Assembling a Covered Call Portfolio on Dividend-Paying Stocks

Posted on June 18, 2014 | AAII Journal

Covered call writing is one of several ways options are traded.

While often done on an ad hoc basis, one can assemble and manage a portfolio of covered call option positions as either a part of a larger portfolio or on a stand-alone basis. Such an approach does require more detailed attention than managing a stock-only portfolio. Nonetheless, systematically managing a portfolio of covered calls has much for me to recommend it.

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Peculiar Facts From 500 Years of Finance

Posted on May 30, 2014 | AAII Journal
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Lesser-known but notable events that not only have led us to the present day, but also had an impact beyond the financial markets.

If you are like most people, you learned history in classes that largely covered facts related to dates, places, and people…and you probably couldn’t wait until the school bell rang.

Sadly, children’s exposure to history is often framed in a way that is less interesting and engaging than it could be, and it robs students of a curiosity about the past that could benefit their own future by understanding the richness of the human experience.

When it comes to the intersection of the financial markets and human history, there is a kaleidoscope of tales drawn from centuries of market mischief, mishaps and mayhem. This article reveals a few less-known but notable events drawn from the past half-millennium that might pique your own interest in the rivers of time that have led us to the present day.

You are probably acquainted with the fabled “tulipmania” that gripped Holland during the early 1600s. What most people don’t know is that two viruses played central roles in this drama.

The tulip bulbs themselves were classified into three groups: the single-colored, the multi-colored, and the “bizarres.” This last category is most important, as bizarres were the rarest and most sought-after tulip. The reason these unusual flowers came about was due to a virus that interfered with the plant’s ability to create a uniform color on the petal. It is today known as a “breaking” virus, since it breaks the plant’s lock on a single petal color without killing the plant. The effect on the flower was striking, producing mosaic-like flames of color on each petal. Of course, the Dutch of the time knew nothing of such things; they merely took a strong liking to these rare and unusual flowers.

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Relative Portfolio Returns Influence Happiness

Posted on May 29, 2014 | AAII Journal

How a portfolio performs relative to your expectations may impact how happy or unhappy you will be.

Whether an investor is happy or unhappy with his performance is significantly influenced by how his portfolio performs relative to the market. Investors are likely to be happy even if they lose money as long as their portfolio declines by a smaller magnitude than the broad market. Conversely, the proportion of investors likely to be unhappy rises during periods of strong market returns.

This conclusion is based on a study of British individual investors. Over 600 self-directed investors at Barclays Stockbrokers were surveyed during the period of September 2008 through September 2010. Respondents had a median age of 53 and median wealth of approximately $252,000. Answers were compared against actual returns.

The average threshold for anticipated happiness was a three-month gain of 5.4%. The average threshold for anticipated unhappiness was a three-month decline of 0.2%. Expectations for the level of returns that would lead to happiness did not alter much after the initial quarterly survey period, even though the FTSE All-Share Index (benchmark for the UK equity market) rebounded strongly from the financial crisis. Individual thresholds varied greatly; some respondents were happy even with a modestly negative return, while others required returns in excess of 20%. A strong positive relationship existed between return expectations and the minimum return an investor would be happy with.

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10-K Filing Size Impacts Volatility

Posted on May 27, 2014 | AAII Journal

The size of a 10-K report, an annual filing required from public companies by the Securities & Exchange Commission SEC, is correlated with a stock’s price volatility. Stocks of companies with larger 10-K file sizes experience more price volatility in the period immediately following the filing date. These stocks also experience larger earnings surprises and have a greater dispersion of forecasts by the covering analysts.

These were the conclusions reached by two University of Notre Dame professors, Tim Loughran and Bill McDonald, in a forthcoming Journal of Finance paper. The two professors proposed replacing The Fog Index, a commonly used measure, with file size as a gauge for determining how readable a 10-K filing is. The professors believe the goal of readability should be “the effective communication of valuation-relevant information, whether it is directly interpreted by individual investors or assimilated and distributed by professional analysts.”

