ONXX BB&RO&Up

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."

          FCX   Freeport-McMoRan Copper & Gold Inc.

THE POSITION DATE :    April 2007 to August 14, 2007

THE STOCK: Freeport-McMoRan Copper & Gold Inc. (FCX) through its majority-owned subsidiary, PT Freeport Indonesia, is engaged in copper, gold and silver mining and production operations.

LATEST STRATEGY: The Buy Back & Roll Out & Up

It has been stated there are many strategies within the Systematic Covered Writing process, and as such, one should be aware they are 'intertwined'. This means the strategies can be used in various combinations as the market value of the underlying stock position fluctuates. At other times, a writer may elect to use a strategy simply to generate cash, and/or to take advantage of the capital appreciation of the underlying stock.

RULES FOR BUY BACK & ROLL OUT & Up

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

The strike price of the option used to re-cover the stock must be higher than the strike price of the option that is closed.

The duration of the new option contract should be as short as possible, while generating enough premium to justify the transaction.

The new premium (cash generated) from the Roll Out option must be greater than the amount needed to close the existing option.

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 an Initial Position about six months prior to expiration. The 'why' behind this activity is forthcoming.

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 a writer to hold positions even though the current price of the underlying stock is above the current strike price.

THE COMMENTARY:   To begin, this position is held in the online $400k Portfolio. Several weeks ago, there was a tremendous amount of 'chatter' about the Dow reaching 14,000. Tomorrow, it is entirely possible this major average will fall below 13,000! Who knows where it will be by the time you are reading this example.
While the major averages are falling, the writer has elected to attempt to protect a position that has appreciated significantly since its inception. Take a look at the historical data for this position as maintained with the SysCW Position Tracker.

			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	14-Aug-07
17-Apr-07	Initial Stock Purchase		Buy 100 FCX @ $71.3764	($7,144.64)			$8,361.00
	Current Price	$83.61	Freeport-McMoRan Copper & Gold Inc.
17-Apr-07	Initial Call Option		Sell '08 Jan $70 LEAP @ 10.10		$1,001.73
1-Aug-07			Dividend Received		$31.25

	Cash in Hand	14.46%				$1,032.98	$400k

As with most stocks, August 14, 2007 brought with it a drop in value. In fact, FCX closed down $4.19 for the day. Even with this loss in value, it is still trading thirteen-dollars and change above the $70 strike price. The point here . . . even though the stock is trading above the strike price . . . the odds of the call being exercised early are slim (I'm tempted to add: 'and none', but I won't).
So . . . . why was this position rolled today? Keep in mind this position is held in a $400,000 portfolio. Diversification is one of the attributes of a successful portfolio. In addition to diversification, note the $31.25 dividend, which was paid on August 1, 2007. At the purchase price, the dividend yield is 1.75%. To the writer this means that in addition to the premiums from call options, the position will also generate $125 a year in cash from dividends.
The stock has been rated a Strong to Moderate Buy, is reporting a profit margin of 26.30%, and has a current P/E ratio of 10.6. All this leads to the writer 'liking' the stock. So . . . let's check out the position after the Buy Back & Roll Out & Up.

			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	15-Aug-07
17-Apr-07	Initial Stock Purchase		Buy 100 FCX @ $71.3764	($7,144.64)			$8,361.00
	Current Price	$83.61	Freeport-McMoRan Copper & Gold Inc.
17-Apr-07	Initial Call Option		Sell '08 Jan $70 LEAP @ 10.10	Rolled 8/14/07	$1,001.73
1-Aug-07			Dividend Received		$31.25
14-Aug-07	Buy Back & Roll Out & Up		Buy Jan $70 call @ 19.60		($1,968.25)
14-Aug-07	Appreciated Trade		Sell '10 Jan $80 LEAP @ 24.30		$2,421.71

	Cash in Hand	20.80%				$1,486.44

First, note this position has now generated 20.80% of the investment, and the new strike price is $80 instead of $70. In other words, the position has already generated over a year's worth of cash, based on the 15% per year goal. The stock is already trading above the $80 strike price. With this in mind, let's look ahead to two plausible events.
ASSIGNMENT IN 2010 - Yes, this is rather forward looking, but it is one of two outcomes that will occur if the writer does nothing going forward. The math at that time would be as follows:

			Systematic Covered Writing
			. . . More than just covered calls . . .
			SysCW Position Tracker

Historical Data			Closed Position
				Stock	Cash	Total Cash	Annualized
Date	Strategy	Status	Position	Investment	Generated	Generated	Gain
17-Apr-07	Initial Stock Purchase		Buy 100 FCX @ $71.3764	($7,144.64)
			Freeport-McMoRan Copper & Gold Inc.
17-Apr-07	Initial Call Option		Sell '08 Jan $70 LEAP @ 10.10	Rolled 8/14/07	$1,001.73
1-Aug-07			Dividend Received		$31.25
14-Aug-07	Buy Back & Roll Out & Up		Buy Jan $70 call @ 19.60		($1,968.25)
14-Aug-07	Appreciated Trade		Sell '10 Jan $80 LEAP @ 24.30		$2,421.71
Quarterly			Anticipated Dividends		$281.25
15-Jan-10	Hypothetical Assignment		Sell 100 FCX @ $80	$7,982.91	$838.27
15-Jan-10			Hypothetical Net Gain			$2,605.96	Annualized
1004	Days		Hypothetical Percentage Gain			36.47%	13.26%

So . . . let me ask you . . . if you could make an investment now that would end in January of 2010 with a reasonable expectation of generating 13.26% per year . . . would you? Given current geo-political world conditions, do you think there is a reason for copper and gold to hold their value over the next 1004 days? If you answered yes to both of those questions, and factor in that the writer 'likes' this Company, then you will understand a major portion of the rational for today's activity.
PRICE FALLS - Given that nobody knows, another possibility is for the price of the stock to fall back down to the $70 range. If this happens, the writer will probably use the Buy Back & Lower strategy to generate additional cash prior to 2010. Remember, just because a 2010 LEAP is in place, does not mean the writer is compelled to leave it in place!

One more point of interest. When the Dow was trading in the 14,000 neighborhood, this stock was trading at over $90 a share. One of the underlying beliefs of Systematic Covered Writing is that someday the market will be higher, there is good reason to think that a price above $80 a share could be held by this Company when 2010 rolls around. But . . . nobody knows.

For now . . . the writer is attempting to capture potential capital appreciation of the underlying stock, while also 'creating' additional cash to be used for other transactions. Today the Dow lost over 200 points. To the writer . . . this means a 'sale' is available on a stock . . . somewhere. Creating extra cash to partake in a downtrend sale is an objective of a portfolio this size.

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 FCX 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: 08/15/07