Systematic Covered Writing

 . . . 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 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,

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Tax Deferral Strategy Example

TODAY'S DATE: October 7, 2007

THE STOCK:  Telik, Inc. (TELK) is a biopharmaceutical company, which discovers, develops and commercializes small molecule drugs to treat diseases.

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 year's 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 to itemize he or she can find, an investor should do the same.

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THE COMMENTARY:  The fruit of the labor.  First, take a look at the existing TELK position in this portfolio.  Notice that initially, the writer originally purchased this stock in February of 2006.

Good news, bad news.  The good news is because the writer understood the value of downside protection, the Initial Call Option provided $691.72 of the $822.70 generated to date.  The bad news is the stock is trading close to $3.50 a share as of June, 2007. Also notice from the Position Tracker history the writer used Dollar Cost Averaging at the beginning of this year. 

Okay . . . a sad state of affairs, but this is a taxable portfolio, so in June the writer elected 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 TELK position which was shared with subscribers on June 7,2007.

Note the 'protection' for this position.  Rather than hoping the stock would appreciate from $3.5681to a $5 strike price, the writer sold two of the Oct $2.50 calls for $1.30 a share.  This option provided the writer with slightly over 34% in downside protection from the $3.57 purchase price.

OCTOBER 5, 2007 -  Today the writer closed the TDS position.  Now . . . please note that in the vast majority of instances, a TDS position will be closed at a small profit. This does not happen to be the case with this position.  The writer actually lost a little bit of working capital with this TDS position.  The explanation as to why is coming . . . here is the closing data.

			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-07	Initial  TDS Stock Purchase		Buy 200 TELK @ 3.5681	($720.62)
TDS	Current Price	$3.10	Telik Inc
7-Jun-07	Traditional TDS Initial Call Option		Sell two Oct $2.50 calls @ 1.30		$250.49	Email 6/07/7
23-Aug-07	Buy Call to Close		Buy two Oct $2.50 calls @ .75		($159.00)
5-Oct-07	Sell Stock to Close Position		Sell 200 TELK @ 3.0919	$611.37	($109.25)
5-Oct-07			Net Cash Loss			($17.76)
120	Days

Okay . .  so the back-to-cash result of this position is a loss of $17.76.  Before the 'why' close it now discussion, please note how this data will be posted in the Capital Gains Tracker.

			Systematic Covered Writing
			. . . More than just covered calls . . .
		SysCW Gains Tracker
Realized Capital Gains
				Stock	Cash	Realized
Buy	Sell	Symbol	Position	Investment	Generated	2007 Gain/Loss
14-Feb-06	5-Oct-07	TELK	Buy 100 TELK @ 20.1186	(2,018.86)	$305.69	($1,713.18)
20-Jan-07	14-Mar-06	ZULAD	Sell '07 Jan $20 LEAP @ 7	Expired	$691.72	$691.72
29-Jan-07	5-Oct-07	TELK	Buy 100 TELK @ 6.518	(658.80)	$305.68	($353.12)
3/17/2007	1/29/2007	ZULCU	Sell two Mar $7.50 calls @ .25	Expired	$40.49	$40.49
Active	7-Jun-07	ZULJU	Sell two Oct $7.50 calls @ .50		$90.49
7-Jun-07	Active	TELK	Buy 200 TELK @ 3.5681	($720.62)
23-Aug-07	7-Jun-07	ZULJZ	Sell two Oct $2.50 calls @ 1.30	($159.00)	$250.49	$91.49
				Realized Gain/Loss		($1,242.60)

All of the data for every transaction for TELK is maintained in one section of the Gains Tracker.  The writer simply uses copy and paste to transfer the data from one Excel workbook to the other.  The greenish rows are closed equity positions, and therefore 'reportable' for 2007. The lighter color rows are the current active or open equity holdings that have something to do with TELK.

Note that when the writer posted the sale of 200 shares of TELK, the 'first in first out' rule requires that the stock that was sold be the oldest shares. This works out great . . . but then again, that was the plan the whole time.  So, thanks to the closure of the TDS position, this position of the portfolio will be reporting a loss for 2007. There will be another $90.49 realized gain when the Oct $7.50 calls expire.

THE WHY NOW?

As mentioned earlier, the writer rarely closes a TDS position with a 'real' loss.  Here is the rational for closing the position early:

•     The loss was only $17.76.
•     The waiting period for a second Dollar Cost Averaging purchase of TELK begins on the day the shares are sold.  With TELK continuing to trade below $5 a share, purchasing shares for less than $4 a share will further reduce the 'break even' cost basis of the stock.
•     The cash position was increased by closing the position. 
•     TELK has struggled . . . let's face it.  So, if the writer waits, and the stock falters again, the TDS option could just expire.  The writer does not want that to happen at this point in time.  There are only three months left to 'book' losses.

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 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 TELK 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!

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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: 10/08/07