Systematic Covered Writing

 . . . more than just covered calls . . .

---

For this 'what about value' position the reader will see a position that was down, and yet was closed with a reasonable back-to-cash gain. Is it possible that a different stock may have provided a higher return if a loss was accepted?  Absolutely, but then again the converse is also true because . . . nobody knows.

---

Dealing With Value

PREFACE - This is a tough one at times, for the covered writer will hang onto positions that have lost significant value, even though the bulk of 'modern strategies' say to take the loss and move on.  The covered writer's opinion is contrarian to this philosophy, and the reason why is because Systematic Covered Writing provides a plan for handling losing positions.  In fact, this is exactly why you learn how to use strategies before you need to use them. Here is a detailed, historical example of this philosophy. As long as options are traded with a company, the 'plan' has a chance. 

THE POSITION - For this example, the covered writer is going all the way back to 2002.  Please note that as you read the historical comments that the covered writer did not 'know' how this position was going to end . . . what the writer always knows is what will be done as the value of a stock changes.  With the strategies you have been shown, you will see them put to use in a real example.  This time the stock is JNPR and the portfolio is an IRA.

THE STOCK - Juniper Networks, Inc. - (JNPR) engages in the design and sale of products and services that provide customers with Internet Protocol network solutions primarily in the United States

THE INITIAL POSITION   -  In January 2002, 100 shares of JNPR were purchased and a July $25 call was sold for $4.30!  Let's begin with the Initial Position listed in the Position Tracker. (This position began at a traditional brokerage firm with higher commissions, the figures listed are net, including commissions.)

The covered writer purchased this stock because the belief was that it would appreciate between January 2002 and July 2002. Well, looking at a chart of this stock up though July 2002 will show what really happened.

The red horizontal line illustrates the strike price location.  This example will show how the covered writer traded a stock that lost over 76% of it's value and ended with an annualized gain of close to 10% PER YEAR . . . . Relate this to the fact that the NASDAQ had appreciated a total of slightly over 13% from January 2002 to April 7, 2006!

Needless to say, the covered writer was just plain 'wrong' on the direction of this stock.  But, because the writer has a plan, and part of that plan is that investments are not viewed with a short term horizon, the writer just kept on keeping on.

The stock was so depressed, that the writer decided to wait and see if it would appreciate.  Finally, in November of 2002, the writer decided to write a one month call against this loser.

Notice that the July call is now highlighted in green to indicate that it is closed. Of course, as soon as the stock is covered, it begins to appreciate (see . . . wrong again) and the December call needs to be rolled.  Because the strike price ($7.50) is so far below the cost basis ($22.96) the writer decides to use the Buy Back & Roll Out & Up strategy.  The strategy was used on December 20, 2002 as follows:

In March, the covered writer decided to establish a second position using JNPR as the strategies of SysCW suggest using the Dollar Cost Averaging strategy to lower the cost basis.  One hundred additional shares were purchased and a July $10 call was sold. The covered writer is aware of the possible ultimate outcome . . . it is that 'awareness'' that reduces the fear of increasing a holding.  The only time the Dollar Cost Averaging philosophy won't work is if a company goes out of business or ceases to offer options.

The stock was trading at below $10 (still down over 50%) and so the April option expired.  The covered writer is aware of the 'possible' ultimate outcome . . . it is this 'awareness'' that reduces the fear of increasing the size of a holding. The Position Tracker is now updated to reflect the additional purchase and the expiration of the April contract.

 One fact to note here is that the Cash in Hand percentage reflects the combined purchase.  This percentage is determined by dividing the net cash generated (484.96) by the total net investment ($3,223.39). Also notice that the cost basis is now $16.12 on a stock that is trading at $8.96, still in a situation where conventional 'wisdom' would suggest to exit the position and just 'move on' to greener pastures. The writer will state that the Systematic Covered Writing philosophy is contrarian to this thought process!

The stock actually appreciates as the July expiration approaches.  What to do?  The chart below Illustrates what has happened since the position was established.

See the problem?  In May 2003, the stock moved above the $10 strike price and stayed there!  The writer does not want the stock sold for $10 per share.  This time the Combo Buy Back & Roll Out Strategy is used to (a) protect the position and (b) increase the strike price.  Here comes the Position Tracker data:

One more contract to sell, which was completed on July 21, 2003 at a $15 strike price for January 2004.  This option was rolled up using the Buy Back & Roll Out & Up strategy so that all three hundred shares were covered with 2005 Jan $17.50 calls. These calls were exercised in January and the position went back to cash.  The net closed historical data is part of the Position Tracker record for this portfolio.

CONCLUSION

1. The total investment in this position was $4,700.74.  When all was said and done, the covered writer ended up with a net back to cash gain of $1,357.39.  Not bad for a stock that at one point was down over 76%!
2. Whereas current conventional 'wisdom' would suggest dumping positions like this, the covered writer's view is: "why throw another dart?"  What if the replacement loses value?  Do you move on to greener pastures with that one also?
3. The back-to-cash annualized gain of 9.5% is based on the entire investment being active for 1,109 days, which is not true. Some funds were invested in December of 2002 and the rest in July of 2003, so if anything, the 'annualized' return would be higher than 9.5% PER YEAR!
4. If . . . a position that begins by losing over 76% of it's value ends up gaining over 9.5% per year . . . why would someone writing covered calls, close a position?  The covered writer knows the answer!  It is fear! Fear of losing more money. The strategies and process of Systematic Covered Writing are designed to alleviate that fear by providing a logical process for handling losing positions.

When using SysCW . . . some positions will appreciate . . . we know that . . . and the back -to-cash results are predicted when the position is established. Some positions, on the other hand, will lose a significant amount during the holding period.  What is lost is only  the 'value' of the stock . . . not the cash that is generated.  As the example above indicates . . . SO WHAT?  We are long-term investors . . .  right?  Having said that and in context with the current conventional wisdom of taking losses and moving to greener pastures, the covered writer offers the following:

If you think the grass is greener on the other side,

maybe it's time to fertilize your grass!

---

LEASE NOTE THAT THIS EXAMPLE IS NOT TO BE CONSIDERED AS A RECOMMENDATION TO INVEST IN JNPR 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 suggesting 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 provide 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: 02/05/07