81

2011 Investing for Cashflow – Net Gains

*Adjusted ROI = (Cashflow+Captial Gains)/Capital Invested

Premiums Capital Gains Adj. ROI
Jan $2,279 ($830.30) 5.6%
Feb $2,879 $275.52 6.4%
Mar $3,154 ($2,791.86) 0.8%
Apr $3,488 $1,215.15 7.6%
May $3,037 ($866.70) 3.4%
Jun $3,556 ($4,390.80) -1.5%
Jul $4,025 ($2,736.18) 2.1%
Aug $4,452 ($16,796.41) -50.3%
Sept $0 $311.01 0.0%
Oct $3,168 ($2,048.09) 4.1%
Nov $3,934 ($5,442.53) -3.7%
Dec $3,774 ($1,655.68) 5.5%

2012 – The Year Ahead

I won’t know the federal/state tax impact until later this spring, but using a conservative estimate of 35% puts me at ~3% return last year. Better than a majority of the indexes, but no where close to my expectations 5-6% PER MONTH!

I think my monthly goals are still ok. The $3,600 income level is high enough for now, and removing $3,600 will force my hand in terms of capital gains awareness. That said, I need to alter my strategy and tactics to account for market trends (up, down, and sideways).

At the end of 2012, I would like to see more than 90% of my cashflow converted into useable dollars, rather than 90% going to towards offsetting capital losses. With my current strategy, selling covered calls into uptrends was the most robust tactic (i.e. created capital gains AND positive paper income). So I need better asset allocation in combination with some sort of trendfollowing indicator. I’m not sure if that means only invest in uptrending ETFs at this point, but without the ability to sell naked calls, my choices are limited.

And finally, my money management rules (personal and trading) need some work. Even though I wasn’t fully invested in August, losing 50% of the money I had in the market absolutely destroyed my profitability in 2011.

2011 Cashflow Reports

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About T. Knight
Blogging about my journey to financial independence via investing for cashflow.

6 Responses to Year End Cashflow Report – Paper Income during 2011

  1. InvestSafely says:

    Reblogged this on The Safe Investing Blog and commented:
    Here’s a great example of how to crush a yearly review.

    Good with the bad, and a list of things to improve next year…very much in line with my principles of investing.

    Way to go Troy. Check it out for yourself!

  2. June says:

    Your blog is a great learning tool for me!

  3. Daniel Milstein says:

    That is so true. As an author and business man, I can relate to how you said “it is a great baseline for investing performance and provides a good backdrop for my goals and any trading successes/failures encountered through the year”. I hope more people discover your blog because you really know what you’re talking about. Can’t wait to read more from you!

  4. Pingback: February Option Investing – Covered Calls « Investing for Cashflow

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