End of the Month Summary – May 2014

May surprised me and I ended up with a better gain by month’s end than I expected.  At mid-month, I thought we were on pace to see a good correction finally.  Luckily, I didn’t panic and instead of dumping options while some of my positions moved in-the-money, I bought hedges on SPY and UWM and reduced my risk, but kept most of my upside potential.  The swing higher in stocks helped put me back on track to surpass my minimum goal of a 10% gain for the year.  My current pace is closer to 11.2% if I can maintain the same returns for the next seven months that I pulled out for the first five months.  I’d like to hit 15% for the year, but not if I have to take big risks to get there.

I ended May with a Net Liquidation Value (NLV) of $104,672.19 and a Net Asset Value (NAV) of $104,677.92 according to Interactive Brokers (IB) after finishing April with an NLV of $103,233.51.  That gave me a gain of $1,438.68 (~1.39%) on paper for May and a realized gain for the month of $883.22 on three closing trades.  I received no dividends in May since I still don’t own shares of any stocks or ETFs.  Quicken reported that I have $104,677.92, in line with IB’s reported NAV, but only after I added a $0.02 deposit to reconcile the difference from whatever rounding error Quicken didn’t catch from Interactive Brokers.

It’s not really a terrible market for selling options.  Volatility is low, so the premiums aren’t very good, but the sideways movement in most indexes allows option sellers to profit on the low dips and short lived runs higher.  Eventually, one side will crack and we’ll see a much quicker 5-10% move in one direction or the other.  In the meantime, I’ve pulled ahead of all major stock indexes for the year-to-date, except for the S&P 500.  I’m also ahead of all the stock indexes for the past 12 months, except for the NASDAQ.  By both measures, I’m only trailing by a small amount.  My diversification helped me stay above the majority of the indexes, but kept me from beating every one since I didn’t push the envelope too far in any single sector.

For the next seven months, I’ll need to put more money at risk if I want better returns.  If all of my naked puts were assigned, I would be 91.47% invested in this account.  This is 13.14 percentage points higher than how I closed out April and doesn’t factor in the $5,685 I have protected from losses if a black swan event sends prices plummeting.  Since I do have the two hedges in place, I need to sell more puts, even if they are out of the money.  I’m of the same mindset as I was last month – I don’t see a lot of upside or downside risk in the near-term.  A lot of data is due out this week.  I’m planning to add more exposure when I have a better idea of how the data is going to affect stock prices.

XLF remains my only naked put position that is in-the-money.  The good news is that it has moved to a paper profit since the end of last month and only has a few weeks to go before the options expire.  I’ve been debating closing the position early.  I’ll probably roll the expiration out to July or August to keep the potential gains big while I add to my downside protection.  It’s too early to make the trade today, because the puts are so deep-in-the-money that there isn’t a huge difference in time value between the months.  That spread will get bigger if XLF draws in closer to my strike as time value on the June contracts erodes.

My only other option set to expire in a few weeks is on MDY.  This June $245 put is my only mid-cap exposure and I have no intention of abandoning the ETF yet.  Instead, I’ll probably enter a limit order to roll the contract up to $250 and maybe out to July or September.  August contracts aren’t available yet.  If we get some good macro-economic data soon, I’ll have to give the $255 strike some serious consideration.

This is my asset allocation in my IB account as of the end of May:

• Large-cap ETF: 18.15%*
• Mid-Cap ETFs: 23.41%
• Small-Cap ETF: 28.09%*
• International: 8.41%
• Oil: 0.0%
• Individual Stocks & Other Sector ETFs: 14.47%
• Bonds: 0.0%
• Short ETFs: 0.0%

* Does not include put spread hedges on SPY and UWM.

These are my returns according to Quicken through May 30, 2014:

• YTD Return: +4.65%
• 1 Year Return: +20.89%
• Average Annual (not cumulative) Return since November 18, 2009 (when I opened my IB account): +8.14%

According to Morningstar, here’s how I compare to the major indexes (including dividends) through the month’s last trading day, May 30, 2014:

• Dow Jones Return: YTD change +1.92%, 1 year change +13.27%
• S&P 500 Return: YTD change +4.97%, 1 year change +20.45%
• NASDAQ Composite Return: YTD change +1.58%, 1 year change +22.76%
• Russell 2000: YTD change -2.02%, 1 year change +16.79%
• S&P Midcap 400: YTD change +3.23%, 1 year change +18.04%

The VIX ended the month at 11.40 and the VXN ended at 13.77.  Both readings are well below the levels seen at the end of April and show an extreme lack of volatility.  Sometimes low volatility can mean complacency has taken over and stocks are set to tank soon, but the VIX can stay low for years before stocks roll over.  The bonus is that buying hedges can be cheap while the market trolls through this wake-free zone.

Maybe a better indicator than the VIX is CBOE SKEW Index, which finished May at 124.23.  In a Business Insider interview I read, Barron’s Steve Sears says, “SKEW measures the pricing differences between puts and calls. Now the implied volatility is essentially the probability that the stock will rise or fall. And to figure out if it will fall, you would look it at put options, and if you see that the implied volatility is saying 85% for the put but 20% for the call, what you’ve just learned is that the most sophisticated stock investors think something bad is going to happen and you could use that decision to combat chaos.”  The 124 range is not signally chaos is about to hit.  The CBOE has charts available to show the difference between SKEW and VIX and how they predict or react to major market movements.  Check it out to learn more and I’ll plan to include a SKEW update each month from now on.