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Do’s and Don’ts of IRA Investing

Posted on May 23, 2014 | AAII Journal

Investor-Update
Individual retirement arrangements (IRAs) are supposed to be simple and flexible investment vehicles, but their investment rules are more complicated and restrictive than many investors realize.

When you invest only in publicly traded stocks, bonds and mutual funds, there are no special issues. However, the tax law prohibits or penalizes some other investments by IRAs. Though part of the law for a long time, these pitfalls are becoming more important as the investment options available to mainstream investors increase and as investors are attracted more to “hard assets” and other non-traditional investments.

The restrictions on IRA investments are not well-known and, as a result, investors often stumble into penalties or other problems. The most common mistake is using a retirement account to hold an investment that falls under one of three categories: prohibited investments, taxable investments and transactions, and prohibited transactions.

The prohibited investment rules apply to IRAs and also to other self-directed accounts, such as 401(k)s. The main category of prohibited investments is “collectibles” as defined in Section 408(m) of the Internal Revenue Code.

When an IRA acquires a collectible, the amount used for the acquisition is treated as a distribution to the IRA owner. It does not matter whether the collectible is held or eventually sold.

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ETFs and ETNs: Knowing What You Own

Posted on May 20, 2014 | AAII Journal

The liquidity composition of a fund’s underlying assets, the historical tracking error and fees are important characteristics to consider when investing in an ETF.

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Researching Adviser Fees Gets Easier

Posted on May 16, 2014 | AAII Journal

The U.S. Securities and Exchange Commission (SEC) has made it easier for investors to look up and compare financial adviser fees and policies. The Form ADV Part II Brochure now discloses information that advisers previously did not have to include in regulatory filings.

Perhaps the most notable information is the disclosure of fees. Clear information is provided on what the firm charges and what is required for clients to qualify for discounted fees. (Most typically, certain minimum dollar amount thresholds must be exceeded.) Also included is information on investment strategies, research methods, disciplinary actions, and whether the adviser receives commissions.

Though the filings are open to the public, accessing them at the SEC website is not straightforward. These instructions from SmartMoney.com should get you to them…

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The Danger of Getting Out of Stocks During Bear Markets

Posted on May 13, 2014 | AAII Journal, AAII.com

One of the biggest risks to investors’ net worth is the portfolio decisions they make.

Failing to adhere to an appropriate long-term strategy has a significant damaging impact on wealth. Since wealth is generated from the compounding of returns, actions that severely reduce an investor’s portfolio balance can have a long-term impact.

A common dangerous action is panicking and pulling out of stocks during a bear market. Such an action limits the immediate damage to a portfolio, but can cause an investor to miss out on the big rebound that follows a large drop by not jumping back into stocks soon enough. Even being out of the market for just one or two years can cause a considerable amount of wealth to be forfeited.

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Confusion About Retirement Income Taxes

Posted on May 12, 2014 | AAII Journal

Many middle-income Americans age 50 and over do not understand the tax rules regarding retirement savings, according to a Banker’s Life Center for a Secure Retirement survey. While 94% of respondents could correctly explain how lottery winnings are taxed, only 29% could explain the tax rules for 401(k) plans.

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Reduce Stock Exposure in Retirement, or Gradually Increase It?

Posted on May 1, 2014 | AAII Journal

For the past 20 years—due to the growing research on safe withdrawal rates, the adoption of Monte Carlo analysis (a method of considering many simulations), and just a difficult period of market returns—there has been an increasing awareness of the importance and impact of market volatility on a retiree’s portfolio.

Dubbed “sequence of return” risk, retirees are cautioned that they must either spend conservatively, buy guarantees (e.g., annuities), or otherwise manage their investments to help mitigate the danger of a sharp downturn in the early years.

One popular way to manage the concern of sequence risk is through so-called “bucket strategies” that break parts of the portfolio into pools of money to handle specific goals or time horizons. For instance, a pool of cash might cover spending for the next three years, an account full of bonds could handle the subsequent five-to-seven years, and equities would only be needed for spending more than a decade away. This “ensures” that no withdrawals will need to occur from the equity allocation if there is an early market decline.

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