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Model Portfolio - Industrials Sector
I allocated 5% of the income generation of the overall portfolio to Industrials. I have decided to only use one company in this sector, Russel Metals. This is a company that I wouldn't even be aware of if it wasn't in the XDV ETF. This company makes metal products (plates, tubes, structural steel, etc) for industry. Recently they have been quite well as a result of strong sales of tubular steel used in the energy sector. This company has a strong history of raising dividends.
Currently Russel is paying a dividend of $1.60 per share per year. Since I have allocated 5% of the total income of the portfolio to this sector the income requirement is $175/year. So 110 shares (rounded up to the nearest share) of Russel Metals will give us the necessary income ($176 pre year actually).
Russel Metals: 110 shares ($1.60*110 = $176)
In my next post on the Model Portfolio I will discuss the Health Care sector.
Disclaimer: This model portfolio is intended for illustrative purposes only and should not be used as a guide for building your own portfolio. Before making any investment decisions you should do your own homework and consult with the appropriate financial professionals. I am not a financial professional.
Considering An Options Strategy
I'm a little nervous. With the recent tear-down of almost the whole income trust sector by our lovely Conservative (minority) government (hopefully the November 23 fiscal update will actually provide a little clarity on the issue and maybe even a little bit of back peddling) there has been a shift of cash flowing in the market. There has been a move away from income trusts and a move into other income producing stocks, and a lot of the cash seems to be going into financials. This is good for the overall value of our portfolio (which is currently at an all-time high, up about 1% from October 31) but it makes me slightly nervous.
Most of the banks (we hold Royal Bank, Bank of Montreal and Bank of Nova Scotia) have been hitting 52 week highs in the last two weeks. Royal Bank in particular has been making some pretty impressive gains, up from around 49.50 on October 31 to yesterday's close of 53.46 an 8% gain in a little more than two weeks. Not including dividends Royal Bank is up ust over 17% this year (it started the year at 45.40, split adjusted). That is spectacular for a bank. This is what makes me nervous.
At the beginning of the year I set up goals for the stocks we have in our portfolio. The goals were simply based on a 8%-10% return depending on the stock. My target price for Royal Bank at the beginning of the year was 49.26. It is now 8.5% above that. So if I expect the stock to retreat a little bit but I don't want to sell the shares I have what can I do to protect my gains?
Options will allow me to protect my gains. There are two kinds of options, puts and calls. The owner of a put option has the right to sell a stock at a specified price, the strike price, within a specified time period between when the option was bought and the expiry date of the option (which is the third Friday of the month that the option is for). The owner of a call option has the right to buy a stock at a specified price. An investor can either buy or sell (also known as writing) a call so there are a total of 4 positions you can have in an option. You can write a put which means you have agreed to accept a stock for the strike price in exchange for cash today. You can buy a put which allows you to sell a stock to some one at the strike price. You can write a call which means you agree to sell a stock at the strike price. Finally you can buy a call which allows you to buy a stock at the strike price.
So how can I protect my gains? Let's look at Royal Bank. I would like to finish the year with Royal Bank at just over $49. I can buy a put option for Royal Bank that expires in January, 2007 with a strike price of $50. So if between now and the third Friday of January the stock price of Royal Bank drops to $49 I could sell the stocks that I have (by exercising my options) to some one for $50. But I don't have to sell the stocks. In fact I don't want to sell the stocks because I am sitting on gain of just over 50% on them and (since they are in my non-registered account) I don't want to have to pay capital gains tax on the stock. I could just sell the options which will be valued based on how far away from $50 the actual stock is trading. If the stock continues to go the options expire worthless and I lose the money I paid for them.
As of yesterday Royal Bank $50 Jan 07 Puts were trading at about 25 cents per option. You can only buy an option 'contract' which is for 100 options (one option per stock). So excluding commissions (which are usually something like $30 + about $2 per contract) for $25 I can limit my downside on 100 shares to about $400. The April 2007 $50 Puts are trading at about 80 cents so I could buy an extra 4 months of 'protection' for about $55 per 100 shares.
I think my assumptions an calculations here are correct but I'm not totally sure. This is something that I am considering doing but I haven't done a complete evaluation yet. If anyone reads this and sees any problems with my reasoning please leave a comment (which are moderated by me and it might take me a day or two to approve) or send me an email, 0xcc at this domain (which I check more often than the comments)...
