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  1. The Ground Rules
  2. A Model Portfolio
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This chapter is from the book

A Model Portfolio

In the examples in the following chapters, these five underlying assumptions demonstrate how options work within the conservative framework. These criteria are applied to a model portfolio of ten stocks in various combinations throughout. This helps tie together the various examples and range of possible outcomes. This model portfolio is by no means a recommendation of stocks you should own; it was selected to include stocks with some common attributes. These stocks have increased dividends every year for the past seven to ten years (or more) and have reported low volatility in trading. Dividend yields are higher than average, between 2.7% and 5.3%. Some issues have exhibited rising market value in recent years. All these stocks have available both listed options and long-term options (LEAPS), enabling you to look at a variety of scenarios for each conservative strategy. Analysis includes a study of options expiring in 1, 2, 4, and 16 months.

Employing a single portfolio throughout the book is helpful in another way. Not every strategy works well for each stock in the model portfolio, so you can walk through the selection process to demonstrate how a particular strategic decision is made. Although your portfolio might contain a number of excellent value investments, some strategies simply do not work at all times or in all cases. You can compare the different potentials for strategies across a range of stocks by following the model portfolio throughout the explanations in each chapter.

The values of each stock, current bid, and ask value of every option in this book are based on the last traded closing prices reported by the Chicago Board of Exchange (CBOE) on September 25, 2013. Table 1-1 summarizes this model portfolio. The portfolio’s overall value is estimated at $1 million, split as equally as possible among the ten stocks.

Table 1-1 Model Portfolio

Stock Name

Trading Symbol

Closing Price*

Shares Held

Total Value

%

Kimberly Clark

KMB

$94.69

1,100

$104,159

10.4%

Coca-Cola

KO

38.33

2,600

99,658

10.0

McDonald’s

MCD

97.60

1,000

97,600

9.7

Microsoft

MSFT

32.51

3,100

100,781

10.1

Occidental Petroleum

OXY

92.91

1,100

102,201

10.2

Reynolds Aluminum

RAI

49.09

2,000

98,180

9.8

Southern Company

SO

41.72

2,400

100,128

10.0

AT&T

T

34.05

2,900

98,745

9.9

Target

TGT

63.24

1,600

101,184

10.1

Verizon

VZ

46.95

2,100

98,595

9.8

Total

$1,001,231

100.0%

* Closing prices as of September 25, 2013

This portfolio is split equally among the ten issues, a modest but effective level of diversification. An individual portfolio would likely select an entirely different list of stocks, perhaps more than ten, and perhaps split in a different manner. This is only one example of how a $1 million portfolio might be diversified among ten value investments (value, in this sense, is defined as having a consistent record of increasing dividends, higher than average dividend yield, a medium level of debt ratio, and a preference for increasing revenues and earnings).

This raises a question every portfolio manager faces: Is this a “conservative” portfolio? That is a matter of opinion and one that depends on the timing of purchase, long-term goals, and your opinion about the fundamentals for each corporation. These ten stocks provide a cross-section of stocks that illustrate where strategies work well and where they do not work at all. The actual definition of a conservative portfolio is (and should be) always evolving based on changes in the market, in a stock’s market price and volatility, and, of course, in emerging information concerning fundamental strength or weakness of a particular company.

Is this information outdated? The data gathered on the closing date of September 25, 2013, is dated, but it would be impossible to perpetually update ten stocks and still meet the publication date of this book. However, all the information is relative. The values of options for a particular stock will probably be consistent from one period to the next, assuming that the proximity between closing price and option strike price is about the same and that months to go until expiration are the same as well. Although these relationships can and do vary based on ever-changing perceptions about a particular company, the data is valid for the purpose of illustrating strategies. The use of some measurement in time is necessary, and all these stocks were selected and summarized on the same date. Given all these qualifications, these closing prices (and the options values used in this book) are fair and reasonable. Thousands of stocks have options available to trade, and this translates into many choices for conservative investors.

Throughout this book, the ten portfolio companies compare options trades for a series of different strikes and expiration dates. The purpose of using so many different versions of an options trade is to accommodate many different strategies employing calls or puts (or both); in-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM) options; and a variety of expiration dates. The following chart summarizes the strikes and expirations for each.

