Systematic Covered Writing

 . . . more than just covered calls . . .

Portfolio Evaluation

October Expiration Friday is behind us for 2006 and it's time to pick out a portfolio and give it the 'once over' yearly review.  One of the philosophies the writer adheres to is the idea that in order for an investment style to be truly viable, in needs to function in a variety of market conditions. Let's face it, so far 2006 has been a very good year for equities.  If the investment strategy being used has not worked during the 'good times', good luck when things aren't so rosy.  Please keep this thought in mind as we look at a set of examples forthcoming dealing with a portfolio that was established in August of 2002.

Example Index

THE Portfolio: Established on August 22, 2002 with an initial (and current) funding of $48, 467.61.  This portfolio is an IRA, so there are no tax issues to discuss at this time.  The account is currently not being funded, other than the initial deposit.

THE DATE: October 21, 2006

THE STOCK:  BRCD - happens to be one of the original holdings in the portfolio. The stock has been depressed for quite some time, but now seems to be in the mood to appreciate.

THE STRATEGY: One of the interesting points with this position is the fact that so far, every option established has expired.  Option traders keep paying the holder of this stock even though the value is below the initial purchase price.

THE COMMENTARY:  The benefit of Dollar Cost Averaging is apparent with this holding. Take a look at the Position Tracker data and we will pick up the commentary on the other side . . .

 

      Systematic Covered Writing      
              . . . More than just covered calls . . .      
    SysCW   Position Tracker    
               
Historical Data Open Positions  
        Stock Cash Total Cash  Value as of 
Date Strategy Status Position Investment Generated Generated 20-Oct-06
26-Aug-02 Initial Stock Purchase Buy 100 BRCD @ 16.06 ($1,651.45)     $877.00
Current Price $8.77 Brocade Communications Systems, Inc.      
26-Aug-02 Initial Call Option Sell Jan $15 call @ 4 Expired 1/18/03 $347.43    
2-Jan-03 Dollar Cost Averaging Buy 100 BRCD @ 4.54 ($479.55)     $877.00
$ CA 2,131.00 200 @ $10.66 Combined Position        
21-Jan-03 Interim Trade  Sell two Jul $7.50 calls @ .5 Expired 7/19/03 $69.44    
31-Jul-03 Interim Trade  Sell two Jan $7.50 calls @ .55 Expired 1/17/03 $78.64    
20-Jan-04 Continued Trade Sell two '05 Jan $10 LEAPS @ .8 Expired 1/22/05 $123.64    
25-Jan-05 Interim Trade Sell two Jul $7 calls @ .35 Expired 7/16/05 $60.49    
3-Nov-05 Dollar Cost Averaging Buy 100 BRCD @ 3.4499 ($351.99)     $877.00
$ CA 2,482.99 300 @ $8.28 Combined Position        
3-Nov-05 Interim Trade Sell three '07 Jan $5 LEAPS @ .30   $79.24    
Cash in Hand 30.56%       $758.88  

Several key thoughts are revealed with this position:

♦   With SysCW, information about 'great' positions is provided . . . just like any other service.  The difference is, subscribers will also see how 'not so great' positions are handled.
♦   Note that with two Dollar Cost Averaging additions, the cost basis is below the current trading price and almost 1/2 the price per share of the purchase from August 26, 2002.
♦   Even though the stock is trading above the current strike price ($5), the call options have not been exercised.
♦   Notice the horrendous loss in value based on the initial purchase.  Granted, the position is not generating any kind of a huge profit, but it is also not losing so long as the writer sticks with the program.  We take the good with the bad, as well as the phenomenal with the ugly. 
♦   Two hundred of the three hundred shares could be sold at the $5 strike price with a nice gain.

This last point brings up an involved strategy . . . Think about this . . .  The writer splits this holding into two parts.  The initial purchase of 100 shares as a separate position, and the two, 100 share purchases, as a second position.  The writer could allow these to be called in January at the $5 strike price because that strike would be above the cost basis.  Then the writer is left with the 100 share holding with that $16 cost basis.

In January, the writer uses the Combo Buy Back & Roll Out and Up strategy as follows:

  1. Buy one contract of the $5 call to close.

  2. Buy 100 additional shares of the stock to Dollar Cost Average . . .

  3. Then sell two contracts of a $10 or $12.50 strike price to continue the position.

The rational is that this would be better than trying to roll all three $5 calls as they cannot be rolled higher without adding additional shares.  The effect of a Dollar Cost Average transaction is significantly greater when 100 shares is added to 100 shares than when 100 shares is added to 300 shares. Just a thought, but one the writer will explore as January approaches or if BRCD continues to appreciate.

Comments, questions and opinions are always welcome . . . rlcoveru@wavecable.com

The Covered Writer

______Update 2007______

This update begins with a refresh view of the current data as on January 24, 2007.

