Systematic Covered Writing

   

          TASR     TASER International, Inc.

THE POSITION DATE :    June 30, 2004 to June 2007

THE STOCK: TASER International, Inc. (TASR) develops and manufactures electronic control devices (stun guns) designed for use in law enforcement, corrections, private security and personal defense.

THE STRATEGY:  The Buy Back & Roll Out & Up

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. 

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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.

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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 options without the fear of the stock being assigned.  Note:  the strike price for an Interim Trade option should always be above the trading price of the stock at the time the call is sold.

THE COMMENTARY:   This position has been active since June of 2004.  Before discussing the recent BB&RO&Up transactions, it will be worthwhile to discuss the previous activity with this holding.  The discussion begins with the establishment of the original Initial Position. One advantage of the Position Tracker lies in the ability to look back at the entire history of a position without looking through months of brokerage statements.  We learn what to do in the future from what we have done in the past.  If a process cannot be repeated over an extended period of time, it is not worth using in the first place.  This is, and always will be the opinion of the Covered Writer.

As you can see, the premium for the Initial Call Option was significant!  The position generate over 26% of the investment with the Initial call.  Note that if the price of TASR had remained above $40, the writer would have 'given back' $3.42 of the $11.60 in premium. But . . . the writer would have retained the difference, or $8.18, against a $43.42 investment for six months.  If you do the math, you will see that this would have worked out to over a 37% back-to-cash generation rate when annualized.  Needless to say . . . the math worked!

August 9, 2004 - With TASR trading at $27 a share, the writer had two choices.  One would be to do nothing and just continue to wait for the December expiration. There would be nothing 'wrong' with this approach given the position had already generated over 26% in new cash.

The other possibility was to be pro-active and attempt to generate additional cash with the same investment given the fact that the stock had lost about $17 in value.  The writer elected to use the SysCW Buy Back & Lower strategy in order to increase the total amount of cash generated.  Here is a view of the updated Tracker information:

The writer used $208.50 to close the Dec $40 call, and then immediately replaced the cash with $410 by selling the Dec $30 option.  Note the expiration month is the same, just the strike price is lower. Note also that the total cash 'created' was now $1,344.46 or 30.91% of the net investment.

November 17, 2004 - Shoot!  TASR was now trading at over $57 a share!  Obviously, the Buy Back & Lower strategy was not productive given that the stock had moved back above the original strike price.  This is part of the 'nobody knows' aspect of investing in general. In this case, the writer would have been better off leaving the original position alone . . . it is important to understand that this is one of the risks of the Buy Back & Lower strategy.  When it works . . . it generates extra cash over the same time period.  When it does not work . . . one would wish they had not used it in the first place!

The writer did not want to sell the stock at $30, so the SysCW Buy Back & Roll Out strategy was used to prevent the holder of the Dec $30 option from winning the game of chicken. The data:

Check it out . . . even though the stock was trading at $57, the writer was able to create positive cash flow by rolling the Dec $30 call to the Jun $30 call. Think about the overall objective of Systematic Covered Writing. The object is to have investments generate 15% in new cash per year, regardless of the change in value of said investment.  Well look at the math.  Five months into this position, the net cash investment of $4,349.00 had generated over 34% in new cash. This is exactly why the writer decided to roll out to the Jun $30 position. Thirty-four percent is 34%, and the writer is simply not worried about the strike price being $13.42 below the purchase price.  Why?  Because the writer is not finished . . . the writer is not going to allow the $30 option to be exercised.

Part of the price run up late in 2004 was cased by the pending 2:1 stock split which took place on November 30, 2004. Once this happend, the position became 200 shares with an adjusted cost basis of $21.75 per share, and two Jun $15 options.

June 20, 2005 - TASR lost significant value between the end of 2004 and June 2005. On June 20, 2005, the stock closed at $10.52.  With a post split cost basis of $21.75, this meant that the stock had lost over half its value. The two Jun $15 calls expired, and the writer sold two Sep $12.50 calls using the SysCW Recover After Expiration strategy.

Keep in mind  that June of 2005 represents the end of the first year.  With the sale of this newest option the position had generated over 37% of the net cash investment in twelve months.  Note that a 'value' watcher would have probably sold this position at a loss. The writer, on the other hand, focuses on the cash being generated and not the value of the stock, for that is something that cannot be controlled.

SECOND POSITION - In January of 2005, the writer elected to establish a second two-hundred share position using TASR.  The rational was to combine the two positions at some point in time, which in effect would make this second purchase part of a SysCW Dollar Cost Averaging strategy.  Of course, if TASR had recovered during 2005, the writer would have allowed this second position to be assigned.  That . . . unfortunately that did not happen.  Here is the second position data . . . keep in mind this is a completely separate holding in the portfolio until September 2005.

As you can see both this new two-hundred share position of TASR and the original had options with September expirations.  As it turned out, both options expired, and the four-hundred share position was recovered as follows.

Recall that the initial 100 shares became 200 via the two-for-one stock split.  On September 19, 2005 four of the Mar $10 calls were sold against the combined position.  At the time, the stock was trading at $7.52. With a cost basis of $19.09 . . .this would qualify as a 'significant' loss. 

March 15, 2006 - As the March expiration approached, TASR moved above the $10 strike price.  This is one of those events that can happen, and all a writer needs to know is what to do if it does happen.  Given that the cost basis was close to $20 a share, and the strike price was only $10 a share, the writer elected to use the SysCW Buy Back & Roll Out & Up strategy.  This strategy ends the game of chicken while increasing the strike price.

Note that additional cash was generated through the use of the strategy, and the new option was the '07 Jan $12.50. As luck would have it, TASR lost value once again and the $12.50 calls expired. 

January 23, 2007 - Using the SysCW Recover After Expiration strategy once again, the writer elected to sell four of the Jun $10 calls.  At the time, TASR was trading at $7.82.  This last look at the historical data brings the position up to June 2007.

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June 6, 2007 - Today . . . TASR was trading above $10 again.  With less than two weeks to go before expiration, the writer decided to use the SysCW Buy Back & Roll Out & Up strategy once again to prevent assignment at $10 and to increase the strike price (again). Here is the current view of this position as maintained with the Position Tracker:

Let us not forget that this is a position that has lost significantly more than half its value during the holding period.  At the same time, including today's activity, the position has generated 43.90% of the total net cash investment.  This happens to be the end of three years for 200 shares and two and a half years for the other 200.  Given the loss in value, the fact that the position has generated close to 44% in new cash makes the value issue more palatable.

CONCLUSION - Some holdings will produce stellar returns, others will not.  From the writer's perspective, this investment has generated 43.90% over the holding period.  The value is the value . . . and it is the one aspect of writing calls that the investor cannot control.  The key now is to stay ahead of the trading price of TASR . . . just in case it really is ready to appreciate towards the cost basis of $19.09.

As always . . . please feel free to ask questions or offer comments to rlcoveru@wavecable.com.

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PLEASE NOTE THAT THIS EXAMPLE IS NOT TO BE CONSIDERED AS A RECOMMENDATION TO INVEST IN TASR 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: 06/06/07