Since I began teaching and writing about bond replacement investments in 2008, I have struggled to express the risks and returns of this class of investments to subscribers.
Certainly, the yield generated through a bond replacement investment is not the same as the interest generated from a bond investment. In the case of a bond replacement investment, there is a significant chance that one will own the shares at expiration so that one’s final return will depend on the stock price level and holding period.
Over time, my thinking has changed about bond replacement investments and how one might incorporate them in a portfolio. In my own investments, I realized that some bond replacement investments were those that I had researched carefully and would not mind owning. For these, I tended to be comfortable with relatively larger positions. Other investments were more statistical – these are stocks that I have not researched carefully, but which are based on some sort of screen. For these, I prefer to take smaller positions and diversify across industries.
We publish Tear Sheets with carefully researched bond replacement investments (such as Apple or IBM on the bullish side and Whole Foods Market on the bearish side). We also publish Covered Call Corner screens each month, and these are statistical investments.
This month, I’ve started to represent the Covered Call Corner investments in a way that I think is most realistic in terms of the returns that an actual investor can generate in them. I have included a Summary tab in the workbook and inserted several notes in it. In our next Office Hour session, I’ll be going into detail about this and talking about the portfolio management of option-based income investments – both the researched sort and the statistical sort.
For the time being, here is the update for our Covered Call Corner. In short, our realized investments have generated a very good return of 5.8%; in-process investment returns have been more modest – only 1.8%. If all the in-process investments were immediately realized, we would have realized a return of 2.2% over 4 months (around 6.6% annualized). This is not a bad return, compared to investment-grade bond investments.