Systematic Covered Writing

 . . . more than just covered calls . . .

ONXX - Going With The Flow

THE DATE: February 12, 2007

THE STOCK:  ONYX Pharmaceuticals Inc. - (ONXX) This company discovers and develops novel cancer therapies and has proprietary technologies that target the molecular basis of cancer.

THE STRATEGY:  It seems like just the other day the covered writer was writing about stocks that lose value, and used ONXX as an example.  So, to those that have 'value' issues, how about the value of this stock today? On February 12, 2007 the stock traded up over $12 to close at $12.15.  The strategy needed today involved prevention of a stock from being assigned at an unfavorable strike price. Given that the price of the stock doubled today, the writer would say that this presents an extreme example of price fluctuation.  No problem . . . Systematic Covered Writing can deal with extremes.

The SysCW methodology suggests that value will go down and up, or up and down in spite of our best efforts to pick 'good' stocks. So long as one is a long-term investor, the idea is to semi-ignore value, for it cannot be controlled. Easier said than done, but if you read some of the longer term examples, where value has been an issue, you will see that more often than not, positions end with a gain.

THE COMMENTARY: For this portfolio, there were two separate ONXX covered positions.  Let's begin with a look at how they looked on Friday February 9, 2007 as maintained in the SysCW Position Tracker.

First, note the Row indicator column . . . then note the value of the two 100-share positions on rows 1 and 9 as of market close last Friday.   Rows 1 - 8 are the older position, rows 9 -14 are the newer position, which happened to be established a year later than the first position.

First Position & Strategy

Even though they are the same stock, they are separate positions in the covered writer's eyes. In July of last year, the decision was made to use the Buy Back & Lower strategy in order to increase the amount of cash this 'losing' position had generated.  The word losing is only used to identify the fact that the value of the underlying stock is (was) depressed.  There are those that focus on value and out of respect for their thought process this position is referred to as a 'loser'.

Of course from the Systematic Covered Writing point of view, the position is not a loser at all, but rather an asset which had produced 30.10% of its cost basis as of last Friday. Even with today's movement, the Feb $22.50 strike looks good.  If this were the only ONXX position in the portfolio the Feb $22.50 could have been rolled Out & Up ... easily! At market close the Feb $22.50 call could be purchased for $2.30 and the May $25 could be sold for $2.65 using the Buy Back & Roll Out & Up strategy.

In one day, this position would have changed from a 'loser' to a winner!  So much for value.  In the writer's eyes, it would simply be an asset that is used to generate cash.  Some assets are more attractive than others. Again, if this were the only ONXX position, that is probably what would have taken place today.

Second Position & Strategy

The second position was establish as either a pre-Dollar Cost Averaging position, or as a profitable shorter term Initial Position.  If the stock had been trading above $15 in January, assignment would have taken place with an above average annualized return.  That was Plan A.  Well, the stock was below $15 in January, so the writer opted for plan B.

Using the new short-term Recover After Expiration strategy, the Mar $12.50 call was sold.  The plan was going to be to sell a second Mar $12.50 call when the Feb $22.50 call expired.  Keep in mind that as of last Friday, when the stock was trading at $12.26, this plan was 'looking good'. The writer would have combined the two positions into one, and continued selling short-term calls while waiting for the stock to appreciate. The asset was to produce cash . . . in spite of its value.

Favorable Trial Results &  the Current Strategy

What a difference a day makes!  Unfortunately,  an issue arises with the second position. Not a huge issue, given that the position would have ended with a small gain if the writer chose to do nothing.  If fact, the first position would have ended with a decent back to cash profit. Now . . . given that we want to be diversified, and given that ONXX was already in the portfolio, and add in the fact that good news just occurred, why not keep the ONXX holding? For record keeping illustration, I'm going to display the previous tracker again as I explain what I do in Excel when I combine positions.

To combine the positions I delete rows 7&8 and row 10.  In doing so, the line that separates the two positions is eliminated.  I then click on what was row 13 and insert four additional rows. Here is what the rows will be used for:

1. Record the transaction closing the Feb $22.50 call.
2. Record the transaction closing the Mar $12.50 call.
3. Used to display the combined position data.
4. Record the replacement option position.

Two other bookkeeping tasks are to make sure the AutoSum feature is adding all the data in the Cash Generated column, and adjust the Cash in Hand percentage by dividing the Total Cash Generated by the combined cost basis. Here is how it looks now:

Rows 10 - 13 are the four new rows.  The $3,922.99 is simply the sum of $1,540.99 and $2,382.00 expressed as a positive number. The number of shares and the price are now net including commissions.  Therefore, the cost basis can easily be seen by looking at the yellow section when positions are combined.

Understand that when a stock doubles in one day, there is significant extra extrinsic value in the option pricing.  It was mentioned in the email message that at some point half this position could be closed at a 'nice' profit in six months or so.  Keep in mind this is hypothetical . . . but I hope you realize it is based on a reasonable thought process. (Six months may be a bit off, but at some point.)

Here is the only assumption:  At some point in time, with ONXX stock is trading at about the same price it is today. The '09 Jan $17.50 LEAP could probably be closed for the same price for which it was sold for today.  If that were the case, AND the writer wanted to liquidate half the position, here is how the hypothetical data would look:

Please note that this is a hypothetical.  If, at the beginning of next year, ONXX is trading where it is today, AND the call could be closed for the same price it was sold, the positions could be split apart again. One purchase would be closed with an annualized return of 14.70% and the other position would still have the active '09 Jan $17.50 LEAP.  Needless to say, that option would need to be rolled.

The whole point of looking at a hypothetical like this is to realized certain aspects of Systematic Covered Writing:

1. Just because long-term options are sold, does not mean the writer has to wait until they expire.

2. Positions that are combined can be separated at a later date.

3. It's not about value, it's about having your assets generate cash.

Please feel free to email the covered writer if you have any questions about these transactions.  rlcoveru@wavecable.com   

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PLEASE NOTE THAT THIS EXAMPLE IS NOT TO BE CONSIDERED AS A RECOMMENDATION TO INVEST IN ONXX 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: 02/13/07