Systematic Covered Writing

 . . . more than just covered calls . . .

 

"Systematic Covered Writing is a series of strategies for long-term investors (covered writers) who believe nobody really consistently knows which stock is going to appreciate at any particular point in time. They also believe there are a limited number of possible overall changes in any individual stock's value during a specified period of time and that someday the value of a stock will be higher than when it was originally purchased. Lastly, they understand that their wealth is not emotionally connected to any individual stock held within the portfolio."

The following information is presented for educational purposes only!  This is a historical example of some of the strategies contained within the Systematic Covered Writing process and philosophy.  Be advised of the TERMS OF USE, located at the bottom of this page.

Upside Potential verses Downside Risk

Over the past few weeks, you have received a number of examples of Systematic Covered Writing.  These examples were selected to demonstrate some of the strategies used in the SysCW process.  An attempt was made to diversify the underlying stocks, rather than using the same stock over and over.  Additional information was made available and the ability to ask questions also presented itself.

For this example, the covered writer will explore one of the main reasons investors do not use covered call positions.  As a reader, one thing will be asked as you read this example. and that is to think for yourself . . . in other words have an open mind.  You can agree with what you are reading or you can disagree.  That is, and always will be, your right. The same applies to the covered writer.  Below, a photo image of the cover of the booklet known as "CHARACTERISTICS AND RISKS OF STANDARDIZED OPTIONS", can be found on the right hand side of your screen.

On the left hand side is a photo image of page 62 of this booklet.  So, what is this booklet?  The is the 'guide', if you will, that every investor using options (in any way) is required to receive from the broker or brokerage firm, prior to option trade activity in a given account.  The investor is to either have a physical copy, or indicate that they have read this booklet in the past.  Hopefully, from that statement, the reader recognizes just how important this little booklet it.

Given it's importance . . . please read page 62, concentrating particularly on section 2.  The commentary will be continued below . . .

 

The reader will now be provided with a number of examples that in the covered writer's opinion, contradict section 2. of this page of the booklet.  The reader is entitled to formulate his or her own opinion.  The underlined statement in section 2. is only true if the writer of the call option allows the call to be exercised, but the statement is not true for the original option if the seller of the call option chooses to do something!

 1.    Take a look at the following YHOO example:

Date Strategy Position Investment Generate Total
17-Feb-04 Initial  Stock Purchase Buy 100 YHOO @ 46.419 ($4,666.90)    
      Yahoo! Inc.      
17-Feb-04 Initial Covered Call Sell Mar $47.50 call @ 1.55 Expired 3/20/04 $130.00  
22-Mar-04 Continued Trade Sell Apr $47.50 call @ 1.05 Rolled 4/02/04 $80.00  
2-Apr-04 Buy Back & Roll Out Buy Apr $47.50 call @ 3.20   ($345.00)  
2-Apr-04 Continued Trade Sell May $47.50 call @ 4.10 Rolled 5/11/04 $385.00  
11-May-04 Buy Back & Roll Out &Up Buy May $47.50 call @ 5.80   ($605.00)  
11-May-04 Appreciated Trade Sell Oct $50 call @ 7.40   $715.00  
            $360.00

Notice that the stock was purchased for $46.419 per share and the initial strike price was $47.50.  According to the statement on page 62 "The writer of covered call options forgoes the opportunity to benefit from an increase in the value of the underlying" stock.  Notice that the covered writer wanted to partake in the appreciation of YHOO and used the Systematic Covered Writing strategy know as the Buy Back & Roll Out & Up to increase the strike price from $47.50 to $50.  That means that if the call were to be exercised, the covered writer would receive more than the original strike price for the stock.

2.    How about with BIIB . . .

Date Strategy Position Investment Generate Total
3-Mar-04 Initial Stock Purchase Buy 100 BIIB @ 57.98 ($5,823.00)    
      Biogen Idec      
3-Mar-04 Initial Call option Sell Apr $55 call @ 4.70 Rolled 4/02/04 $445.00  
2-Apr-04 Buy Back & Roll Out & Up Buy Apr $55 call @ 3.50   ($375.00)  
2-Apr-04 Appreciated Trade Sell Oct $60 call @ 5.50   $525.00  
         
          $595.00

Biogen Idec was purchased for $57.98 and the Apr $55 call was sold.  To prevent the option from being exercised, the Apr $55 option was closed and replaced with on October $60.  Would not the covered writer partake in capital appreciation over the $55 strike price if the new call were to be exercised?

3.    Or maybe AMZN . . .

Date Strategy Position Investment Generate Total
13-Feb-04 Initial Stock Purchase Buy 100 AMZN @ 47.369 ($4,761.90)    
    Amazon.Com      
13-Feb-04 Initial Call option Sell Jul $45 call @ 6.40   $615.00  
17-Jun-04 Buy Back & Roll Out & Up Buy Jul $45 call @ 5.50   ($575.00)  
17-Jun-04 Appreciated Trade Sell '05 Jan $47.50 call @ 7.60   $735.00  
         
          $775.00

Amazon dot Com was purchased at $47.369 and the $45 July option was sold.  According to page 62 of the booklet:  "The writer of covered call options forgoes the opportunity to benefit from an increase in the value of the underlying" stock.  If that were true . . . and the stock was trading above $45 on the 3rd Friday in July 2004, the stock would have been sold for $45 a share.  It wasn't because the covered writer decided that the possibility of partaking in the capital appreciation of the stock was a good idea.  So, on June 17, 2004 the Buy Back & Roll Out & Up strategy was used to prevent the stock from being sold and to increase the potential sale price. By the way, the covered writer also added $150.00 in cash premium at the same time.

4.    What about FRX?

Date Strategy Position Investment Generate Total
29-Jun-04 Initial Stock Purchase Buy 100 FRX @ 57.77 ($5,802.00)    
    Forest Labs Inc.      
29-Jun-04 Initial Call option Sell Aug $55 call @ 4.30 Rolled 7/30/04 $405.00  
30-Jul-04 Buy Back & Roll Out & Up Buy Aug $55 call @ .25   ($50.00)  
30-Jul-04 Interim Trade Sell two Jan $60    calls @ 1.35   $110.00  
           
          $465.00

Once again, Forest Labs was purchased and an option sold.  At some point, the covered writer decides that partaking in the capital appreciation of the underlying stock would be a good idea and using the Systematic Covered Writing Buy Back & Roll Out & Up strategy, the covered writer increases the strike price from $55 to $60.

Think about it ... later on ...could not the covered writer increase the strike price again from $60 to $65?  The correct answer is probably yes.  Keep in mind that if the Buy Back & Roll Out & Up does not work mathematically, the covered writer has the opportunity to use the Combo Buy Back & Roll Out & Up strategy to increase the strike price.

CONCLUSION:   The statement on page 62 of the option booklet makes a true statement.

"The writer of covered call options forgoes the opportunity to benefit from an increase in the value of the underlying" stock.

The covered writer simply recognizes that there is an implied 'if' in accepting this statement as being 'true'.  By now, the reader should realize that, more often than not, the seller of the call option will not partake in the capital appreciation of the underlying stock above the strike price, as the booklet states . . . ONLY IF HE OR SHE CHOOSE TO DO NOTHING!

Return to the Questions by clicking HERE.

PLEASE NOTE THAT THIS EXAMPLE IS NOT TO BE CONSIDERED AS A RECOMMENDATION TO INVEST IN ANY 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 suggesting 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 provide for 'educational purposes' for the sole purpose of illustrating the Systematic Covered Writing strategies.

Thank you!

SYSTEMATIC COVERED WRITING
Copyright © 2006. All rights reserved.
Revised: 06/02/06