Systematic Covered Writing

 . . . more than just covered calls .

September 18, 2007

Question: How do you pick the right stock, and the right call.

 Answer: You would not believe how many times I am asked this question.  Please accept this short answer, and the long one, as reality.

SHORT ANSWER - There is no 'right' stock!

LONG ANSWER - The thought process is based on a perception of what really goes on in the marketplace.  As a covered writer, I simply accept the SysCW guiding principal that Nobody Knows! All one would have to do is look at how many times the supposed experts, the analysts, are either late to the party, or just plain wrong.

Keep in mind that these analysts have access to significantly more information and sophisticated software than the average, or above average covered writer.  Yet, as hard as they try, sometimes they are right, sometimes they are wrong.  It's not perfect.  Never has been.  Never will be.  My advise it to accept the 'Nobody Knows' concept,  and then formulate a plan to make the best of it . . . either way.

Let's take a look at some current examples.  Please note that when these Initial Positions were established, the writer thought they were the 'right' stocks.  Hopefully, you would agree that no one in there right mind would enter a new covered call position believing that the underlying stock was going to go down (lose value).

Here is a group of positions that were all established in April of 2007.  They happen to be in one of the online SysCW Portfolios that subscribers have viewed since their establishment.  The current values listed are as of September 18, 2007.

Again, the expectation when the position is established is that the option will be assigned with the position going back-to-cash with the pre-determined annualized profit.  Let's take a look, one by one.

JCG -  Earlier this month, the decision was made to maintain this holding.  For these positions, there is an emotional attachment to J. Crew.  If the Buy Back & Roll Out strategy had not been used earlier this month, it is sure looking like this would have been one of those 'right' stocks.  By this, the writer means that the Initial Call Option would be exercised this Friday.

Note that the Mar $40 option will take the holding out to one year in terms of duration.  As the strike price is slightly above the cost basis, and the cash generated is in excess of 18%, this holding will satisfy the investment outcome goals of Systematic Covered Writing. Once again . . . the main reason for rolling this position was the emotional attachment to the Company.

ONXX -  One would be hard pressed not to call this a 'right' stock.  At least it was right when it was selected in April. Note the writer followed the 'rules' and has had 21.72% of the investment back in hand since April. Obviously, unless something drastic happens, this stock will be called.  With the strike price below the cost basis, $1.90 per share will be 'given back' when assigned.

This is okay, as the net back-to-cash gain will still be above 15%. 

DPTR - Here we have a 'wrong' (or is it 'left') stock. The stock lost value and the Sep $22.50 call with expire. Notice that even though this stock is not turning out to be 'right' (yet), that the writer is not giving up, which is one of the normal courses of action.  The writer added another 100 shares in August, and now has a $20.06 cost basis for the 200 share position. When the September call expires, the writer will sell a second '09 Jan $20 LEAP.

This should bring in somewhere between $250 and $270 at the current price. This would bring the next cash generated to over 23%, which is not bad for a wrong pick.  The point here is that Systematic Covered Writing understands, and accepts the fact that sometimes writers will simply pick a stock that loses value.  If you make that 'okay', and develope a plan or a series of strategies to trade through the down trends, then the focus on picking the 'right' stock is reduced.

This does not mean you can just be haphazard and pick away, but rather adopt a philosophy of diversification when establishing a portfolio.  The key here is not to chase premiums.

FMT - Now here we have another loser! Thank goodness for the 25.27% downside protection.  Now let me ask you . . . what if the writer allowed the Sep $7.50 calls to expire, and then did nothing.  Then, say in April of 2008, the stock was trading at $8.28 again.  The position would have generated over 25% in one year, even though it lost significant value and was a 'wrong' stock.

Now, this is not how a writer would play this, but it could happen . . . right? On the other hand, what if the writer bought 200 more shares.  The cost basis would drop down to $6.62.  With the rate cut today, the stock moved from $4.93 to $5.40 by the time the market closed. Another couple of pops like that and the writer may be able to just keep the 200 share position and sell $7.50 calls on Monday of next week.   (I will up date this page as trades occur.)

IOC - Lastly, IOC has been an interesting stock over the summer. For a number of months, it has been one of the few companies that a writer could sell a one-month option and bring in 15% downside and at least 15% when assigned. Notice the play here.

The writer rolled the strike price up $5 by going out to the '09 Jan $30 LEAP.  That may seem like a 'long time', but look also at the amount of cash this position has generated. In the writer's opinion, this is another 'right' stock.

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So . . . what's the point to this long answer?  I just wanted you to see that being 'right' is not a requirement with Systematic Covered Writing. Being diversified is a requirement.  Not chasing premiums is a requirement, and being a long-term investor is a requirement.

It is hoped that this information really does answer the question on picking the 'right' stock.  To repeat, all of these positions are in an online $400k Portfolio that subscribers can monitor at any time.

Thanks again for the question.  I hope the answer was satisfactory.

            The Covered Writer

PLEASE NOTE THAT THIS EXAMPLE IS NOT TO BE CONSIDERED AS A RECOMMENDATION TO INVEST IN 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!

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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 suggesting 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 provide for 'educational purposes' for the sole purpose of illustrating the Systematic Covered Writing strategies.

Thank you!

SYSTEMATIC COVERED WRITING
Copyright © 2007. All rights reserved.
Revised: 09/19/07