Systematic Covered Writing

... more than just covered calls!

Close it or Wait Example

This is the 'go back to cash' Systematic Covered Writing strategy, which is respectfully named "Close it or Wait". There may be times when cash is needed for a variety of reasons, or it is possible that a stock has significantly appreciated, and the question becomes, should the writer wait for expiration, or should the writer just go back to cash.

As with all SysCW examples, the transactions listed within the information that follows, took place on the dates listed.  Note that historical executions of various transactions may, or may not, be repeated in the future.

"REALITY: It is only when a position goes back to cash that the actual 'profit' or loss can be determined.  This truly is a case of 'it's not over until it's over".  During the active holding period cash is generated.  When the position is closed, the net result of buying and selling of the stock is factored into the 'cash generation' equation.

Example Index

         NVDA  NVIDIA Corporation

THE TRADE  DATE :    June 26, 2007

THE STOCK:  NVIDIA Corporation (NVDA)

THE STRATEGY:  Close it or Wait?

THE THEORY:  Today's example is an illustration of position management using Systematic Covered Writing strategies. More often than not, the writer will establish long-term covered positions. While other strategist suggest short-term positions, which need to be repeated continuously in order to generate the 'expected' yearly profit, the writer tends to establish the longer term holdings for reasons that have been explained previously.  One of the benefits of the SysCW system is the added cash that is generated at the time the options are sold.

THE COMMENTARY:  One nuance of a longer term holding comes from the understanding that the position can be closed early if the underlying stock appreciates significantly. The writer uses the Close it or Wait Math exercise to evaluate the possible benefit of going back to cash early. Take a look at what the writer saw prior to closing this position.  The key information is at the end of the exercise . . .

             
  Systematic Covered Writing  
  … more than just covered calls!  
           
  Close it or Wait?    The Math Exercise  
             
  Position:          
             
  NVIDIA Corporation with NVDA Jan 2008 25.0000 call
             
  Stock Symbol NVDA   Current Price $40.85  
             
  Number of Shares 100 Option Symbol     .YBTAE  
             
  Net Investment $2,232.99 Existing Strike Price  25.00  
             
  Net Cash Generated (1) $447.23        
           
  Strategy:  Use Systematic Covered Writing to Maximize Cash Generation  
           
  The Question:  Is it better to close the position now, or just wait for it to be called?  
             
  Step 1: Determine the back-to-cash result of closing the position today.    
             
  Ask price for the option $17.10 Net cost to close Option $1,718.75  
             
    Net proceeds from stock sale at current price $4,077.33  
             
    Net Back-to-Cash amount generated $572.82  (A)
             
    Net Back-to Cash percentage gain   25.65%  
             
  Step 2: Determine the back-to-cash result of the existing option being exercised    
             
  Net proceeds from the stock sale if the option is exercised $2,483.00    
             
  Net Back-to-Cash gain if the option is exercised $697.24  (B)  
             
  Net Back to cash percentage with assignment 31.22%    
             
             
  If the position is closed now, you will wind up with the amount shown in box (A)  
  If you wait for the option to be exercised you will have the amount in box (B)  
             
  You are not quite ready to decide.          
             
  There are two key data points that must be considered.  These points are the key to answering the question - "Should you close it . . . .or Wait?" The first issue is how much cash will become available if the position is closed now?  In other words, how much cash will be available?  
    Available Cash    $2,358.58  
             
  The next question has to due with the potential cash gain that is 'lost' or 'given back' by closing the position early.  In other words, if nothing is done, and the call is allowed to be exercised, how much additional cash would this position generate?  
      Cash 'Lost' . . . $124.42  
             
  Now you are ready to decide!  Can you replace the cash that is given back by closing the position early with the proceeds that become available?  
             
             
             
  In order to close a position early, you must be able to generate more than the difference between (A) and (B) with the cash that becomes available when the existing position is closed.  
             
             
  (1) The net cash generated is the total amount of cash generated to date by this position.    
             

Notice that $2,358.58 will become available by closing the position and that $124.62 of potential profit will be given back.  The question reduces to: "Can a writer generate more with the cash now available than the amount given back by closing the position early"?  It is hoped that this question is a rather easy one to answer based on Initial Position examples with a duration of around six months.

Does it make sense to close the position early?  Take a look at the Closed Position data as maintained in the Position Tracker.  Realize that because this position was active for slightly over one year, the annualized gain percentage is a very 'real' number. Nothing needs to be repeated in order for $2,232.99 to grow by 24.37% annually because it already has and is back to cash.

      Systematic Covered Writing      
              . . . More than just covered calls . . .      
      SysCW   Position Tracker        
               
Historical Data Closed Position  
        Stock Cash Total Cash  Annualized 
Date Strategy Status Position Investment Generated Generated Gain
7-Jun-06 Initial Stock Purchase Buy 100 NVDA @ 22.25 ($2,232.99)      
      NVIDIA Corporation        
7-Jun-06 Initial Call Option Sell '08 Jan $25 LEAP @ 4.56 Closed 6/26/07 $447.23 Email 6/07/06  
26-Jun-07 Buy Call to Close Option Buy '08 Jan $25 LEAP @ 17.10   ($1,718.75)    
26-Jun-07 Sell Stock to Close Position Sell 100 NVDA @ 40.852 $4,077.13 $1,844.14    
26-Jun-07     Net Cash Gain     $572.62 Annualized
384

Days

         25.64% 24.37%

One final comment.  There are two ways positions are closed using the Systematic Covered Writing process. One way is to simply allow the stock to be assigned.  There are numerous examples available on this Web site.  The other way is to manually close them early as was the case with this NVDA position.

Questions?    rlcoveru@wavecable.com

Return to Links

PEASE NOTE THAT THIS EXAMPLE IS NOT TO BE CONSIDERED AS A RECOMMENDATION TO INVEST IN NVDA 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 © 2006. All rights reserved.
Revised: 06/27/07