OK heirs, for the most reliable return and with reasonably low risk the existing portfolio of stocks should be liquidated whenever obligations related to options contracts sold on those positions have been satisfied either through expiration or assignment.
The current portfolio strategy requires lots of trading and lots of maintenance and is designed to evolve into one that requires neither of those two.
Instead of making 2000+ trades each year and constantly on the prowl for new positions, the strategy that I would like to have implemented might require 10-20 trades each year and potential replacement from a list of pre-selected blue chip companies.
Once liquidation of those stock positions occurs the assets should be reinvested according to the portfolio guidance that I laid out in the spreadsheet. That lists stocks to buy and in what quantity, based upon the value of the portfolio at the time of liquidation and the then current prices for the proposed new stock positions. Instructions for the use of the spreadsheet are included in the spreadsheet. Basically, all that needs to be done is to enter the current stock price of the various stocks listed and to link that file to another file, as directed.
As of April 2021 those proposed stocks, their ticker symbols and their relative portions of the portfolio are:
INDUSTRIALS: 3M (MMM 7%) and Dow Chemical*(DOW 5%)
TECHNOLOGY: Cisco* (CSCO 4%), IBM (IBM 5%) and Intel* (INTC 5%)
CONSUMER: Coca Cola (KO 6%), McDonalds (MCD 8%) and Proctor and Gamble* (PG 10%)
COMMUNICATION: Verizon (VZ 4%)
ENERGY: Exxon (XOM 5%) and Chevron (CVX 8%)
RETAIL: Home Depot (HD 10%) and Wal-Mart* (WMT 8%)
FINANCE: JP Morgan* (JPM 9%)
HEALTH CARE: Merck (MRK 4%) and Walgreens* (WBA 3%)
There is nothing sacred about any of these stocks, nor their relative proportions in the portfolio. All of these stocks are Blue Chip Dow Jones components and pay relatively high and safe quarterly dividends. Currently, the weighted dividend yield is about 3.3% which means that for every $10,000 invested there will be $330 of annual dividends deposited into the account on a quarterly basis.
A portfolio comprised of those stocks will require far less maintenance and trading than the current portfolio and would be well suited to a “buy and hold” approach, but perhaps with an added twist of boosting income through the occasional hedging strategy of selling long term dated call options.
At any moment in time the market may be depressed or expensive or a given sector may be out of favor or booming. Because that may be the case there may be reason to not invest all of the funds at once or to wait until relatively expensive stocks may become more reasonably priced.
In this example, you can see the price history of Verizon stock over the course of the previous year:
The current price is about $4.50 per share higher than its lowest price over the past year and about $4.20 lower than its highest price of the past year. That is often a good level to consider buying shares.
I recommend, in order to generate greater revenue, but without the need for significant efforts to maintain the portfolio that long term call options (LEAPS) be sold on each of the positions. Ideally a one year option would be sold each January for the next January. However, if the portfolio is re-invested in these new positions in June, August or any other time, the options sold should be for the very next January. Then, if those expire new one year options can then be sold.
I recommend selling options with strike prices (the price that you would be paid if the shares are transferred to the holder of the option contract you sold) that is 10% above the price of the shares on the date of sale.
For example, if Verizon is trading at $57.65 per share, I would recommend selling $62.50 options. The price is generally mid-way between the “bid” and the “ask.” In this case, today’s price would be about $1.18 per share for an option expiring about 9 months later, in January 2022.
If you had 1,000 shares you would “Sell Open” 10 contracts (1 contract = 100 shares) and would receive $1, 180 in additional income. In general, the higher the dividend yield the lower the option income yield. Verizon, having a 4.4% yield as of April 13, 2021 would offer a lower option yield, since you as the option seller generally get to keep the dividend, unless the buyer prematurely exercises his option, which generally only occurs near the end of the term of the option contract and if the then current price of shares is above the agreed upon sales price, also known as the “strike price.”
The action taken is “Sell to Open 10 January 21, 2022 Verizon $62.50 call contracts.”
Still, at the current price of $57.65, a $1.18 premium for a 9 month option will annualize to a 2.7% option yield in addition to the 4.4% dividend yield.
The net result of those sales on the average portfolio stock would likely be an additional 3-5% of income, or $300-500 for every $10,000 of stock per year.
Plus, there is the possibility of up to 10% gain in share appreciation.
The spreadsheet has a section for “What If?” scenarios where you can see the impact of changing the investment yield, such as may occur if you sell call options on portfolio positions. You can also see the impact of changing your annual withdrawal amount or the number of years of expected withdrawal and how much will remain for heirs when withdrawals are no longer being made.
As an example, at a 3.3% yield from dividends alone on a $1,000,000 portfolio, you can remove $50,000 per year for 20 years and your heirs will get $433,000 before taxes
However, if the yield is 7% because you sold options in addition to the dividends received, your heirs would receive $1,626,000 even as you removed $1,000,000 over 20 years. That’s because if your rate of withdrawal is 5% and your income yield is 7% the accrual of income exceeds the withdrawal. Of course, inflation may become a factor and asset value can go downward and dividends may be cut.
The net result of those adverse events in the short term, a year or two, would really be inconsequential. In the longer term the consequence would reflect itself in the amount left for heirs.
If shares are transferred to the holder of the option you sold, I would try to replace those shares with a company from the same sector, unless that sector already is worth substantially more than 12% of the total portfolio., in which case consider adding a position to a relatively under-weighted sector
Examples of such replacement stocks are:
INDUSTRIALS: Caterpillar (CAT) and Honeywell (HON)
TECHNOLOGY: Microsoft (MSFT) and Apple (AAPL)
CONSUMER: Pepsico (PEP), Kraft Heinz (KHC) and Mondelez (MDLZ)
COMMUNICATION: AT&T (T)
ENERGY: Conoco Phillips (COP)
RETAIL: Target (TGT)
FINANCE: Bank of America* (BAC) and Visa (V)
HEALTH CARE: Pfizer* (PFE) and United Healthcare (UHC)
All pay reasonable dividends and are blue chip companies (although not all are Dow Jones components) that in the long term would be expected to maintain value and dividend payments.
* In portfolio (as of 4/19/2021)