Systematic Covered Writing

... more than just covered calls!

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Dollar Cost Averaging is an important Systematic Covered Writing strategy. Having something to do, other than giving up, when a stock loses value allows writers to cope with an ever changing market place.  Some would say to just dump the losers and move on.  Many actually follow that philosophy, and the covered writer believes there are two reasons why this is so:

1. It is the only 'plan' they have.
2. They somehow think they will be 'right' with the next selection.

If there is no 'plan', what else would an investor do?  Many will continue to use stop losses or exit strategies.  The SysCW philosophy is to have a plan, and this is another example of this plan in action.  Some examples will be cases where the  Dollar Cost Averaging strategy was the latest strategy implemented, while others will illustrate the benefits of the strategy as the position continues to generate additional cash.

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Dollar Cost Averaging Example

THE DATE: January 4, 2007

THE STOCK: ImClone Systems Inc (IMCL) is a biotechnology company that develops, manufactures and commercializes monoclonal antibodies for the treatment of solid tumor cancers.

EXAMPLE TYPE:  This is an interesting example of planning ahead.  The 'averaging' will (may) not take place until 2008, which seems odd given that 2007 just began! The reason the hedge (may) is in the previous sentence will be discussed below.

COMMENTARY: The situation is as follows:  In this portfolio there is an existing IMCL position that has been discussed in previous email messages to subscribers.  The last message was distributed on August 8, 2006 when the stock was recovered with the '08 Jan $35 LEAP.  The data for this position, as maintained in the Position Tracker is as follows:

Note that the strike price has remained the same since the position was established in January 2005. As of the August transaction, the position has generated over 48% of the total investment.  The stock is currently trading below $30, which is why this unusual Dollar Cost Averaging idea came to mind.

What if the writer purchased another 100 shares of IMCL now, and sold a second '08 Jan $35 as a potential Combo transaction. Take a look at the data for this new position first, after which the commentary will be continued.

The writer was willing to accept downside protection of 10.61% for two reasons.  One is the idea of using this position as a Dollar Cost Averaging position in 2008. The writer could combine the two positions in the Position Tracker right now, but there are scenarios where the $CA strategy would not be used. With this understanding, and for the sake of clarity, take a look at what the combined positions would look like by first looking at how the two positions are listed one after another, and then how they would look if combined.

The combined view shows that the cost basis for the 200 shares is $34.64, which is below the strike price of $35.  Now look at the down side protection!  With both positions added together, the downside protection, or cash generated percentage is 32.31%. This percentage is arrived at by dividing the total cash generated ($2,238.66) by the total 200 share investment ($6,927.80).

With this 'combined' view . . . think of the possible outcomes:

•    The stock appreciates significantly and the entire position is assigned. That would be good!
•    The stock is trading slightly above $35 and the writer can let the new position be assigned and roll the older position either Out or Out & Up. This would be good also.
•    The stock could be trading slightly below $35 and the writer could recover the 200 share position after expiration. Given that over 32% has already been generated, this would be just fine.
•    The stock could be trading significantly below $35, which would be the only less than satisfactory outcome.

As additional rational for entering this new IMCL position, take a look at a price chart of this stock for the last two years.

The red line represent the $35 strike price. It would appear that the stock has more of a chance of being below $35 than above.  If that is true, the Dollar Cost Averaging would need to be completed eventually in order to have the cost basis of the position be close to the strike price. 

If the price of IMCL is below $30 in 2008, the writer could decide to $CA again in order to further reduce the cost basis.  This would open the door for the sale of $30 options.  For now, there are two positions.  As cash is generated, the funds need to be invested in 'something'.  At times, the writer will use the funds to 'help out' an existing position as in this example.  At other times the writer will use the funds to establish new positions.  It's all part of the process.

Please direct comments or questions to rlcoveru@eavecable.com.

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

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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