KCI - Adjustment

An adjustment was made today on KCI (see bottom of this post). This adjustment is quite complex so I'll take some time to explain it.

History:

KCI was originally purchased in Aug05 at $59.83. This is a solid company which had a virtual monopoly on it's vacuum-assisted closure (VAC) product until Medicare and Medicaid Services announced their decision to use the same reimbursement code for competitor BlueSky Medical and its own VAC product in Oct05. The stock gapped down from $56.00 to close at $34.94, or down about 38%, the following day. At this point the stock position was down about 42%.

In Mar06, I bought an additional 100 shares of KCI and now have an average cost basis, excluding option premiums, of $49.53.

Then in Aug06, KCI lost a patent infringement case against BlueSky Medical and once again the stock gapped down from $42.58 to close at $24.95, or down about 41%. At this point the stock position was down about 50%.

The Dec 35 Call options were an interim trade, meaning they were below the cost basis, and at a strike that I did not want to sell the stock. This is one strategy used to recover a losing position, but it must be monitored closely.

With less than 2 weeks until Dec expiration, the Dec 35 Calls were ITM and had only .10 time value left so the decision was made to roll out to Jun07 and up to the 40 strike to avoid assignment.

Position Summary:

Stock Investment: $9,906.00
Income Generated: $1,454.00
Percent Income Generated: 14.68%
Net Profit If Called: -$452.00
Percent Return If Called: -4.56%
Annualized Return If Called: -2.44%
Days to Expiration: 683 days

Trade History:

01-Aug-05 - Initial Stock Position - BTO 100 KCI @ 59.83
01-Aug-05 - Initial Call Option - STO 1 Aug05 60.00 Call @ 1.69
22-Aug-05 - Continued Trade - STO 1 Sep05 60.00 Call @ 1.29
19-Sep-05 - Continued Trade - STO 1 Oct05 60.00 Call @ 0.54
06-Oct-05 - Buy Back & Roll Out - BTC 1 Oct05 60.00 Call @ -0.11
25-Oct-05 - Continued Trade - STO 1 Nov05 60.00 Call @ 0.44
28-Oct-05 - Buy Back & Roll Down - BTC 1 Nov05 60.00 Call @ -0.11
28-Oct-05 - Interim Trade - STO 1 Nov05 35.00 Call @ 2.04
14-Nov-05 - Buy Back & Roll Out/Up - BTC 1 Nov05 35.00 Call @ -4.11
23-Nov-05 - Interim Trade - STO 1 Jan06 45.00 Call @ 0.69
23-Jan-06 - Interim Trade - STO 1 Feb06 45.00 Call @ 0.39
21-Feb-06 - Interim Trade - STO 1 Mar06 45.00 Call @ 0.09
20-Mar-06 - Dollar Cost Averaging - BTO 100 KCI @ 39.23
20-Mar-06 - Combined Cost Basis - $9,906.00 200 @ 49.53
20-Mar-06 - Interim Trade - STO 2 Sep06 45.00 Call @ 4.59
18-Sep-06 - Interim Trade - STO 2 Dec06 35.00 Call @ 0.94
05-Dec-06 - Buy Back & Roll Out/Up - BTC 2 Dec06 35.00 Call @ -3.69
05-Dec-06 - Interim Trade - STO 2 Jun07 40.00 Call @ 4.00

This position consists of 200 shares bought at different times and for different prices. The second purchase was at 39.23, which is below the 40 strike. I could let those 100 shares get called away for a profit, so I decided to spilt the position into 2 positions as follows:

Position #1 Summary:

Stock Investment: $5,983.00
Income Generated: $869.00
Percent Income Generated: 14.52%
Net Profit If Called: -$1,114.00
Percent Return If Called: -18.62%
Annualized Return If Called: -9.95%
Days to Expiration: 683 days

Trade History:

01-Aug-05 - Initial Stock Position - BTO 100 KCI @ 59.83 -
01-Aug-05 - Initial Call Option - STO 1 Aug05 60.00 Call @ 1.69 - Expired
22-Aug-05 - Continued Trade - STO 1 Sep05 60.00 Call @ 1.29 - Expired
19-Sep-05 - Continued Trade - STO 1 Oct05 60.00 Call @ 0.54 - Closed
06-Oct-05 - Buy Back & Roll Out - BTC 1 Oct05 60.00 Call @ -0.11 -
25-Oct-05 - Continued Trade - STO 1 Nov05 60.00 Call @ 0.44 - Closed
28-Oct-05 - Buy Back & Roll Down - BTC 1 Nov05 60.00 Call @ -0.11 -
28-Oct-05 - Interim Trade - STO 1 Nov05 35.00 Call @ 2.04 - Closed
14-Nov-05 - Buy Back & Roll Out/Up - BTC 1 Nov05 35.00 Call @ -4.11 -
23-Nov-05 - Interim Trade - STO 1 Jan06 45.00 Call @ 0.69 - Expired
23-Jan-06 - Interim Trade - STO 1 Feb06 45.00 Call @ 0.39 - Expired
21-Feb-06 - Interim Trade - STO 1 Mar06 45.00 Call @ 0.09 - Expired
20-Mar-06 - Interim Trade - STO 1 Sep06 45.00 Call @ 4.59 - Expired
18-Sep-06 - Interim Trade - STO 1 Dec06 35.00 Call @ 0.94 - Closed
05-Dec-06 - Buy Back & Roll Out/Up - BTC 1 Dec06 35.00 Call @ -3.69 -
05-Dec-06 - Continued Trade - STO 1 Jun07 40.00 Call @ 4.00 -

