SYSTEMATIC COVERED WRITING

As you consider this strategy, you may find it valuable to read the frequently asked questions section and the Glossary on the SysCW website. Here are the links to

and the SysCW

Thought process: Imagine establishing an Initial Position and when the expiration month arrives, the stock has lost value and the option expires. The price of the stock is such that selling a new call at the same strike price is not practical because of the minimal premiums. No problem . . . a covered writer would then recover the stock with an Interim Trade strike price option. By definition, this is an option that the covered writer does not want to be exercised.

The Buy Back & Roll Out & Up strategy does not work mathematically, meaning the cash received for the Roll Out option is not greater than the cash needed to close the existing option. Keep in mind . . . the idea is to always add cash by the time trading is finished for the day. There is a solution and that is the Combo BB&RO&Up strategy where a covered writer combines the Dollar Cost Averaging strategy with the BB&RO&UP strategy.

The Strategy: The situation for using this strategy is when a stock is trading close to or above the current strike price, and there is a need to prevent the option from being exercised. This will generally occur when a position is in an 'Interim Trade' status. Two keys to the success of Systematic Covered Writing is the observation that it is very unlikely for an option to be exercised early, particularly if there is extrinsic value left in the option. A covered writer also has strategies to use which prevent options from being exercised.

For review of extrinsic value just remember that If you subtract the option strike price from the trading price of the stock you will have the intrinsic value. In order for an option to have intrinsic value, it must be trading above the strike price. The option must be 'worth' at least this intrinsic amount. (For the option it is the BID price that should be considered.) The difference between the option BID price and the intrinsic value is the extrinsic (also know as the 'time') value of the option. The larger this number is, the less likely the option will be exercised.

Put them all together and you have the Combo BB&RO&UP strategy. Without trying to get too far ahead, keep in mind that at some point you can sell off part of the position and then continue with the original cost basis. Sometimes the purchase of additional shares is a 'permanent' holding. This is particularly true if the existing holding is only 100 shares. Ultimately, you want 200 share positions to reduce the effect of trade commissions. Just not in the beginning.

The rules for this strategy are the same as the Buy Back & Roll Out & Up strategy.

When the three transactions are entered you will have increased the total amount invested in active stock positions and you will have increased the net amount of cash generated. The amount of cash generated with the Roll Out Option must be greater than the cash used to close the existing option. Once again, the main concern of covered writing comes to mind. Many pages ago the following statement was presented.

"The writer of a covered call gives up the opportunity to benefit from an increase in the value of the underlying stock above the option price, but continues to bear the risk of a decline in the value of the stock. Unlike a holder of the stock who has not written a call against it, the covered call writer has (in exchange for the premium) given up the opportunity to profit from an increase in the value of the stock, above the exercise price. If the option he sold is exercised, the net proceeds that he realizes from the sale of the stock due to the exercise of said option, could be substantially below its prevailing market price."

If this statement was an absolute fact (as it is presented), an investor would never want to write a call below the 'break-even' cost basis of the underlying stock. By using the strategies of Systematic Covered Writing, the primary concern of that statement is addressed in a satisfactory manner. The key difference is the understanding that the word 'may' is missing! The statement is only true if the seller of the option does nothing! The following examples show you 'what' to do. No magic here. No highly unlikely concept, but rather a simple strategy that is duplicatable. Over, and over, and yet over again. You be the judge. . .

In order to use this strategy, additional shares of stock need to be purchased. The source of this cash can be positions that can be closed early, cash in the money market or margin balance. Note that this is one reason not to be fully invested in a margin account (using the max of 25% rule) and why it's okay to let positions sit in an IRA that could be closed. The basis for making these decisions is by knowing where you are in each position, which is the purpose of the position tracker.