Systematic Covered Writing

 . . . more than just covered calls . . .

Tax loss strategies are used in the Systematic Covered Writing process to defer taxes. This is no different than 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 investment 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: February 9, 2007

THE STOCK:  Onyx Pharmaceuticals, Inc. (ONXX) is a biopharmaceutical company building an oncology business by developing therapies that target the molecular mechanisms implicated in cancer.

WHY TDS:  There will be times when a stock loses significant value.  In a taxable account a covered writer looks at this negative event 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 the current liability created with realized gains. The idea is to maintain control of 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.

Email Comments:

This position has some unique features to it.  A detailed explanation will be forthcoming.

The Covered Writer

THE COMMENTARY:  Now that 2007 has arrived, the writer begins looking for ways to defer taxes for the 2007 tax year.  Notice that a covered writer does not wait until the end of the year to try to reduce the tax burden, but rather is always on the lookout for opportunities.  In a way, it is almost good that stocks lose value, because it allows the TDS strategy to be implemented.

Let's begin with a historical view of a position dating back to March of 2005.

      Systematic Covered Writing      
              . . . More than just covered calls . . .      
    SysCW   Position Tracker    
               
Historical Data Open Position  
        Stock Cash Total Cash Value as of
Date Strategy Status Position Investment Generated Generated 9-Feb-07
31-Mar-05 Initial Stock Purchase Buy 100 ONXX @ 31.139 ($3,121.90) TDS USED   $1,242.00
  Current Price $12.42 Onyx Pharmaceuticals, Inc.        
31-Mar-05 Initial Call Option Sell '06 Jan $30 LEAP @ 7.20 Expired 1/21/06 $711.23    
3-Feb-06 Continued Trade Sell Aug $30 call @ 3.10  Expired 8/24 $301.24    
24-Aug-06 Interim Trade Sell Jan $20 call @ 1.40 Expired 1/20/07 $116.24    
2-Feb-06 Initial Stock Purchase Buy 100 ONXX @ 27.768 ($2,784.80)     $1,242.00
2-Feb-06 Initial Call Option Sell '07 Jan $30 LEAP @ 5.80 Lowered 6/25/06 $571.23    
25-Jun-06 Buy Back & Lower Buy Jan $30 call @ .60   ($68.75)    
25-Jun-06 Interim Trade Sell Jan $20 call @ 1.95 Expired 1/20/07 $186.24 Email 6/25  
Combine $5,906.70 200 @ $29.62 Combined 200 Share Position        
26-Jan-07 New Interim Trade Sell two Mar $12.50 calls @ .25   $40.48    
               
  Cash in Hand 31.45%       $1,857.91  DN

In the Cash Generated column, you can see that the writer already used the March 31, 2005 holding in a previous TDS transaction. With the second purchase, on February 2, 2006, the cost basis has not be 'used'. These were two separate positions which the writer combined in January of 2007.

Interesting to note that the Buy Back & Lower strategy initiated on June 25, 2006 worked as planned with the expiration of the Jan $20 call.  This BB&Lower transaction was distributed to subscribers on June 25th.  Please note that if you have any questions about the record keeping system . . . please ask!

February 9, 2006 - In looking at the data, the writer has two thoughts.

  1. The writer can 'see' that a potential for about a $1500 realized capital loss exists with the second purchase.
  2. With ONXX continuing to trade below $15, at some point in time the Dollar Cost Averaging strategy should be used to lower the cost basis.

With these two thoughts in mind, the writer decided to combine the ideas into one new position which was established today.  For convenience, here is the Math Exercise subscribers received earlier today.

  Position: 200   ONXX   With   May 2007   $12.50   Call
                       
  Onyx Pharmaceuticals, Inc. ONXX May 2007 12.5000 call    
                       
  Stock Symbol   ONXX   Call Symbol     .OIQEV  
                       
  Stock Purchase Price $12.190   Call Sold Price   $1.20  
                       
  Number of Shares   200   Call Strike Price   $12.50  
                       
  Trade Entry Date   9-Feb-07   Expiration M & Y   5 2007  
                       
  Net Cash Generated $230.50   Net Stock Investment $2,445.00  
                       
  Net Return if Called $268.50   Annualized  if Called (1) 40.90%   (A)
                       
  Cash Required for Trade    $2,214.50          
                       
  Percentage Recovered w/Option * 9.43%   (B)        
                       
Days Until Expiration & Expire Date   98   18-May-07  

Okay . . . the writer purchased 200 additional shares of ONXX, and sold two contracts of the May $12.50 call option. To better understand the thought process, take a look at this price history of ONXX for the past six months.

No one needs to agree with the following thoughts, for in the end the covered writer believes nobody knows anyhow! But . . . here are the observations that led to the decision to purchase 200-shares.

  1. The share price fell significantly in December of 2006,  until then, it had been appreciating for four months.
  2. The price dipped even further until about the last week of last year.
  3. For about the last month, the stock has been forming a base at $12.

Two-hundred shares were purchased.  The writer is figuring either the stock will be above $12.50 in May, or it won't (brilliant huh?) If it is, the writer can allow both contracts to be exercised with a 40.9% annualized back to cash return. That works!

On the other hand, if the stock is below $12.50 . . . how low would it be? The bad news came out in December.  Barring any further bad news, the low should have been established there towards the end of December. Call this observation a hope, wishful thinking, or whatever . . . it is the thought process. The writer is thinking the premium received today, should easily cover any loss in value for 100-shares of the stock. No . . . the 100 in not a typing error.

You see, the writer is planning on selling 100 shares in May (or sooner) for $12.50 or less, and use the cost basis of the 2006 February purchase ($2,784.80) to match up with the proceeds of $1237.00 or less that will be received with the sale of 100 shares on ONXX. But what about the other 100 shares?

If they are not called, the writer will use the 'extra' 100 shares as a Dollar Cost Averaging purchase. The position going forward will have a cost basis of $5,906.70 plus $1,222.50 or $23.76 per share.

That's the plan . . . in May, when it works out . . . it was not luck, but rather a combined application of the Systematic Covered Writing Strategies. In the writer's mind, this was a very interesting use of the strategies.  The writer is ignoring the 'protection' thought process for 100 of today's purchase, in order to have $230.50 of downside protection for the other 100 shares. Hope you see that the stock could be trading as low as $10 a share and the 100 shares could be sold without 'losing'.  Yes, this is fudging a bit, but as long as I apply the premium for the two contracts  . . . the math works.

Keep in mind that the writer is 'saving' the tax consequences of about a $1500 gain by creating the $1500 loss.

FINAL THOUGHT: One of the advantages of SysCW is that the strategies are not static. This is the first time the writer has used the COMBO TDS $CA strategy. Catchy name . .  .don't you think? The covered writer is committed to constantly look at ways to keep more of the assets we create. To that end, I hope you find this example useful.

Comments, questions and opinions are always welcome . . . rlcoveru@wavecable.com

The Covered Writer

Tax loss strategies are used in the Systematic Covered Writing process to defer taxes. This is no different than 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 investment strategies.

Example Index

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 © 2005. All rights reserved.
Revised: 02/10/07