Systematic Covered Writing

 . . . more than just covered calls . . .

"Systematic Covered Writing is a series of strategies for long-term investors that believe nobody really consistently knows which stock is going to appreciate at any particular point in time. They also believe there are a limited number of possible overall changes in any individual stock's value during a specified period of time and that someday the value of a stock will be higher than when it was originally purchased. Lastly, they understand that their wealth is not emotionally connected to any individual stock held within the portfolio."

    Example Index

          DNDN     Dendreon Corporation

THE POSITION DATE :    October 2005 to August 2007

THE STOCK: Dendreon Corporation (DNDN) is a biotechnology company focused on the discovery, development and commercialization of therapeutics that harness the immune system to fight cancer.

THE STRATEGY:  The Buy Back & Roll Out & Up

It has been stated that there are many strategies within the Systematic Covered Writing process and that they are 'intertwined'.  This means that the strategies can be used in various combinations as the market value of the underlying stock position fluctuates. 

RULES 

Each strategy within Systematic Covered Writing has its own set of rules.  For the Buy Back & Roll Out & Up strategy, there are only three.

One further noteworthy point:  Normally, a covered writer will close an Interim Trade option transaction if the underlying stock position rises above the 'Interim' strike price.  The holder of an Interim Trade position does not 'really want' to sell the stock for the Interim Trade strike price.  The fact that (in the vast majority of covered positions) a covered writer can prevent an option from being exercised, allows the Interim Trade to be established in the first place.  The ability to close an existing option is a fundamental characteristic of Systematic Covered Writing.

Having said that . . . with this example the writer is increasing the strike price of a position with an Interim Trade status. The Interim Trade is used to generate cash while a stock's value is depressed.  The ability to increase the strike price over time allows the writer to generate this additional cash.

THE THEORY:   As long as there is extrinsic value in an option, the odds of the option being exercised early are extremely low.  This observation allows the establishment of Interim Call Options with little fear of the stock being assigned.  Note:  the strike price for an Interim Trade option should be above the trading price of the stock at the time the call is sold if at all possible.  There will be times when 'catching up' requires the strike to be below the current trading price.

THE COMMENTARY:   The are some commentators who have proudly suggested avoiding this stock.  Okay, possibly their rational is based more on the need to be 'right' with the Initial Call Option, than having a solid basket of strategies to use in order to contend with stocks that lose value.  Check out the history as this commentary will continue below.

      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 4-Aug-07
3-Jan-05 Initial Stock Purchase Buy 100 DNDN @ 10.569 ($1,063.90)     $731.99
  Current Price

$7.32

Dendreon Corporation        
3-Jan-05 Initial Call Option Sell May $10 call @ 2.15 Expired 5/21/05 206.74    
26-May-05 Dollar Cost Averaging Buy 100 DNDN @ 5.249 ($531.90)     $731.99
$CA $1,595.80 200 @ $7.98 Combined Position        
26-May-05  Continued Trade  Sell two Nov $7.50 calls @ .55 Expired 11/19/05 100.49    
21-Nov-05  Continued Trade  Sell two '07 Jan $7.50 LEAPS @ 1.60 Expired 1/19/07 310.48    
29-Jan-07 New Interim Trade Sell two Mar $5 calls @ .25 Rolled 2/21/07 $40.49    
21-Feb-07 Buy Back & Roll Out & Up Buy two Mar $5 calls @ .50   ($109.50)    
21-Feb-07 New Continued Trade Sell two Aug $7.50 calls @ 1.35   $260.49    
               
  Cash to Date 50.71%       $809.19  MG

Note that the covered writer continues to use DNDN for initial positions to this day (August 2007).  With cash generation as indicated above . . . the question becomes . . . why not?  You see . . . with SysCW . . . there is a complete plan . . . not just one that tries to be correct with each position month after month.

Check it out!   The stock initially loses over half its value.  The writer uses the SysCW Dollar Cost Averaging strategy and two and a half years later, the position has generated over 50% of the total investment. Today is August 4, 2007 . . . there are two weeks left before the Aug $7.50 call is due to expire and DNDN closed at $7.32 on Friday.

If the writer could 'draw it up', the stock would close at about this price on August 17th.  What then?  Well, at today's bid and ask, the writer could sell the '09Jan $7.50 calls for $3.80, which is a position writers have been establishing over the past few weeks. Think about it . . . another $750 added to the cash already generated . . . yes folks, in a little over two weeks the position could have generated a total of $1,560.00 or over 97% of the total cost of the 200 shares of stock!

Now lets see . . . January 2005 to January 2009 . . . four years . . . 97% . . . 24.4% per year.   Pretty sure that works!

Two strategies 'make' this position.  One was the 'no fear' use of the Systematic Covered Writing Dollar Cost Averaging when DNDN was trading at $5.249 in May of 2005, and the other was the use of the SysCW Buy Back & Roll Out & Up strategy in February of this year.

FYI . . . DNDN closed at $3.65 on March 15, 2007!  The writer did not care! It all has to do with one of the five basic principles of Systematic Covered Writing . . . this is the one that states that we are long-term investors. The price of an underlying stock on any given day is of little significance with this perspective.

Your comments, questions, and or concerns are always welcome!   rlcoveru@wavecable.com

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

Enjoy!

SYSTEMATIC COVERED WRITING
Copyright © 2007. All rights reserved.
Revised: 08/05/07