SNDK
SanDisk Corporation
THE POSITION DATE : October 2005 to August 2007
THE STOCK: SanDisk Corporation (SNDK) designs, develops, markets and manufactures products and solutions in a
variety of form factors using its flash memory, controller and firmware technologies.
THE STRATEGY: The Buy Back & Roll Out
& Up (on more than one occasion)
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.
-
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 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: FYI . . . SNDK closed at $36.42 on February 28, 2007! By now, a reader should know
why this is being pointed out . . . for it has to do with the whole 'value' issue. Imagine if instead of that initial 07Jan $55 LEAP, if
a writer would have used a short-term call? Yes, they may have generated 3 to 5% for one month . . . but where would they be
today? The advantage of the longer term Initial Positions lies in the extra downside protection and that fact that a writer does not
have to trade (and be right) every month. With this in mind . . . check out the entire history of the SNDK position.
Note the sequence of transactions and the SysCW strategies employed:
- Initial with a duration in excess of one year! (call expired)
- Interim Trade established with a strike price $7.50 below the previous. (call expired)
- Interim Trade established with the Jul $45 strike price. (call rolled)
- The Combo Buy Back & Roll Out & Up strategy was used to prevent the stock from being sold at $45 a share,
lower the cost basis from $54.92 to $51.00, and generate cash ($530.49 minus $293.25).
- The Buy Back & Roll Out & Up strategy used to prevent the stock from being sold for $47.50, increase the
strike price and add cash to the position ($1,770.47 minus $1,149.50).
Check it out! The stock, as of August 3, 2007 is trading above the $51 cost basis, which basically means there is no longer any
loss in 'value'. If an investor was a 'value' oriented person, he or she may have sold this stock when it was trading at $36.42 in
February. After all, at that time, the cost basis for the 100 shares was $54.85, so the loss was in excess of 33%. (Where is
that stop loss?) The diligent covered writer is not concerned with the value, but rather the cash generation.
Okay . . . so how is
this position doing? October of 2007 will mark the two year anniversary . . . we aren't there yet! The position has generated
44.22% in cash, whereas the guideline is for 30% at the end of two years. With the SysCW strategies, this writer has almost three years
of cash generation . . . in the bank!
In January, if SNDK is trading above the $50 strike price . . . the writer could either roll
out to another $50 or possibly decide to increase the strike price. Keep in mind that the position has already generated over 44%,
which means the writer could go either direction and still be within the guidelines.
Seriously . . . this is a very nice position.
Will they all work out like this? Absolutely not! The position is but one tree in the forest of investments. We learn to
take the good with the not so good.
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 SNDK 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:
08/04/07