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Income Power

Richard Croft
November 28, 2011
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When momentum rules the day in stock markets, it’s difficult to go against the grain. Only the boldest of the bold have the stomach to do so, placing bearish trades in the near-certain expectation of some success. In the past few weeks, that type of speculation has borne fruit. Others rely on defensive strategies to at least hedge their positions somewhat, using options as pure insurance or as a way to generate income until negative sentiment plays itself out.

Currently, the eurozone debt crisis is preoccupying investors who are discounting all manner of catastrophe in the financial system should the eurozone crack up completely. It might happen. Or it might drag out for another year to two. The essential problem is that no one knows, and forecasting is rendered all but impossible given the volatile political dynamics of the eurozone area.

So aggressive traders can either continue to bet on the downside or attempt to generate income from a defensive sector that, while not immune to market crosswinds, has held up reasonably well. The sector in question being; utilities.

Year-to-date the utilities sector is down only 2.2% as measured by the S&P/TSX Capped Utilities Index, compared with the near 15% decline in the overall S&P/TSX Composite Index. Unfortunately, for option traders, there are no optionable utilities indexes in Canada. The alternative is to look at option strategies on individual stocks such as covered writes on individual utilities like Transalta Corp. (TSX: TA, Friday’s close $21.43), Emera Inc. (TSX: EMA, $31.22), and Northland Power Inc. (TSX: NPI, $16.72).

The challenge with each of these names is also what makes them comfortable holdings. Fact is they are not particularly volatile stocks and as such do not command very high premiums. There is also the liquidity issue, which is why call buying does not make much sense. With these stocks, if you can sell the calls you will likely be holding the position until maturity. But then again, this sector is not the worst place to be in an uncertain world.

With TA you could look at writing the Mar 22 calls at 40 cents. In the case of EMA look at writing the March 32 calls at $1.00 or better and finally NRI, sell the April 17 calls at 80 cents or better. The assumption is that you own or willing to buy the shares to cover the short option position.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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