Systematic Covered Writing

 . . . more than just covered calls . . .

Reverse TDS   Example 3                                ONXX  Onyx Pharmaceuticals Inc.     

THE DATE: November 12, 2007

IMPORTANT: (You will read this more than once!)  In order to make use of the Systematic Covered Writing Reverse TDS strategy, the investor must be able to specify the lot of stock being sold with the brokerage firm. For example, at E*trade, this is accomplished by choosing the 'lot identification' method instead of FIFO or LIFO when setting up the account.  At Ameritrade, the investor sends a written memo to the firm.  The point?  If you cannot specify lots, you cannot use this strategy.  It's that simple.

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On October 11th, the following position was established in the online $100k Portfolio as a Reverse TDS position.  Needless to say, one of the requirements of this strategy is that the writer would need to 'like' the underlying stock, even though the price has appreciated since the last purchase. 

Another requirement would be that as a stand alone position, the 'math' would need to work.  As you can see above, this new position generated 37.51% the day it was established. Because the strike price is about $4 below the purchase price, we can see that there will be about $400 given back when the call is exercised. If you take the $400 away from the $1651.72, you would still have $1251.72 or about 28%.  What this means is that when the call is assigned, the position will end with about a 28% back to cash gain.  I think you would concur that the 'math' works.

November 12, 2007

It has now been 32 days since the above position was established.  This means that we can go ahead and close the older position.  Here are the Closed Position results for that ONXX holding:

I hope you would agree that with a $30 strike price, and a stock trading price of about $56 a share, that this position would probably 'go away' in January.  Now look back a month when the TDS Position was established. At that time, ONXX was trading at $43.97, and it was the knowledge of the Reverse TDS strategy that inspired the writer to establish the October 11th position. 

Okay . . . now look at the closed position results.  Back-to-cash with a net gain of $567.15 in 265 days.  If you were to extrapolate this out over the course of a year, you would find that the annualized cash generation rate is 27.03%.  This position fulfilled the underlying guidelines of SysCW.

THE TDS

Now for the tax advantage created with these two positions.  Please note there was not 'luck' involved here, but rather the execution of a planned liquidation as part of a SysCW strategy. Check out the position of the CLOSED transactions . . .

Date	Event	Cost	Proceeds	Gain
11-Oct-07	100 Shares ONXX Purchased	($4,403.99)
20-Feb-07	The  '08 Jan $30 LEAP Option  Sold		$521.73
12-Nov-07	Jan $30 call  Option Purchased	($2,728.25)
12-Nov-07	100 Shares of ONXX stock Sold		$5,663.66
	TOTALS	($7,132.24)	$6,185.39	($946.85)

Remember the brokerage firm will report the sale of 100 shares of ONXX on November 12, 2007 for $$5,663.66 on IRS Form 1099. At the time of sale, the covered writer identified the stock being sold as the $4,403.99 basis holding. Because there are two purchases of 100 shares of ONXX in the portfolio, and both purchases have been held for more than 30 days, the covered writer can choose the cost basis for the shares that were sold.  Did the covered writer make money or lose money?  The correct answer is 'both'.  A realized capital gain of $567.15 was generated by closing the older position. At the same time a realized (but paper) loss was created through the use of the Reverse TDS concept developed for Systematic Covered Writing. In this case the 'loss' was $946.85.

I hope you see the advantage of reporting a $948.85 realized loss rather than a $567.15 realized gain.  One is 'real' the other is on paper.

The preceding example is not intended as an offer or solicitation for the purchase or sale of any security or financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. The example does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendations in this example, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.

Before initiating the use of strategies involving tax issues, the reader is advised to consult with their CPA.  Systematic Covered Writing does not profess to provide tax advice.  The use of tax deferment strategies like the one illustrated above, when ever possible is suggested to possibly reduce your tax liability.  Whether a given strategy is appropriate for use in your portfolio is between you and your professional tax advisor.

On the other hand ... it is your money!

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 © 2007. All rights reserved.
Revised: 11/13/07