THE TRADE DATE : November 14, 2006
THE STOCK: Elan Corporation (ELN) engages in the discovery, development, manufacture, and marketing of advanced
therapies in autoimmune diseases, such as pain and neurodegenerative diseases.
THE STRATEGY: Establish a new Initial Position.
THE THEORY: The underlying philosophy of
Systematic Covered Writing is the establishment
of
diversified Initial Positions where a math exercise indicates that the
position will generate a return of 15% (when annualized) if the Initial Call
Option is exercised, and the Initial Call Option will immediately
generate 15% of the net investment in the stock. In other words . .
. either the call option is going to be exercised with a reasonable
'back to cash' profit, or the option is going to expire with the covered writer
keeping the premium from the sale of the call and the stock. If no
other transactions are initiated by the covered writer, then one of these two
events will happen. Given that Nobody Knows ... if the math works, and the
position fits within the guidelines of a covered portfolio . . . enter the
position!
Furthermore, a covered writer is aware that there are
five net (beginning value verses ending value) movements a stock can make from the time the call option is sold to
when it expires. For review, these movements can be described as
follows:
-
The stock's value can increase by over 20% during
a specified time period.
-
The stock's value can decrease by over 20% during
a specified time period.
-
The stock's value can vary with an increasing
value from zero to plus 20% during a specified time period.
-
The stock's value can vary with a decreasing
value from zero to minus 20% during a specified time period.
-
The stock's value can vary with an overall
unchanged value.
Systematic Covered Writing
provides the 'what to do next' strategies to each of the possibilities
listed above. A step by step guide to 'cash generation' using covered
call option positions is exactly what SysCW is all about.
THE COMMENTARY: The whole process of
Systematic Covered Writing begins with the
establishment of multiple initial positions in a portfolio. The idea
is that in all likelihood, some of the stock holdings may appreciate, some
may trade sideways, and some may lose value. It is just not known
which ones will do what! Rather than trying to be 'right', or worrying
about the value of a particular holding, SysCW strategies are used to create cash, regardless of the value of the underlying
(covered) stock position. Today's example is another new position. It was established on November 14, 2006.
It is important for a covered writer to recognize that
'liking the stock' is an important aspect of investing. If the stock
that is purchased loses value, it may be held in the account for a number of
years, which is okay as long as the writer can continue to be paid because
it is owned. Or, at least it is 'okay' in the eyes of the
Systematic Covered Writer! The reader will be provided with examples of positions that have lost
value in future examples.
The Initial Position Math Exercise ...
Note: If you desire an explanation of the Initial
Position Math Exercise click
MATH
HELP. Use your browser back page to return to this location.
What does the covered writer have?
-
One hundred (100) shares of ELN stock, which were purchased for a net
investment of $1,472.90.
-
The right to buy that stock was sold to someone (we don't know who)
and they paid the covered writer $401.75 (net) in cash. The
covered writer is obligated to provide (or sell) 100 shares of ELN
stock if, and only if, the right to buy the stock is exercised.
The 'right to buy' is the call option that was sold.
Going forward, there are only two possible outcomes to this
Initial Position (assuming the covered writer does nothing).
-
Either the stock is going to be sold (called), meaning the '08 Jan $15 option is exercised. This can happen any time between the
time it was sold and the third Friday in January 2008. When the position is established,
the covered writer knows exactly
what will be received if the stock is sold, namely: (100 X $15) - $17 = $1,483. This also means that when
the position is establish, the writer knows the net 'back to cash'
potential profit if the call is exercised. The writer paid $1,472.90
for the stock that may be sold for $1,483 (again, this is if the
option to buy the stock for $15 a share is exercised). The
result of this sale produces a net gain of $10.10. There is a net gain of $401.75 from the sale of the call. Combine
the stock gain with the option gain to obtain the 'net back
to cash profit. $401.75 + $10.10 = $411.85
Notice that this is exactly what the 'Math Exercise' computed.
The only other possibility is the option will not be exercised!
This will happen if the stock is trading below $15 on January 19, 2008. Could this happen? Sure! Will it?
Nobody knows ... but if it does, the covered writer will keep the 100 shares of
ELN stock and all of the premium
received from the sale of the call ($401.75), which just happens to
be over 27% of the amount invested in the stock. By the way . . . the writer already has the cash . . . there is not
'waiting' to be paid.
Guarantees are a 'no no' in the investment world. Having said that, it should be
perfectly clear that one of the two events listed above will absolutely,
positively take place. The call option will either be exercised ... or
it won't .... GUARANTEED! One
possibility is the writer will be back to cash with a net profit of $411.85.
The other possibility is the writer will still own 100 shares of ELN and
will keep the entire $401.75 generated from the sale of the call.
Think about this . . . "What has to happen to the price or value of ELN
stock in order to generate a realized capital gain of $411.85 in thirteen
months?" The answer ... "very little!" The value of ELN would need to appreciate from $14.66 to slightly over
$15. Will that happen .... the covered writer has no idea
... and neither does anyone else!
2006 - Some examples will be
historical and some (like this one) will be delivered to subscribers on 'trade day'. The focus should be on the process, or the
strategy, not the particular stock. Rather than using 'XYZ' or 'ABC' hypothetical examples, this example is based on
a real
position using real assets.
PLEASE NOTE THAT THIS EXAMPLE IS NOT
TO BE CONSIDERED AS A RECOMMENDATION TO INVEST IN ELN 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!
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 © 2005. All rights reserved.
Revised:
12/09/06
and the SysCW
.