Systematic Covered Writing

 . . . more than just covered calls . . .

Tax strategies are used in the Systematic Covered Writing process to defer taxes. This is no different that claiming all the deductions possible to reduce your earned income tax liability.  Having said that . . . please verify this process with your CPA .  It is important that your professional advisors are on the same page as your strategies.

As with all SysCW examples, the transactions listed in the information that follows took place on the dates listed.  Note that historical executions of various transactions may, or may not, be repeated in the future,

Tax Deferral Strategy Example

THE DATE: November 7, 2006

THE STOCK: Cyberonics Inc. - (CYBX) This company designs, develops, makes and markets medical devices for the treatment of epilepsy and other neurological disorders through vagus nerve stimulation.

WHY TDS:  There will be times when a stock loses significant value.  In a taxable account a covered writer looks at this negative even as a positive opportunity. The opportunity at hand is to use the depressed stock to create a paper realized capital loss, which in turn can be used to reduce realized gains. The idea is to maintain the capital that would be used for taxes for at least another year, if not longer.  Just as a tax payer looks for all the legitimate deductions he or she can find, an investor should do the same.

THE TDS POSITION: In this example, you can see that the Initial TDS Position that was established in June was rolled in July.  To be honest . . . the strike price for the call that was sold was too low.  Not sure how this happened, but obviously the writer did not use the math exercise when establishing the position.  So.....the position was rolled in order to come closer to a break even proposition.

In the real world . . . it is hoped that ending a trade with a loss of $1.67 is not considered breaking the 'rules'.  The loss created by closing this position was slightly over $2000.  This means that at least $600  (15% of $2000) in tax will be deferred for at least a year.  When looking at the philosophy of a TDS position, one needs to focus on the tax that was saved as what the investment 'made'. 

Not sure if made is the best word . . . the idea is the investor is allowed to keep the tax that would have been paid for an extended period of time.  Which means it can be used to generate additional premiums (cash).

Here is the closed TDS position data as maintained in the Position Tracker database.

      Systematic Covered Writing    
              . . . More than just covered calls . . .    
      SysCW   Position Tracker      
             
             
Historical Data Closed Position
        Stock Cash Total Cash
Date Strategy Status Position Investment Generated Generated
7-Jun-06 Initial TDS Stock Purchase Buy 100 CYBX @ 23.8758 ($2,395.58)    
TDS     Cyberonics, Inc.      
7-Jun-06 Initial TDS Call Option Sell Jul $17.50 call @ 6.40   $631.23  
20-Jul-06 Buy Back & Roll Out Buy Jul $17.50 call @ 3.60   ($368.75)  
20-Jul-06 Continued  Trade Sell Jan $17.50 call @ 5.30   $521.23  
8-Nov-06 Buy TDS Option to Close Buy Jan $17.50 call @ 2.20   ($228.75)  
8-Nov-06 Sell Stock to Close TDS Position Sell 100 CYBX @ 17.4701 $1,838.95 ($556.63)  
8-Nov-06 TDS Created ($2,010.09) Net Cash Gain     ($1.67)
154 Days          

Needless to say . . . this was a very successful TDS execution as the loss that was 'created' is significant.  Now that the writer has 'taken advantage' of the loss in value, the next strategy to use on this position may be to Dollar Cost Average the holding in order to reduce the cost basis of the original purchase. The key is to make sure 30-days pass prior to purchasing additional shares.

The writer adds the following note on the last line of the active CYBX position as a reminder not to purchases additional shares:

Do not Trade CYBX until December 9

This comment is placed in the Position column, and yes it is bright yellow and boldface!  One point to gleam from this example is what to do if the TDS position is not called or closed at a profit.  The answer is the writer would either write another call or convert the position to a Dollar Cost Averaging purchase.

Example Index

PLEASE NOTE THAT THIS EXAMPLE IS NOT TO BE CONSIDERED AS A RECOMMENDATION TO INVEST IN CYBX 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 © 2005. All rights reserved.
Revised: 02/05/07