Super SMSF Investment Strategies – Double Digit Return Possible in Bear Market

Our Self Managed Super Fund (SMSF) began the financial year (July 08 to June 09) with a very defensive portfolio. We were about 80% invested in cash, 10% in gold and 10% in silver. When the Federal Reserve started to slash interest rates, I knew we could no longer afford to remain in cash if we wanted a decent return. The Australian stock market had already corrected about 25% from its all time high so I thought it may be time to dip a toe into the stock market. I watched the price charts each day of some blue chip shares I liked and when the price pulled back to a recent historical low, I would sell put options at a price that I was prepared to pay for the stock.

For example, I noticed that BHP always rebounded when the price fell close to $30. In Sept 08, when BHP was trading at $34, I sold a PUT 33 option which expired in Oct 08 for a premium of $1.50. What this meant was that on 27 Oct 2008 which is the date when this PUT option expires, if the price of BHP was less than $33, I will have the obligation to buy 1000 shares of BHP shares from the person who bought this option, at the price of $33 per share. For the right to sell at this guaranteed price, the option buyer paid me a  premium of $1.50 per share. In the event that BHP falls below $33, I would buy the stock for $33 but the net cost to me would actually be $31.50 because of the $1.50 premium I received up front. I was happy to own BHP stock at $31.50. On 27 Oct 2008, BHP closed at $24.60 so I had to buy 1000 BHP shares at $33 as per my obligation for selling the Oct 33 PUT option.

Getting into stocks via selling put options ensures you buy the stock at a discount to current market price. However, it does not guarantee you can buy the stock at that price. If the price for BHP was above $33 on 27 Oct 2008, my put would have expired worthless which means I get to keep the $1.50 premium but I don’t get to buy the stock. This equates to a 4.5% return in two months (based on having to set aside $33,000 to buy the stock if need be) or an annual return of 27%. In practice, the return is even higher because my broker does not require me to hand over the $33,000 when I sell a put. They only require a variable margin which seldom exceeds half of that amount so the rest of the money could be sitting in a high interest cash account earning interest in that 2 months.

If you do end up having to buy the stock as in my case with BHP in Oct 2008, the next thing you can do is to sell calls over your stock to generate income. Some people call this strategy ‘covered call’ or renting out your shares. In Nov 08, BHP shares rebounded strongly back to $30. I did not expect BHP price to increase further as this was a strong technical resistance area so I decided to sell a call option. I sold a Dec 32 CALL option which meant that on 18 Dec 08 when this call option expires, if the price of BHP goes above $32, I would be forced to sell my shares at $32 to the option buyer. For the right to buy at this pre-determined price, the option buyer paid me a premium of $1.25 per share. If the BHP share price was higher than $32 on 18 Dec 08, I would have to sell my shares at $32. I would effectively still enjoy a net profit of $1.75 per share as I bought the shares at the net price of $31.50 and I got an extra $1.25 premium for the call option. It turned out the price for BHP was below $32 in Dec 08 so I got to keep the $1.25 which is a 4% return in two months (or annual return of 24%) on the $31,500 tied up in BHP shares.

Selling put and call options require a little more work than the “buy and hold” strategy favoured by most conservative investors. It takes just a few hours per month to do this and it has helped to boost the returns for my fund this financial year. These strategies also provide income (like dividends) which can be useful if you are a retiree who needs to live off the income from your share portfolio. Even though the year has not ended, we are on track for a double digit return this financial year. Do visit my blog for further information and discussion of these strategies.