Systematic Covered Writing

... more than just covered calls!

Buy Back & Lower Example

---

The Buy Back & Lower strategy is one to be used by those writers who are willing to increase the risk on a given position. It is an important Systematic Covered Writing strategy as it allows a writer to add additional cash to a position over the same period of time.  Caution should be used, for if the stock appreciates above the lowered price, action will be needed to prevent the stock from being sold at the lower price.  But . . . that's one of the reasons there is a Buy Back & Roll Out & Up strategy.  So . . . this is the 'Do you feel lucky?' strategy that is used under the SysCW philosophy.

---

AGIX   AtheroGenics, Inc.

DATE: December 11, 2006

PURPOSE: The idea behind this strategy is to try and increase the amount of cash generated per unit of time.  The expiration month remains the same, but with a lower strike price.  This strike price must be above the current trading price of the underlying stock, and one high enough that the writer does not 'think' the stock will reach.  If the strategy "works", the writer will have more cash than if he or she had done nothing. If the strategy does not work, the writer will wish the strike had not been lowered! There are two possible outcomes. The question becomes . . . do you feel lucky?

COMMENTARY: Life happens!  For this writer there was a need for cash, but rather than liquidate a position, the writer rolled an existing option. Here is why . . . . once an investor removes principle from a portfolio, it no longer can generate capital.  As long as the principal is in tact, the investment can generate new capital.  It is this generated capital that can be removed if necessary. Having said that, take a look at the history of this position.

Note that two separate positions were combined to make the existing 200-share position.  The Initial Positions began within six days of each other. Because AGIX had lost value, the writer was able to close the existing options and sell a lower priced option with an extended term.  PLEASE NOTE . . . that this is not the normal Buy Back & Lower strategy as one of the rules of the strategy is the term cannot be extended.  This is an exception to that rule, but there is a reason why the exception is allowed.

Remember, the purpose was to generate 'free cash' for withdrawal.  To close the existing Initial Call Options the writer had to spend $271.50 ... ($153.25 + $118.25 = $271.50), but then received $1,250.46 from the sale of the '08 Jan $15 LEAPS. The net result of the Buy Back & Lower was the 'creation' of  $978.96 in cash.  Mission accomplished, but what about breaking the rules?

Okay, look at the current arrangement.  Someone has the right to buy these 200-shares of AGIX for $15 a share.  Let's say they did just that! The writer would receive approximately $2,983.00 for the stock.  This would mean the writer would lose the difference between the investment ($3,985.89) and the proceeds ($2,983.00) or $1,002.89.  So how would the position end?  Take the $1,002.89 from the cash generated total of $3,062.37, and you have the net back-to-cash result of the position, which happens to be a gain of  $2.059.48. This is why the rule could be broken! 

So . . . if the math works, a writer can break the 'rules'.  If the price of AGIX is below $15 in January 2008, this will end up being a phenomenal position. Also note $3,985.89 has generated $3,062.37 in less than a year!

CAUTION: Nobody knows!  Normally with the Buy Back & Lower strategy, if the stock is below the lowered strike price on expiration Friday, additional cash would have been generated over the same holding period.  Extra cash is good, and that is the objective of this philosophy. On the other hand, if the stock recovers and is trading above this "lowered" strike price, then the  position would normally need to be rolled.  The point . . . If this happens a covered writer would have been better off not using the strategy. Understand this risk before entering the transactions.  The rational behind this trade was the need for cash.  The need justified the increase in risk.

The Covered Writer

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