Copyright 2016  by Rich MacDuff    All Rights reserved    E-Mail: rlcoveru@cox.net
Systematic Covered Writing
   ... more than just covered calls
OUR DESTINY

It probably will come as no surprise that the stock market has it's ups and downs. The establishment suggests that investors grow their wealth until they retire. At that time, due to a fear of loss in value, it is suggested that investors move out of stock holdings and into 'safer' fixed income types of investments. They basically teach that the older we become, the less risk we should take. Again, this suggestion is based on the fear that the market may decline which would decrease your ability to consistently withdraw or generate a given amount of income.

Believe it or not, this is all based on a theory developed by Harry Markowitz in 1952. Later, he won the Nobel Prize for his work know as Modern Portfolio Theory.  You can read about this topic on the internet. The only point I will make is that he never considered a portfolio that was entirely made up of covered call and or cash secured put positions. He did not do that, because there was no data available to do so. From the SysCW perspective, this 'modern' theory is not so modern after all.

Before I get to the destiny issue, please understand why the greater investment community suggests that you reduce your exposure to the stock market as you approach retirement. It all has to do with how investors are supposed to make money. Their approach is to Buy Low and Sell High. This is their view of the world, which brings us to the issue at hand. If in your later years, your investments in the stock market decline in value, then you would have to wait for them to appreciate just to get back to 'even'. Because your ability to supplement your retirement income is based on the size of your nest egg, they suggest that your reduce your risk over time. I think it is important to understand why they suggest what they do.

One more thought. When you retire, you are not supposed to touch the nest egg itself, but rather you are to supplement your retirement with fixed income investments. It should be obvious, the larger the egg, the greater the income. Once again, the circle is back to why you should reduce your risk. It really does make sense if the only way you can make money is via capital appreciation.


SYSTEMATIC COVERED WRITING

With SysCW we have an alternative mindset to making money. Our approach is not necessarily via the capital appreciation route, but rather by being paid for owning stock. The same risks apply to covered call positions as with long stock positions. Namely, they may go down. Fortunately for us, there is a difference. Rather than just waiting for a depressed stock to appreciate to a previous value, we sell options against the stock holdings in order to generate cash while we wait. I hope you realize, we both want the same thing. We want the stocks to move higher. The difference is, we are going to be paid while we are waiting.

In a nutshell, this explains why we do what we do. Unfortunately, as time progresses, we will eventually be holding positions where the underlying stocks have lost value. It's going to happen. We should know that before we start. In doing so, we will not be surprised when it does happen. Again, this is not something we want, but rather a consequence of being 'in the market'.

In order to illustrate this, we will take a look at the activity involving positions using United States Steel (X) as the underlying stock in one SysCW Portfolio. As with all examples, these transactions actually took place, but in no way am I suggesting that these transactions  can be repeated as per the disclaimer at the end of this discussion. Having said that ... let's look at some current history.

We begin with a position that began in March 2016. The position is Closed now as the call was exercised. Here is the data for this position.

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As the data depicts, 100 shares of stock were purchased on March 23rd. Thereafter, a call option was sold. At that time, the writer knew if the stock was above the $15 strike price on April 1st, the call would be exercised and the stock would be sold. This is exactly what happened as the stock closed at $16.55 on that date. This is exactly what we wanted to have happen. The desired outcome for every covered call position is for it to be exercised which takes the position back to cash. Because options only expire once a week, the return when annualized is based on a two week duration.

On April 6th, we decided to establish another position using the same stock. Here we have the data for that position.

Once again, 100 shares of stock were purchased and then a call option was sold. These two transactions established a new covered call position. Nine days later the call was once again exercised and the position came back to cash. Using the two week duration, the gain was 69.71% when annualized. Please note as a word of caution, whenever short term positions are 'annualized' the assumption is being made that similar positions can be completed over the course of a year.

Next we have a position that was a little more involved.

With this Closed position, the first call was not exercised. It expired worthless on May 20th. On the 23rd, we sold a new call at a strike price that was $0.50 higher. I'm not going to explain why as that is beyond the scope of this descussion. The same thing happened on May 27 (listed as 37 in error). The $15 call expired worthless and was replaced with a $15.50 call, which in turn was replaced with a $17 call on June 6th. This last call was exercised and the position ended with a significantly above average return. This is not typical, but it obviously can happen.

The discussion now continues with the newest position based on data as of June 24, 2016.

As of June 24th, this portfolio is now holding an X position where the stock that was purchased for $17.34 is not trading at $15.96. A traditional investor that had purchased this stock on June 22nd, would now have to wait for the stock to move back to $15.96 just to be 'even' with the investment. The SysCW investor owns the same number of shares of stock, but also has $33.94 in cash that was collected on the same day the stock was purchased. On Monday, June 27th a new call will be sold against this stock position. In other words, regardless of the fact that the stock lost value, the covered writer will continue to be paid because the stock is owned.

SysCW investors are not dependent on the capital appreciation of stock positions in order to generate capital. Stated otherwise, we have a source of capital that is not based on the value of the stock that is held in a portfolio. We know that there will be times when a stock that is purchased loses value. It is going to happen. It has to because that is simply the way the stock market behaves. The reason we do not 'worry' about this inevitability is because we can continue to generate cash in spite of the loss in value.

The process is more complicated than this one example, but this 'other source' of income allows us to stay in the market even though 'they' say we are too old.