Systematic Covered Writing
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. . more than just covered calls
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Tax loss 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 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
TODAY'S DATE: August 8, 2007
THE STOCK: Renovis, Inc. (RNVS) is a biopharmaceutical company with a primary focus on the discovery, development
and commercialization of drugs to treat neurological diseases and disorders.
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.
THE COMMENTARY: The fruit of the labor. First, take a look at the
existing RNVS position in this portfolio. Notice that initially, the writer was attempting one of those short-term positions as
the stock was purchased in October, and the call was for November.
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Systematic Covered Writing |
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. . . More than just covered calls . . . |
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SysCW Position Tracker |
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Historical Data |
Open Position |
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Stock |
Cash |
Total Cash |
Value as of |
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Date |
Strategy |
Status |
Position |
Investment |
Generated |
Generated |
8-Aug-07 |
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23-Oct-06 |
Initial Stock Purchase |
Buy 300 RNVS @ 14.6558 |
($4,403.74) |
TDS Pending |
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$918.00 |
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Current Price |
$3.06 |
Renovis, Inc. |
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23-Oct-06 |
Initial Call Option |
Sell three Nov $10 calls @ 6.80 |
Expired 11/20/06 |
$2,029.18 |
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19-Jan-07 |
Interim Trade |
Sell three Jul $5 calls @ .30 |
Expired 7/21/07 |
$79.24 |
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1-Aug-07 |
Interim Trade |
Sell three '09 Jan $5 LEAPS @ .85 |
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$224.24 |
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Cash in Hand |
52.75% |
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$2,332.66 |
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Good news, bad news. The good news is because the writer understood the value of downside protection, the
Initial Call Option provided $2,029.18 of the $2,332.66 generated to date. The bad news is the stock is trading close to $3 a
share as of August 8, 2007.
Okay . . . a sad state of affairs, but this is a taxable portfolio, so the
writer elects to use the Systematic Covered Writing TDS position in order to gain some good out of a
sad situation. Remember, in a taxable account, establish the paper loss first, then Dollar Cost Average if necessary. With this in mind,
the writer established a second RNVS position as follows:
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Systematic Covered Writing |
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. . . More than just covered calls . . . |
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SysCW Position Tracker |
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Historical Data |
Open Position |
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Stock |
Cash |
Total Cash |
Value as of |
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Date |
Strategy |
Status |
Position |
Investment |
Generated |
Generated |
8-Aug-07 |
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13-Apr-07 |
Initial Stock Purchase |
Buy 300 RNVS @ 4.2775 |
($1,290.25) |
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$918.00 |
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TDS |
Current Price |
$3.06 |
Renovis, Inc. |
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13-Apr-07 |
Initial Call Option |
Sell three '08 Jan $2.50 LEAPS @ 2 |
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$589.24 |
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13-Apr-07 |
TDS Potential |
($3,081.50) |
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Cash in Hand |
45.04% |
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$589.24 |
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Note the 'protection' for this position. Rather than hoping the stock would appreciate from $4.2775 to a $5
strike price, the writer sold three of the Jan $2.50 LEAPS for $2.00 a share. Yes . . . this provided the writer with slightly
over 45% in downside protection.
AUGUST 8, 2007 - Tonight, the writer is considering
closing the TDS position. The thought process is quite simple. How much will it cost to buy back the $2.50 options, and how much
will the sale of 300 shares of RNVS generate?
The current price of the stock is $3.06 . . . the math is
rather straight forward.
(Shares x Price) - Commissions = Proceeds
(300 x $3.06) - $7.00 = $911.00
The current Ask
price for the Jan $2.50 call option is $1.20. Again . . . the basic math is as follows:
(Shares x Price) + Commissions = Cost to Close
(300 x $1.20) +
10.75 = $370.75
By inserting a couple of rows in the Position Tracker and entering the
figures to close the position, the writer can pre-determine the results of closing this TDS position.
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Historical Data |
Open Position |
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Stock |
Cash |
Total Cash |
Value as of |
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Date |
Strategy |
Status |
Position |
Investment |
Generated |
Generated |
8-Aug-07 |
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13-Apr-07 |
Initial Stock Purchase |
Buy 300 RNVS @ 4.2775 |
($1,290.25) |
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$918.00 |
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TDS |
Current Price |
$3.06 |
Renovis, Inc. |
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13-Apr-07 |
Initial Call Option |
Sell three '08 Jan $2.50 LEAPS @ 2 |
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$589.24 |
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13-Apr-07 |
TDS Potential |
($3,081.50) |
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Hypothetical |
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Buy three Jan $2.50 calls @ 1.20 |
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($370.75) |
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Hypothetical |
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Sell 300 RNVS @ 3.06 |
$911.00 |
($379.25) |
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Cash in Hand |
-12.29% |
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($160.76) |
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See how easy this is? The TDS position can not be closed yet! Two things will effect the
potential net result of this position. First. as we approach January, the extrinsic value of the call will dissipate. Currently,
the intrinsic value of the call is $0.56, which means there is $0.64 in 'fluff' or extrinsic value.
The other thing that would help would be for RNVS to appreciate from it's current value of $3.06 per share.
Obviously, the loss this position will 'create' is significant, so we will continue to watch the two factors that could allow early
closure.
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 that claiming all the deductions possible when completing you personal income tax return in 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.
PLEASE NOTE THAT THIS EXAMPLE IS NOT
TO BE CONSIDERED AS A RECOMMENDATION TO INVEST IN RNVS 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:
08/09/07