Position #2 Summary:

Stock Investment: $3,823.00
Income Generated: $585.00
Percent Income Generated: 14.91%
Net Profit If Called: $662.00
Percent Return If Called: 16.87%
Annualized Return If Called: 13.63%
Days to Expiration: 452 days

Trade History:

20-Mar-06 - Dollar Cost Averaging - BTO 100 KCI @ 39.23 -
20-Mar-06 - Interim Trade - STO 1 Sep06 45.00 Call @ 4.59 - Expired
18-Sep-06 - Interim Trade - STO 1 Dec06 35.00 Call @ 0.94 - Closed
05-Dec-06 - Buy Back & Roll Out/Up - BTC 1 Dec06 35.00 Call @ -3.69 -
05-Dec-06 - Interim Trade - STO 1 Jun07 40.00 Call @ 4.00 -

Since it's very likely that Position #2 will get called away at June expiration, resulting in a profit, I'll just let it get called away.

Position #1 needed to be adjusted to avoid assignment, which would result in a loss. So, I bought back the Jun07 40 call today for 10.21, since it was ITM with very little time value left. My plan says to roll out to a further month and up to a higher strike for a net credit. The problem was that there wasn't a higher further out strike selling for anywhere near 10.21. Normally the solution to this problem is to dollar cost average by buying an additional 100 shares of stock and selling 2 call options at 5.11 each or more. I always limit my positions to 5% or less of total capital. Doing a DCA would exceed this limit. However, since Position #2 is most likely to be called away at June expiration, I decided to temporarily exceed my 5% limit. So, I made the following adjustment:

23-May-07 - Buy Back & Roll Out/Up - BTC 1 Jun07 40.00 Call @ -10.21 -
23-May-07 - Dollar Cost Averaging - BTO 100 KCI @ 49.87 -
23-May-07 - Combined Cost Basis - $10,970.00 200 @ 54.85 -
23-May-07 - Interim Trade - STO 2 Jan08 50.00 Call @ 6.20 -

Position #1 After Adjustment:

Stock Investment: $10,970.00
Income Generated: $1,088.50
Percent Income Generated: 9.92%
Net Profit If Called: $118.50
Percent Return If Called: 1.08%
Annualized Return If Called: 0.44%
Days to Expiration: 900 days

Trade History:

01-Aug-05 - Initial Stock Position - BTO 100 KCI @ 59.83 -
01-Aug-05 - Initial Call Option - STO 1 Aug05 60.00 Call @ 1.69 - Expired
22-Aug-05 - Continued Trade - STO 1 Sep05 60.00 Call @ 1.29 - Expired
19-Sep-05 - Continued Trade - STO 1 Oct05 60.00 Call @ 0.54 - Closed
06-Oct-05 - Buy Back & Roll Out - BTC 1 Oct05 60.00 Call @ -0.11 -
25-Oct-05 - Continued Trade - STO 1 Nov05 60.00 Call @ 0.44 - Closed
28-Oct-05 - Buy Back & Roll Down - BTC 1 Nov05 60.00 Call @ -0.11 -
28-Oct-05 - Interim Trade - STO 1 Nov05 35.00 Call @ 2.04 - Closed
14-Nov-05 - Buy Back & Roll Out/Up - BTC 1 Nov05 35.00 Call @ -4.11 -
23-Nov-05 - Interim Trade - STO 1 Jan06 45.00 Call @ 0.69 - Expired
23-Jan-06 - Interim Trade - STO 1 Feb06 45.00 Call @ 0.39 - Expired
21-Feb-06 - Interim Trade - STO 1 Mar06 45.00 Call @ 0.09 - Expired
20-Mar-06 - Interim Trade - STO 1 Sep06 45.00 Call @ 4.59 - Expired
18-Sep-06 - Interim Trade - STO 1 Dec06 35.00 Call @ 0.94 - Closed
05-Dec-06 - Buy Back & Roll Out/Up - BTC 1 Dec06 35.00 Call @ -3.69 -
05-Dec-06 - Interim Trade - STO 1 Jun07 40.00 Call @ 4.00 - Closed
23-May-07 - Buy Back & Roll Out/Up - BTC 1 Jun07 40.00 Call @ -10.21 -
23-May-07 - Dollar Cost Averaging - BTO 100 KCI @ 49.87 -
23-May-07 - Combined Cost Basis - $10,970.00 200 @ 54.85 -
23-May-07 - Interim Trade - STO 2 Jan08 50.00 Call @ 6.20 -

Now I could let this position get called away in Jan and end up with a very small profit or I may be able to continue with this position and get more profit out of it. Note that I've brought in almost 10% income during the holding period which has been reinvested into other positions.

This is not one of my better positions. I made a few mistakes along the way but I should still be able to get out with my initial investment and thereby preserve my capital. Some would say taking the loss and moving on to another position would be a better use of the funds, and they may be right, but who's to say that the next position would be any better. A primary goal of my trading plan is capital preservation so I do what I can to avoid losses.