      Systematic Covered Writing      
              . . . More than just covered calls . . .      
    SysCW   Position Tracker    
               
Historical Data Open Position  
        Stock Cash Total Cash Value as of
Date Strategy Status Position Investment Generated Generated 24-Jan-07
26-Aug-02 Initial Stock Purchase Buy 100 BRCD @ 16.06 ($1,651.45)     $868.00
  Current Price $8.68 Brocade Communications Systems, Inc.        
26-Aug-02 Initial Call Option Sell Jan $15 call @ 4 Expired 1/18/03 $347.43    
2-Jan-03 Dollar Cost Averaging Buy 100 BRCD @ 4.54 ($479.55)     $868.00
$ CA 2,131.00 200 @ $10.66 Combined Position        
21-Jan-03 Interim Trade  Sell two Jul $7.50 calls @ .5 Expired 7/19/03 $69.44    
31-Jul-03 Interim Trade  Sell two Jan $7.50 calls @ .55 Expired 1/17/03 $78.64    
20-Jan-04 Continued Trade Sell two '05 Jan $10 LEAPS @ .8 Expired 1/22/05 $123.64    
25-Jan-05 Interim Trade Sell two Jul $7 calls @ .35 Expired 7/16/05 $60.49    
3-Nov-05 Dollar Cost Averaging Buy 100 BRCD @ 3.4499 ($351.99)     $868.00
$ CA 2,482.99 300 @ $8.28 Combined Position        
3-Nov-05 Interim Trade Sell three '07 Jan $5 LEAPS @ .30 Rolled 12/14/06 $79.24 SysCW 144  
14-Dec-06 Combo Buy Back & RO&Up Buy three Jan $5 calls @ 3.90   ($1,187.75)    
14-Dec-06 Dollar Cost Averaging Buy 100 BRCD @ 8.8299 ($889.99)     $868.00
$ CA 3,372.98 400 @ $8.43 Combined Position        
14-Dec-06 Interim Trade Sell four '08 Jan $7.50 LEAPS @ 2.60   $1,027.96    
  Cash in Hand 17.76%       $599.09  

What do you do when a stock is trading above the strike price with an Interim Trade?  One possibility is to use the Buy Back & Roll Out & Up (BB&RO&Up) strategy. In this case that was not feasible as the proceeds for the '08 Jan $7.50 LEAP were lower than the cost to close the existing Jan $5 option.  The solution is to use the Comb BB&RO&Up.  In this case is still did not quite work, but now the strike price is much closer to the cost basis. 

Oh . . . and notice the benefit of the dollar cost averaging.  One more hidden possibility is if the writer need cash, and was comfortable with the $7.50 strike price relative to the current trading price, the writer could liquidate the shares with the lower cost basis.  The only problem with this is the basis of the remaining 200-shares would be higher.  But it is a possibility if the need arises.

Not a very exciting position, but note that the stock is currently trading at the adjusted cost basis.  Rather than selling a loser ($16.06 down to $3.45), the writer has traded through the bad times.  Obviously the return is not going to be something to write home about, but any return is better than taking a loss and trying to make up for it! We all have opinions . . . mine has been expressed. 

Comments, questions and opinions are always welcome . . . rlcoveru@wavecable.com

The Covered Writer

PLEASE NOTE THAT THIS EXAMPLE IS NOT TO BE CONSIDERED AS A RECOMMENDATION TO INVEST IN BRCD STOCK OR ANY OTHER EQUITY.  THE INFORMATION IS PROVIDED FOR EDUCATIONAL PURPOSES ONLY.  THERE IS NO GUARANTEE THAT SIMILAR TRANSACTIONS CAN BE EXECUTED IN THE FUTURE. INVESTING IN THE STOCK MARKET INVOLVES RISKS, DO SO ONLY WITH A KNOWLEDGE AND UNDERSTANDING OF THE RISKS INVOLVED! STRATEGIES INVOLVING TAX ISSUES SHOULD BE DISCUSSED WITH YOU TAX PROFESSIONAL.

The information provided above is for informational purposes only, and no mention of a particular security constitutes a recommendation to buy, sell, or hold that or any other security, or that any particular security, portfolio of securities, transaction, investment strategy is suitable for any specific person. You further understand that the Covered Writer will not advise you personally concerning the nature, potential, value or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. To the extent any of the information available on this website may be deemed to be investment advice, such information is impersonal and not tailored to the investment needs of any specific person. Always remember that past results are not necessarily indicative of future performance.

These are the terms of use.  Why are they here?  Because the examples provided are real.  The transactions actually took place.  The dates are real, the positions are real.  Some transactions will have been executed on the day you receive the email.  What you are agreeing to, is the fact that in no way is it being suggested that you can, or should, enter a similar position.  Why?  Because that would be providing investment advice and the Covered Writer is not authorized to do that.  There is also no guarantee that similar transactions could be executed at any time in the future. Only licensed brokers are allowed to provide investment advice.  Therefore, you are agreeing that the preceding example was provided for 'educational purposes' for the sole purpose of illustrating the Systematic Covered Writing strategies.

Thank you!

SYSTEMATIC COVERED WRITING
Copyright © 2006. All rights reserved.
Revised: 04/15/07