2011 investment portfolio performance and future planning

We started 2011 with about 54% of our portfolio in stocks and the rest in cash (click to read last year’s update). The portfolio size went up slightly (~2.5%) this year as we liquidated some treasury’s to take advantage of lower taxes this year as we do not have salary income. During the year, we continued to write several cash-covered puts and covered calls in an attempt to reduce our cost-basis and to realize periodic investment income. Many of them expired worthless letting us generate income as envisioned. We will continue to use both these vehicles in the coming year. Our cash position has come down to around 27% of our total portfolio value.

Our portfolio generated an overall return of ~1%. The returns out-performed most of the major indexes that were flat (US markets) to significantly down (emerging, pacific, and most others) during the year.

While last year’s performance was respectable, going forward, we plan to shift the portfolio towards a strategy of generating absolute returns as opposed to returns that correlate with the general market direction. As such, we plan to gear our portfolio to a long-short model by using short-selling along with long calls, short puts, and non-directional options strategies. Also, the number of positions and the allocations will be shifted to have a few very large (upto 10%) high-conviction positions, some large (upto 5%) positions, and a number of medium-sized positions (~2%). With options, covered positions (covered calls and cash-covered puts) will be limited to 2% of portfolio value. Positions with entire premium at risk (long calls) will be limited to 1% to limit the downside. Positions with more than the committed cash at risk (shorts and short puts) will be managed to have a downside risk that is limited to the size of the initial position (click to read about the strategy).

Our portfolio details as of 12/31/2011 follow:

Longs: Altria (MO ~2%), Philip Morris (PM ~2%), Kraft (KFT ~2%), iRobot (IRBT ~2%), Plum Creek Timber (PCL ~2%), CPFL Energia (CPL ~3%), BP Plc (BP ~2%), AT&T (T ~2%), Sysco (SYY ~2%), Excelon (EXC ~2%), Vonage (VG ~3.5%), Archer Daniels Midland (ADM ~2%), Intel (INTC ~4%), Pearsons (PSO ~2%), Nucor (NUE ~2.5%), Procter & Gamble (PG ~2%), Walmart (WMT ~2%), Waste Management (WM ~2%), United Parcel Service (UPS ~2%), Microsoft (MSFT ~9%), and Quality Systems (QSII ~2%). We also have smaller positions in Itron (ITRI), Aegon (AEG), Dryships (DRYS), Telefonica (TEF), Nokia (NOK), Harris (HRS), NYSE Euronext (NYX), Encana (ECA), National Presto (NPK), Market Vectors Gold (GDX), SPDR Gold (GLD), Diebold (DBD), Clearwire (CLWR), Cameco (CCJ), and Alcoa (AA).

Short Puts: Click Software (CKSW) shares (May 2012 7.5), Applied Materials (AMAT) shares (Apr 2012 10), and Ameritrade (AMTD) shares (Feb 2012 14) with a cash coverage requirement of about 21% of our cash position.

Short Calls: Diebold (DBD) shares (May 2012 35 written at $3.40).

Long Calls: Apple (AAPL) shares (Feb 2012 380 bought at $21.75) with ~1% of total portfolio value.

Watch List: Automatic Data Processing (ADP), Amgen (AMGN), Air Products & Chemicals (APD), Beam Inc (BEAM), Bemis Company (BMS), Canon (CAJ), Church & Dwight Company (CHD), Canadian National Railway (CNI), Cresud (CRESY), Darden’s Restaurants (DRI), Emerson Electric (EMR), Kaman Corporation (KAMN), Coca Cola (KO), McGraw Hill (MHP), 3M Company (MMM), PepsiCo (PEP), State Auto Financial (STFC), Teva Pharmaceuticals (TEVA), and Whirlpool (WHR).