Lest We Forget
In Flanders fields the poppies blow
Between the crosses, row on row,
That mark our place: and in the sky
The larks, still bravely singing, fly
Scare heard amid the guns below
We are the Dead. Short days ago
We lived, felt dawn, saw sunset glow,
Loved, and were loved, and now we lie
In Flanders fields.
Take up our quarrelt with the foe:
To you from failing hands we throw
The torch; be yours to hold it high.
If ye break faith with us who die
We shall not sleep,
Though poppies grow
In Flanders fields.
In Flanders Fields, by John McCrae.
The first world war, the war to end all wars ended today in 1918 with the signing of the Armistice. The eleventh hour of the eleventh day of the eleventh month.
Today we honour those that served, those that are serving, and those that gave the ultimate sacrifice for our freedom. This year has been a very difficult year for Canadians serving over seas, most notably in Afghanistan. Today our thoughts are with all the families that have lost loved ones in any conflict.
posted on Saturday November 11, 2006 at 11:00:00
Although the majority of the trusts in our portfolio are lower than they were a week ago, other stocks have been moving up nicely in the last couple of trading days. Our portfolio at the market close last night is about $100 higher than is was at the close on October 31, the day that the Conservatives announced that they couldn't possibly keep their election promise and not change the taxes on income trusts. A couple of the power trusts had a very nice day yesterday but they haven't totally recovered. It looks like Canadian Oil Sands has almost totally recovered after a nice 6% increase yesterday, putting my total gain so far on COS.UN at just over 22%.
Now keeping in mind that the income generated by our holdings isn't going to change for at least 4 years this broken promise doesn't appear to be all that bad. What remains to be seen though is what will happen if these changes get passed and then what will happen as we get closer to the 2011 implementation of the changes. It will be an interesting time around then. We are planning to be mortgage free in September 2010 so if we are both still working full-time in 2011 we should have a good chunk of extra cash to be putting into our portfolio. It will be interesting to see if income trusts will make sense then.
Surveying The Damage
Unfortunately, I was right. Last Wednesday did hurt. My guess of a 3%-5% decline in our portfolio was maybe a little bit pessimistic, our portfolio shrank 3.4%. I think that is the biggest, single day decline we have seen in our portfolio since I started managing our own portfolio in late 2003. Actually, I just went back and checked and on June 13, 2006 we had a 3.7% decline but since our portfolio has grown a lot since then the dollar amount of that decline was only about 75% of what we saw on Wednesday last week.
There are actually a few good things that came out of the income trust tax announcement last week. First, I was able to pick up another trust, Canadian Oil Sands trust, for what I consider a very good price, $24.50. I am up around 15% already (it closed on Friday at 28.28) on that but I bought it for the long term so I am going to be holding on to it for awhile. Another good thing is that the market in general seemed to over react to the announcement and recovered a bit on Thursday and Friday. The sector that seemed to benefit the most from the income trust shock was the financial sector, which we have just under 30% of our portfolio in. Another good thing that came out of this is the eventual change of treatment of income from income trusts. We have about half of our income trusts outside a registered account and the changes that are proposed to take place in 2011 will mean that the after tax income we get from these trusts will either stay the same or go up slightly.
Finally, our portfolio has actually almost completely recovered from Wednesday's move, now down about 1.1% from Tuesday's close. If the financial sector can continue the move it has been having (a lot of stocks are getting close to or exceeding 52 week highs) and if the really beaten up trusts can recover slightly our portfolio should be in pretty good shape. Also, I have to keep in mind that the goal of our portfolio is not necessarily capital appreciation but is income growth. So as long as the after-tax income generated by our portfolio is growing, then we are doing something right.
Today Is Going To Hurt
I don't know what the longer-term impact is going to be but last night the federal government here in Canada announced that it is going to change the rules on most income trusts. This is going to cause a big sell-off in income trusts today as I suspect that a lot of investors are going to sell first and then wait until they can figure out what this will mean in the long term.
Here is the Globe and Mail's article on this.
Here is the Toronto Star's article.
And finally, the National Post's article.
Our combined portfolio is about 25% income trusts. I expect that today we are going to lose about 3%-5% of our portfolio's value. I can see already that the bid and ask on some of the trusts we own are about 30% below yesterday's close.
I don't see how this isn't going to become an election issue for the Conservatives. I just hope they counter this bad news for the markets with some good news for investors related to their capital gains exemption promised in the last election.