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."

This example of the Buy Back & Roll Out & Up strategy.

THE DATE:  October 10, 2007

THE DILEMMA: The online $100k Portfolio contains a RMBS Position with the following parameters.

With a cost basis of $28.94 and a strike price of $17.50, there is a need to end the 'game of chicken' in the writer's favor.  The game involves the option trader, who has the 'right to buy', and the covered writer, who has the right to take the right away. Needless to say, the position would suffer greatly if the option trader won the game.

Please note Systematic Covered Writing is a serious business, and not a 'game' at all, it is hoped the analogy is perceived in the light it is intended.

THE SOLUTION: The solution is to use the Buy Back & Roll Out & Up strategy of Systematic Covered Writing.  The knowledge of the existence, and how to use this strategy, allows the covered writer to writer calls significantly below the cost basis (Interim Trade status) in the first place. Some quick rules for these strategies are:

  • The amount of cash used for the Buy Back, must be less than the cash received for the Roll Out option.  Each use of the strategy must result in a net cash gain.

  • The replacement strike price must be higher than the existing strike price. 

Interim Trades are established to generate cash while a stock is depressed.  Remember, the fundamental purpose of SysCW is being paid because stock is in a portfolio. Some will pay more than others at times, which is why diversification is stressed. Having said that, let's take a look at the details of this holding.

      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 10-Oct-07
10-Apr-06 Initial Stock Purchase Buy 100 RMBS @ 41.77 ($4,184.00) TDS Used   $2,107.00
  Current Price $21.07 Rambus Inc        
10-Apr-06 Initial Call Option Sell '07 Jan $40 LEAP @ 12.20 Lowered 5/15/06 $1,211.71    
15-May-06 Buy Back & Lower Buy '07 Jan RMBS $40 LEAP @ 3.30   ($338.25)    
15-May-06 Interim  Position Sell '07 Jan $35 LEAP @ 4.90 Lowered 7/26/06 $481.73 E-mail 5/15  
26-Jul-06 Combo Buy Back & Lower Buy Jan $35 LEAP @ .75   ($83.25)    
26-Jul-06 Dollar Cost Averaging Buy 100 RMBS @ 15.97 ($1,604.00)     $2,107.00
$CA $5,788.00 200 @ $28.94 Combined 200 Share Position        
26-Jul-06  Interim  Position  Sell two '07 Jan $25 calls @ 1.50 Expired 1/20/07 $290.49    
23-Jan-07 New Interim Trade Sell two Feb $20 calls @ .70 Rolled 2/05/07 $130.49    
5-Feb-07  Buy Back & Roll Out &Up  Buy two Feb $20 calls @ 3.20   ($649.50)    
5-Feb-07 Interim Trade Sell two Aug $25 calls @ 3.50 Expired 8/18/07 $690.47    
20-Aug-07  Interim Trade Sell two Jan $17.50 calls @ 1.15 Rolled 10/10/07 $220.49    
10-Oct-07  Buy Back & Roll Out &Up  Buy two Jan $17.50  calls @ 5.10   ($1,029.50)    
10-Oct-07  Interim Trade Sell two '09 Jan $20 LEAPS @ 7.10   $1,410.47    
               
  Cash in Hand 40.35%       $2,335.35 Kids

Notice the interesting use of the Dollar Cost Averaging strategy as the same time the Buy Back and Lower strategy was used in July of 2006. 

As mentioned above, this holding is in the online $100k portfolio. This Portfolio happens to be taxable . . . with this in mind, take a look at the Jan $17.50 position that was closed today.  Note that only 'closed' equity positions are reported to the IRS.  Do you see a side benefit of closing this option this year? The cost basis for the option is $1,029.50, which is what the writer had to pay to close the option today. The proceeds for the option were established when the contracts were sold in August. So . .  by closing the option today the writer established a $809.01 realized capital loss for the 2007 tax year ($220.49 - $1029.50 = - $809.01).

A second benefit of today's activity can be found in the difference between the cash in and the cash out.  The math of the BB&RO&Up ends up as a net gain of $380.97.  This is the net effect of rolling the position. On top of that, the strike price was increased from $17.50 to $20 a share.

This is not the greatest position in the world, but factor in that the position started with a cost basis of $41.84 a share, it really is not all that bad either. The position has been active for about eighteen months and has generated slightly over 40% during that time frame.  More work is needed, but for now the writer is the winner of the game of chicken.

The cash that was generated with this strategy can be combined with other cash to establish another position. 

Additional information on the use of strategies is always available in the frequently asked questions section, the Glossary, and especially in the discussion of each strategy.  These discussions are accessed by clicking the strategy button on the left side of the Home page on the SysCW website.  Here are the links to  FAQS  and the SysCW Glossary.

PLEASE NOTE THAT THIS EXAMPLE IS NOT TO BE CONSIDERED AS A RECOMMENDATION TO INVEST IN RMBS 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 © 2007. All rights reserved.
Revised: 10/23/07