Option Premium

Trading Symbol

Strikes

Closing Price

1 Month (24 Days)

2 Months (52 Days)

4 Months (115 Days)

16 Months (479 Days)

KMB

$94.69

C

85

8.70

11.50

9.90

13.90

90

5.80

5.80

6.90

9.90

95

1.30

2.35

3.40

7.80

100

0.16

0.60

1.29

4.80

105

0.03

0.25

0.45

3.30

P

85

0.09

0.26

0.90

5.12

90

0.25

0.90

1.90

7.21

95

1.55

2.55

3.40

9.70

100

3.46

5.20

6.16

12.30

105

8.50

10.60

11.50

15.60

KO

$38.33

C

36

2.65

2.83

37

1.60

1.84

38

0.88

1.15

39

0.37

0.62

40

0.13

0.32

0.67

2.20

P

36

0.09

0.23

37

0.20

0.41

38

0.49

0.75

39

0.97

1.23

40

1.72

1.65

2.47

4.71

MCD

$97.60

C

92.50

5.40

5.85

6.30

8.85

95

3.00

3.95

4.26

6.91

97.50

1.28

2.10

2.70

6.10

100

0.30

1.03

1.75

5.00

105

0.02

0.16

0.52

3.20

P

92.50

0.14

0.53

1.39

6.25

95

0.35

1.01

2.16

7.45

97.50

1.02

1.89

3.25

9.00

100

2.70

3.19

4.70

10.50

105

7.95

8.30

8.00

13.65

MSFT

$32.51

C

30

2.64

2.86

3.00

4.39

31

1.76

2.02

2.42

32

0.97

1.38

1.75

3.30

33

0.43

0.87

1.25

35

0.08

0.28

0.58

2.10

P

30

0.07

0.27

0.70

2.76

31

0.17

0.49

1.00

32

0.42

0.84

1.45

3.78

33

0.90

1.31

1.89

35

2.51

2.70

3.40

5.70

OXY

$92.91

C

87.50

5.80

6.70

7.70

12.10

90

3.65

4.90

6.00

10.39

92.50

2.05

3.40

4.51

9.38

95

0.95

2.15

3.20

8.05

97.50

0.41

1.30

2.34

5.83

P

87.50

0.34

1.08

2.48

8.70

90

0.76

1.82

3.30

9.90

92.50

1.59

2.65

4.30

11.35

95

2.90

3.95

5.80

13.05

97.50

5.00

6.55

7.25

14.80

RAI

$49.09

C

47

1.65

3.90

3.40

4.91

48

1.55

1.92

1.75

49

1.13

1.30

1.68

50

0.35

0.80

1.25

3.30

52.50

0.05

0.42

P

47

0.15

0.51

1.20

5.72

48

0.35

0.85

1.65

49

0.55

1.20

2.15

50

1.08

1.50

2.20

5.70

52.50

3.22

6.17

SO

$41.72

C

40

1.94

2.23

2.85

3.45

41

1.09

1.26

1.79

42

0.45

0.67

1.11

43

0.12

0.28

0.63

1.90

44

0.05

0.12

0.37

P

40

0.10

0.41

0.75

3.24

41

0.27

0.73

1.15

42

0.65

1.22

1.56

43

1.21

1.92

1.95

4.89

44

1.82

2.46

2.85

T

$34.05

C

32

2.01

2.15

2.28

33

1.15

1.28

1.56

2.50

34

0.42

0.64

0.98

35

0.10

0.28

0.58

1.60

36

0.02

0.11

0.31

P

32

0.11

0.29

0.72

33

0.28

0.56

1.02

3.50

34

0.72

0.97

1.49

35

1.43

1.59

2.25

4.75

36

2.33

2.45

3.02

TGT

$63.24

C

60

3.40

3.70

4.10

6.70

62.50

1.78

2.20

2.94

5.90

65

0.39

0.90

1.61

5.26

67.50

0.07

0.30

0.82

4.10

70

0.02

0.14

0.39

2.55

P

60

0.25

0.53

1.35

5.00

62.50

0.74

1.17

2.22

6.00

65

2.05

2.56

3.45

7.60

67.50

4.13

4.55

5.10

9.30

70

6.55

7.50

7.22

10.59

VZ

$46.95

C

45

2.14

2.50

2.66

4.40

46

1.28

1.55

2.09

47

0.68

0.98

1.54

3.25

48

0.30

0.59

1.81

49

0.12

0.34

0.75

P

45

0.42

0.75

1.56

4.88

46

0.72

1.12

1.98

47

1.28

1.60

2.45

6.10

48

1.93

2.29

2.89

49

2.74

2.94

3.21

The wide range of premium values is affected by both time remaining until expiration and the proximity between the strike and the current underlying stock’s price. All these values are fixed in time as of the close of business on September 25, 2013, so that comparisons among any of the ten are valid. However, even though these premium levels and stock prices are outdated, the relative values, given specific time and proximity, are accurate and apply in any period.

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