Systematic Covered Writing

 . . . more than just covered calls . . .

Buy Back & Roll Out & Up

HD  Home Depot Inc.

January 17, 2007

This SysCW BB&RO&Up  example was emailed to subscribers on the day the transactions were executed.  In order to know what to do in the future, it is important to understand what we did in the past. Recovering occurs each time an option expires, even when a stock loses value.  This is a key philosophy of the Systematic Covered Writing process.  Writers will profit from stocks that appreciate, and they will also generate additional cash with the stocks that lose value.  Then, at some point in time, the strike price is increased, which is the purpose of the Buy Back & Roll Out & Up strategy.

Three events must take place:

  1. The existing option is closed.

  2. A new option is sold at a higher strike price than the closed option.

  3. The amount of cash received for the Roll Out & Up needs to be greater than the amount of cash used for the Buy Back.

A position is not over, until it's over!

THE POSITION: Throughout the year, subscribers will see many SysCW examples involving higher volatility stocks. One of the reasons this happens is because there is generally more activity surrounding a tech stock than a company like Home Depot Inc. For example, the last time there was activity with this holding was in January 2006.

THE STRATEGY: The strategy used with HD today was the Buy Back & Roll Out & Up. One of the principles of Systematic Covered Writing states that a portfolio should be diversified. This is easier said than done, as higher yielding positions are very tempting.  With this in mind, know that the writer does not expect to generate as much with this position as with a biotech holding. On the other hand, what the writer does expect is some resemblance of price stability.  Today, the existing option was rolled to prevent the stock from being assigned in two days. (January 19, 2007 is expiration Friday for 2007 January contracts.)

COMMENTS:  Let's begin with the history of this position, including today's activity:

      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 17-Jan-07
9-Jun-05 Initial Stock Purchase Buy 100 HD @ 39.70 ($3,977.00)     $4,029.00
  Current Price

$40.29

The Home Depot, Inc.        
9-Jun-05 Initial Call Option Sell Jan $40 call @ 2.70 Rolled 1/20/06 $261.73    
15-Sep-05     Dividend Received   $10.00    
15-Dec-05     Dividend Received   $10.00    
20-Jan-06 Buy Back & Roll Out  Buy Jan $40 call @ .70 Rolled 1/17/07 ($78.25)    
20-Jan-06 Continued Trade Sell '07 Jan $40 LEAP @ 4.50   $441.73    
23-Mar-06     Dividend Received   $15.00    
22-Jun-06     Dividend Received   $15.00    
14-Dec-06     Dividend Received   $22.50    
17-Jan-07 Buy Back & Roll Out & Up Buy Jan $40 call @ .52   ($60.25)    
17-Jan-07 Appreciated Trade Sell '08 Jan 45 LEAP @ 2.05   $196.74    
               
  Cash to Date 20.98%       $834.20  

One thing to notice is that the current value of the stock is about $50 more than the investment.  In other words, this stock has 'gone nowhere' in the past year and a half based on today's price. That's really not quite true for during the past year Home Depot traded as low as $32.85 and as high as $43.95.  As a covered writer, the value of the stock is not as a high priority as covered writers focus on being paid to own stock, and not solely on stock appreciation.

Home Depot has been trading sideways during the holding period.  Yes, there have been ups and downs, but the fact is, the stock is worth about the same today as it was in June of 2005.  Now notice how much the writer has been paid. Including the dividends, this position has generated almost 21% of the investment during the same time period of the stock doing 'nothing'. The point?  This is exactly what was expected when the position was established.  Nothing great and nothing bad . . . is what this position was intended to provide.

Today . . . the writer had a choice.  The Jan $40 could have been rolled to the '08 Jan $40.  The writer would have received closer to $4.10 per share as opposed to the $2.05 a share generated with the '08 Jan $45 LEAP. The reason the Out & Up strategy was used is an attempt to stay ahead of the stock's price.  The writer wants this to be a long term holding. With a new CEO, there is hope that the stock will begin to appreciate.  That may happen, on the other hand, it may not . . . nobody knows. If it does, the writer is in a good position, if it does not . . . the writer is still in a good position based on the expectations set forth for this holding.

CONCLUSION:  This example illustrates the use of the Systematic Covered Writing Buy Back & Roll Out & Up strategy. It also illustrates that a wise investor does not put all the eggs in one sector.  Diversification is the key to success and Home Depot is part of that success for this portfolio.

PLEASE NOTE THAT THIS EXAMPLE IS NOT TO BE CONSIDERED AS A RECOMMENDATION TO INVEST IN HD 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 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 © 2005. All rights reserved.
Revised: 02/05/07