. . . more than just covered calls . . .

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FREQUENTLY ASKED QUESTIONS

•     Why is the statement of balance at the brokerage firm different that the Position Tracker information?

The short answer is because the brokerage firm does not show the 'intrinsic value' of the account.  What follows is the long answer to this important question and it is one that every covered writer should understand.  It's complicated . . . but if you take the information step by step, you will agree that it is accurate.

Being aware of what a brokerage firm is required to report is one of the reasons why SysCW developed and uses the Position Tracker!  Understanding the importance of being able to tell 'where you are' in a given position is the difference between the data available either online or within a monthly brokerage firm statement, and the information contained within the Position Tracker.

An Illustration

Pretend you have $4000 cash in your account.  Now, let’s say you buy a stock for $4000 (including fees).  Also, for this discussion, let us stipulate that the 'value' of the stock does not change.  Okay . . . now what would you have in your account after the purchase? . . . . You would have ZERO cash, and an asset that is worth $4000 (the stock)   . . . .  right?  You have to ‘see’ this first . . . . so don’t continue until this is perfectly clear . . . as in  . . .  no doubt about it!

 To repeat, the account began with $4000 in cash and no stock holdings . . . and now the account contains no cash, but it does hold a stock position that is currently worth $4000.  So, what is this account worth?   You’re right. . . it’s worth $4000, which is exactly what you will see when you look at the ‘balance’ or 'value' of your account.  For clarity . . .this same holding would look as follows in the SysCW Position Tracker.

Notice that the Tracker is reporting a total net investment of $4000 and a total net value of the stock within the account of $4000.  Back to the illustration . . .  

Remember . . . no cash and 4k worth of stock is all you have . . . Now, lets sell a call option which is covered by this stock position.  You sell a $40 call option for $8.50 per share including fees. At this point . . . you have a ‘long’ stock position with a cost basis of $4000.  You would also have a ‘short’ option position with proceeds of $870.  What do YOU have . . . you still have that $4000 stock holding but you also have CASH of $870.  Right?  You really do have both . . . the cash is real . . you can withdraw it, if you want to . . . this ‘cash’ is referred to as cash generated throughout the SysCW communications you receive as a subscriber, or as illustrations in the tutorial. 

This is where the 'reporting' issue arises.  The brokerage firm has to report to you the ‘value’ of the account IF YOU WENT BACK TO CASH, which is known as the liquidation value.  Keep in mind this is not the same amount that you would have if the option were to be exercised! The liquidation value, or 'value' of the account according to the brokerage firm represents what YOU would have if you went back to cash. You would be selling the stock holding, but in order to do that YOU would have to close the option position.  In other words, you have to buy back the call option that was sold.  In doing so, you would give back the premium you generated. This would have to be done before you can sell the stock.

THIS is the 'value' the firm reports to you on a daily basis. Is it a real number?  Absolutely!  Is it important?  Only if you plan on going back to cash and if you are planning on doing that, you should not be investing in the first place.  When someone subscribes to SysCW, they receive a number of things. One of the messages contains the Five Basic Principals of Systematic Covered Writing, and one of those principles states the following:

PRINCIPLE THREE

Someday!  Someday, the market will be higher than it is today.  Whether the market is measured by the Dow, the Standard & Poor's 500 or the NASDAQ, there is confidence that 'someday' the overall market will be higher than it is today (or whatever day the investing takes place). This is a simple principle, but an important one to keep in mind, for if an investor does not believe in the market, the investor is better served by not investing in the first place.

The reason this principle is important is because, as investors, we need to realize that we cannot control the 'value' of the stocks we own.

So, when you sell the call against the stock, the firm will report a 'value' of $4000, not $4850.  This is how the account would look:

Asset	Amount
100 shares XYZ stock	$4000.00
1 Call XYZ Call Option	-$  850.00
Money Market	$   850.00
Total Account Value	$4000.00

Even though you have $850 in the money market of the firm, the 'value' of your account is still only $4000. Again, this is because, in order to go back to cash, you would need to buy back the call and sell the stock.  You would give back the $850 you generated and receive back the $4000 you invested. This is correct!  The 'value' of the account is only $4000.

Now let's take a quick look at how the Position Tracker would report exactly the same holdings:

The Position Tracker is reporting that the stock in the portfolio is worth $4000.00 and that $850.00 has been generated.  This is all a covered writer is concerned with because we are not going to go back to cash! The 'back to cash' value is always available from the firm and there is no need to recreate it ourselves.

Now for the 'intrinsic value' of the account. This is the part that is most important to understand.

Let's say you owned at $4000 stock position or a $4000 mutual fund in an account.  The value of the account would be $4000.00, and a statement from this firm would state that the value of the account was $4000. Question . . . what would the value of this account be in six months if the price of the stock or mutual fund did not change?  The answer is . . .  . $4000!  The only way the value of an account can increase is if the value of the holdings increase.  Right?  This is exactly how the brokerage firms are set up to report value.

Having said that, the value reported today ($4000) would be the value reported a year from now ($4000) IF the price of the stock or mutual fund did not change.  Right?

Now go back to the covered call account.  The value today is $4000.  Again, for the last time, this is because you would have to buy back the call in order to go back to cash.

Okay, let's do exactly the same thing.  Let's go out to the expiration of the option (when that is does not matter).  Make exactly the same assumption, namely, the price of the stock is still at $40. Here is the question . . . what would the 'value' of this account be at that time?

Wa La . . . the value magically went from $4000 to $4850 because the value of the option would become zero.  Exercised or not, you would either have a $4000 stock holding that was still worth $4000 and you would have that $850 you received from selling the call, but you would no longer be short the call option because it expired! If the call were to be exercised, you would have back the $4000 you paid for the stock and you would still have the $850 you received from the call.

See the difference?  The value of the account increased by $850 even though the price of the stock did not change one penny! So, what is the 'value' of the account?  Is it $4000 or is it $4850?  The answer could be expressed as follows:

•    The back to cash value today is $4000.

•     The intrinsic value is $4850 and absolutely nothing changes but time.

Okay?  Yes, it’s complicated, but not really . . .it’s just the brokerage firm has to report what an account is worth if you went back to cash TODAY . . . not what the account will be worth if time passes and the price of the stock remains exactly the same as it is today. If you do the math and you hold covered positions - you would see that your account will go up by the extrinsic value of the option, even though the underlying stock does not change value.  This is exactly why we do what Systematic Covered Writers do!