Reminder: Craigzooka is available to chat with Members regarding his virtual portfolio performance, comments are found below each post.
By Craigzooka
I am going to share with you how I manage my IRA and the power of reducing your cost basis. My goal each year is a 20% return in my IRA. Sometimes I make it and sometimes I don't, but I believe that all of my success is due to reducing my cost basis. To illustrate the power of reducing your cost basis here are some trades we did last year. These trades are taken from an educational portfolio we ran in a paper-trading account for a little more than a year.
- We bought RIG on 5/15/2012 for $44.13, sold it on 1/18/2013 for $46 but booked a profit of $1,154.
- We bought MT on 1/4/2012 for $19.24, sold it on 12/21/2012 for $15 but booked a profit of $454.
- We bought CHK on 1/27/2012 for $21.93, sold it on 10/19/2012 for $18 but booked a profit of $800.50.
We were able to lower our cost basis so much by selling calls and occasionally buying additional stock to lower the basis. We did this mechanically without thinking about market conditions. I think we can do better. For the foreseeable future I am going to paper trade a 100k portfolio using IRA margin rules and track it using a TOS paper trading account. I am going to detail the strategy below.
Position Sizing
We don't want one single position to take down the whole portfolio so we are going to risk a maximum of 10k to each stock. Unless there is a once in a lifetime opportunity, we will not spend more than 10k of cash on any one stock.
Position Entry
We hope to eventually own stock but while we wait lets have someone pay us not to own it. We will enter positions by selling a put spread. Should we be put the stock we want it to take up less than 5k of cash, so don't sell too many put spreads to begin with!
Managing Put Spreads
So a put spread we sold is now in the money. Fantastic! We wanted to buy the stock cheaper and now they are giving us a chance. So let them put us the shares and we will begin selling calls against the stock we just acquired. If a put spread expires worthless then great!! They paid us not to buy the stock. We will continue to sell new put spreads under the condition that if put the stock it will lower our cost basis. If the stock runs up to far to sell a put spread which will lower our basis then we wave goodbye and wait until it goes on sale again.
Managing Stock Positions
Now we have been put stock and need to manage it. Every month we will sell both a put spread and a call against it under the condition that if the stock were to shoot upward and be called away we could still book a profit.
Example
Let me walk you through an example of what we would have done in CLF over the last couple of months.
On February 13th CLF would have gotten interesting because it had a huge drop and a volatility spike. We would have evaluated the company using all the resources on PhilStockWorld and determined they were still a good company. So now we begin scaling into our 10k allocation. We would sell the 29-24 put spread in March for a credit of $130. This would put our cost basis on 100 shares at $27.30 or StockPrice+$3.70, whichever is lower.
Fast forward to March 15th, options expiration. CLF is trading at $21.97. We close out the put spread for a $500 debit. We buy 100 shares of CLF at $21.97 for $2197 debit. We now own 100 shares with a cost basis of $2197+$500-$130=$2567 or $25.67 per share. We sell the 21-16 put spread for a credit of $84. Our cost basis is now $2567-$84=$2483 or $24.83 per share. We also sell the $25 calls for $48. Our cost basis is now $2483-$48=$2435 or $24.35 per share.
Fast forward to April 19. CLF is trading at $17.67. We would have closed out the put spread and bought an additional 100 shares at 17.67 for a $1767+$333=$2100 debit. Our cost basis is now $2435+$2100=$4535 or $22.67 per share. We sell the two of the 17-12 put spreads for a $218 credit. Our cost basis is now $4535-$218=$4317 or $21.58 per share. Looking at the 22 calls in may we would only collect $25 per contract. However, the 22 calls in June allow us to collect $55 per contract. So we would sell the two of the 22 calls in June for a credit of $110. Our cost basis is now $4317-$110=$4207 or $21.03 per share.
Fast forward to the 15th of May and CLF is trading at 21 and we can close out our May put spreads and look at selling June put spreads collecting another $180 and having the trade flip positive.
Conclusion
On the day we initiated the trade CLF was trading at almost $30. Less than 3 months later our cost basis is $21.03 and continuing to head down. We are sitting on a stress free profitable trade that we can continue to sell premium against reducing our cost basis even further. If the worst we do is fill our portfolio with trades like these then we will be well on our way to achieving our goal of a 20% annual return in our IRA. Feel free to ask any questions in the comments below.
