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."

    Example Index

SNDK    SanDisk Corporation

THE TRADE  DATE :    July 10, 2006 through January 10, 2007

THE STOCK: SanDisk Corporation - (SNDK) designs, makes and markets flash memory storage products used in a wide variety of electronic systems.

THE STRATEGY:  Buy Back & Roll Out & Up

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 option needs to 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.

THE THEORY:   The Initial Position is established with two noninvolved outcomes.  Either the call will be exercised, or it won't!  There is a third choice though, which requires action on the writer's part.  If the stock is one that is desired for a longer time period, the writer can Buy Back the existing call and either Roll Out, or Roll Out & Up. It is this second strategy which was used today to prevent the 100 share position of SNDK from being called.

THE COMMENTARY:   As always, the example begins with an Initial Position.  The first transactions took place in February 2004 as can be seen in the data below:

      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-Jan-07
10-Jul-06 Initial Stock Purchase Buy 100 SNDK @ 43.69 ($4,377.00)     $4,600.00
  Current Price $46.00 SanDisk Corporation        
10-Jul-06 Initial Call Option Sell Jan $40 call @ 8.80   $870.72 Email 7/10  
               
  Cash to Date 19.81%       $870.72  

As you can see from the notation in the Cash Generated column, subscribers received notification of this Initial Position back on July 10th when it was established. Today,  January 10, 2007, the stock is trading at $46 a share, and the writer has a choice. If the price holds above $40, this stock will be assigned. Remember: . . . Who is in charge? . . . The writer can choose to allow assignment, which is always one of the reasons ‘they’ say not to write calls against stock, or the writer can do something about it . . . if he or she wants to!

The Systematic Covered Writing Buy Back & Roll Out & Up strategy can often be used to play both sides of the fence, which is exactly what happened today with this position. The writer bought back the $40 call for $6.30 and sold the ’08 Jan $45 LEAP for $9.90. Cash was added to the account and the strike price is now above the purchase price. The data for the completed trade is as follows:

    SysCW   Position Tracker    
               
Historical Data Open Position  
        Stock Cash Total Cash Value as of
Date Strategy Status Position Investment Generated Generated 10-Jan-07
10-Jul-06 Initial Stock Purchase Buy 100 SNDK @ 43.69 ($4,377.00)     $4,600.00
  Current Price $46.00 SanDisk Corporation        
10-Jul-06 Initial Call Option Sell Jan $40 call @ 8.80   $870.72 Email 7/10  
10-Jan-07 Buy Back & Roll Out & Up Buy Jan $40 call @ 6.30   ($638.25)    
10-Jan-07 Appreciated Trade Sell '08 Jan $45 LEAP @ 9.90   $981.71    
               
  Cash to Date 27.63%       $1,214.18  

Note that the decision was to increase the strike price, and not maximize the cash generated. The writer is a long-term investor, and as such, realizes that something needs to be owned.  SanDisk is one of those sector leading companies which the writer would like to maintain in this portfolio. By increasing the strike price, the entire Initial Call Option premium of $870.72 will be kept, as well as the difference between the cash-out and the cash-in Buy Back & Roll Out & Up transactions that took place today.

This is because the strike price is now above the cost basis if the underlying stock. It is interesting at this juncture to compare the increase in 'value' (about $223) with the total cash generated ($1,214.18). 

CONCLUSION -   The application of various strategies based on 'the math' make up the process known as Systematic Covered Writing. Some positions will do better than others.  Not only is that part of the 'game', it is also why diversification is so important.  The goal for 2007 is to not only write those words, but adhere to them!

Example Index

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.

Thank you!

SYSTEMATIC COVERED WRITING
Copyright © 2005. All rights reserved.
Revised: 02/05/07

 

 

 

 

 

Date Strategy Position Investment Generate Total
13-Feb-04 Initial  Stock Purchase Buy 100 CREE @ 24.23 ($2,423.00)    
      Cree Inc.      
13-Feb-04 Initial Call option Sell Jun $25 call @ 2.50 Expired 6/18/04 $225.00  
21-Jun-04 Interim Trade Sell Jan $22.50 call @ 2   $175.00  
30-Nov-04 Combo BB&RO&Up Buy Jan $22.50 call @ 13.90   ($1,415.00)  
30-Nov-04 Dollar Cost Averaging Buy 100 CREE @ 36.0696 ($3,631.96)    
$CA $6,054.96 200 @ $30.27 Combined Position      
30-Nov-04 Continued Trade Sell two Jun $30 calls @ 8.80 Expired 6/18/05 $1,735.00  
20-Jun-05 Continued Trade Sell two Dec $30 calls @ 2.30   $435.00  
            $1,155.00

 

Update -  The June $30 call expired and was replaced with the Dec $30 option.