Systematic Covered Writing

 . . . more than just covered calls . . .

Buy Back & Roll Out & Up - The Math Exercise

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.

The position is not over until it's over!

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The Email Comments:

Here is an another example where the writer could allow the existing option to be exercised, or it could be rolled. It is also a great example of options not being exercised early. Heck, the stock is trading at almost twice the strike price ($134.30 vs. $70), and yet the stock has not been assigned.

There are a number of reasons why this position was rolled today:

• The existing strike price was $6.68 below the cost basis. The writer did not want to ‘give back’ 200 times $6.68! (Who is in charge?)
• The new LEAP is $10 higher than the one that was closed, which is basically the same as adding $2000 back into the ‘value’ of this position.
• The previous statement has a great deal of credence, because in order for that not to take place, the stock would have to lose over $53 a share. Yes, that could happen . . . but will it?
• Even though the new LEAP is for 2009, the cash that was generated with the Buy Back & Roll Out & Up strategy is in the account today.
• If the writer has a need for cash sometime later this year or in 2008, there is nothing that says all or part of this holding could not be closed. (Keep in mind . . . there are 200 shares.)

Not that the covered writer would wish this on folks that are long this stock, but it is entirely possible that news could come out that brings this stock back down to $80 by January 2008. Wouldn’t that be special . . . the writer could then easily continue trading this stock. On the other hand . . . in 2008, what if the writer rolled the $90 LEAPS up to the $100 strike price? Could that happen? Well, didn’t we just move the $70 to $80?

What fun, and feeling a little frisky!

The Covered Writer

Systematic Covered Writing
… more than just covered calls!
Buy Back & Roll Out & Up:   Math Exercise
Date of Transaction	Wednesday, January 10, 2007
Stock Symbol	RIMM	Current Price		$134.85
Number of Shares	200
Net Investment	$14,627.00	Existing January Strike Price		$70.00
Net Cash Generated (1)	$4,365.73
Strategy:  Use the Systematic Covered Writing BB&RO&Up strategy.
Purpose:  Prevent an existing option from being exercised and generate cash
and attempt to partake in potential capital appreciation of the underlying stock.
Step 1:  The Buy Back	Net cash used to close Jan $70 calls			$13,009.50
Step 2:  The Roll Out	Net cash received from the sale of '09 Jan $80 LEAP			$13,570.08
Step 3:  The Cash Generated	Net result of the Buy Back & Roll Out & Up			$560.58	(A)
Total Cash Generated to Date			$4,926.31
Net Percentage of the Investment Generated (2)			33.68%
Net Back to cash Gain if this New Option is Exercised			$6,282.31	(B)
Net Back to Cash Percentage Gain if Exercised (3)			42.95%

COMMENTS:  In order to enter transactions, two events should be considered.  One is the amount of new cash generated via the strategy and the other is knowing what the end result would be if the new call is exercised.  Those two amounts are listed above as (A) and (B).   Do the math first . . . then do the transactions if they are merited!

 Legend

(1) This is the total net cash generated from all previous activity with this position.

(2)  This percentage is not a profit percentage.  It is simply the premiums generated to date, divided by the net investment.

(3)  Because the proceeds received if the option is exercised is an amount that can be precisely calculated, the net back to cash amount can be calculated.  Dividing that amount by the net investment yields the net percentage gain.  This is not an annualized amount because the data does not indicate the duration of the position.

CONCLUSION:  By increasing the strike price, a total of $2,000.00 will be added to the amount received if the current option is exercised.  By choosing to 'do something' a covered writer may be able to partake in the capital appreciation of an underlying stock.

For clarity, here is this position as maintained in the Position Tracker:

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