As I mentioned in my end of the year wrap up a couple of days ago I decided to increase the bond allocation in my accounts. I debated if I should do this now or wait longer and see if yield rise some more (meaning the prices of bonds drop more). I also thought about buying JNK which is a high yield bond ETF, but decided that although these are bonds in JNK the prices tend to move more in line with equities, so I’m not really getting much diversification that way. In the end I decided to stick with one of the ETFs I already had a small amount of, BND (Vanguard Total Bond Market ETF).
I bought 50 shares of BND at $79.9294 and paid $3,996.47. I did this in my TD Ameritrade account where I signed up for there commission-free trades on certain ETFs. BND is one of those, so I don’t pay commissions on it as long as I hold it for 60-90 days (I can’t remember exactly, but basically I can’t flip it). BND is down slightly from where I bought my first 25 shares, so I’m getting it a little cheaper this time. Including the dividends I’ve received since I first bought it I am close to break even on the little position. It’s yielding 3.47%, but is 3.7% below its recent high which means some of the expected/easy losses are gone already. Within the past two years it has been as low as $76.00 and tends to find support around there. I won’t be surprised to see it drift back down there, especially if stocks continue to push higher.
Before I made this trade I was thinking about how much this separate account doesn’t make much money and might continue to follow that path if bond prices keep dropping at about the same rate of dividends or quicker. That got me thinking of what else I could do to stoke the return a bit. I decided that if I sold some very far out-of-the-money puts I could increase my return without taking on excessive risk. I started this process before the trade above and used some of the proceeds to buy this much BND on top of the $3,500 deposit this week. While UWM (ProShares Ultra Russell 2000) was trading at $43.68 I sold two UWM January 2012 $30 naked puts for $4.00 and received $788.49 after commissions. This left me with $529.20 in cash in this account, but a possible move onto margin amount of $5,470.08. I don’t think there’s much of a chance I’ll be assigned these LEAPS, but just in case I know I’ll be adding more cash to the account over the next few months anyway.
The strike on this contract is almost $18 out-of-the-money. Including the premium I took in already (and put to work in part) I have a 40.8% cushion before I even get down to break even. UWM can fall 31.71% and I’ll still take a full profit. For UWM to fall that much the Russell 2000 would probably have to fall 13-14% and I don’t think that’s going to happen in the next 54 weeks. If it does it’ll force me to sell bonds and buy the ETF shares (if I don’t want to go on margin). That’s actually what I like about this trade. It’ll force me to reallocate money towards stocks after a severe correction, whenever that happens again. Notice I didn’t say “if that happens”, because we all know we’ll hit another very rough spot again eventually. If this trade works like I expect it to I’ll make an annualized gain of 14.7% on the money I should’ve had available prior to this trade if it was a non-margin account. I plan to add more OTM naked puts in this account if I see that it’s still going my way in a few weeks, but this trade alone increases my return potential in this account by 4.8%. If bond prices flatten out and I just get the dividend yield on my SHM and BND shares I’ll get a return of around 7.5% on my “safe” money.