beginners corner

Rolling Up in the Same Contract Month: Evaluating a Real-Life Trade

Mastering exit strategies is one of the three required skills for covered call writing as well as selling cash-secured puts. In this article I will review and evaluate a real-life trade executed by one of our members. The trade involves rolling up in the same contract month with BWLD when share price accelerates significantly.

 

The initial trade

  • 11/12/2014: Buy BWLD at $144.53
  • 11/12/2014: Sell-to-open (STO) the December $145.00 call at $4.70

 

One week after initial trade

  • 11/19/2014: BWLD trading at $150.00
  • 11/19/2014: Buy-to-close (BTC) the $145.00 call at $7.40

 

Two weeks after initial trade

  • 11/26/2014: BWLD still trading at $150.00
  • 11/26/2014: STO the $150.00 call at $3.00

 

The question we are evaluating is whether the best path to take was to roll the option up from the $145.00 strike to the $150.00 strike. Here is the Ellman Calculator showing results if no action was taken:

covered call writing exit strategies

Calculations if Option is not Rolled Up

If no action was taken and share price did not decline below $145.00, a 3.6%, one-month return would be realized. This profit is protected by $5.00 (down to the $145.00 strike) or 3.3%.  This is a great position and return for conservative investors.

 

Calculations after rolling up

  • Option credits: $4.70 + $3.00 = $7.70
  • Option debit: $7.40
  • Net option credit: $0.30
  • Share appreciation: $5.47 ($150.00 – $144.53)
  •  Net credit: $5.77 = 4%
  • Downside protection of this credit: $0

 

Discussion

By taking no action we generate a 3.6%, one-month return with 3.3% protection of that profit. By rolling up we generate a slightly higher 4.0%, one-month return with no protection of that profit on a stock that has accelerated significantly in a short time frame. For most conservative retail investors taking no action is the prudent approach.

 

Other exit strategy possibilities

Should share price rise causing the $145.00 strike to trade near parity (all intrinsic value), the mid-contract unwind exit strategy may come into play (see pages 264 – 271 of the Complete Encyclopedia for Covered Call Writing). Also, should the strike remain in-the-money as expiration approaches we may still consider rolling out or rolling out and up.

 

Next live appearances

1- St. Louis, Missouri

September 15, 2015

6:30 PM – 9 PM

Link to follow

 

2- All Stars of Option Trading (guess I made the All Star team this year!)

September 16, 2015

Discussion panel

New York Stock Exchange

4:20 PM – 5:15 PM

 

Market tone

Stocks declined reacting (over-reacting?) to weak corporate earnings for Apple, IBM, Caterpillar and Microsoft. However, Morgan Stanley and Amazon beat expectations. The big picture shows that  more than 75% of companies have exceeded earnings forecasts, while 52% have surpassed revenue expectations. This week’s economic reports:

  • In June, US home resales hit their highest point since February 2007. Existing home sales rose 3.2% to an annual rate of 5.49 million units. Sales were 9.6% higher year-over-year
  • However, new single-family home sales fell 6.8% in June to a seasonally adjusted annual rate of 482,000, a seven-month low. However, sales were 18.1% higher than in June 2014
  • The median price of US existing homes sold in June reached a record $236,400. The median June sales price was 6.5% higher than a year earlier
  • Initial jobless claims declined by 26,000 to 255,000 for the week ended 18 July, the lowest level since November 1973
  • Continuing claims dropped 9,000 to 2.21 million for the week ended 11 July

For the week, the S&P 500 fell by 2.21% for a year-to-date return of 1.01%.

Summary

IBD: Uptrend under pressure

GMI: 6/6- Buy signal since market close of July 14, 2015

BCI: Cautiously bullish using an equal number of in-the-money and out-of-the-money strikes. Although there have been more positive surprises than negative ones this earnings season, some of the disappointments have been major players (AAPL, MSFT, IBM). Keep in mind that these reports weren’t egregious ones but rather didn’t meet market consensus. We also have the possibility of an interest rate hike of 25 basis points in September if our economy continues to improve.

Wishing you the best in investing,

Alan (alan@thebluecollarinvestor.com)

Tags:

About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

Connect With Us

To send us an email, contact us here. Subscribe to our e-mail newsletter or RSS feed to receive updates. Contact us by phone at 866-892-2187. Additionally you can also find us on any of the social networks below:

20 Responses to “Rolling Up in the Same Contract Month: Evaluating a Real-Life Trade”

  1. Alan Ellman July 25, 2015 11:00 am #

    Online Discount Broker File updated:

    The 2015 version of our online discount broker file is now available for free by clicking the “Free resources including Ellman Calculator” link on the top black bar of these web pages.

    Alan

  2. Roni July 26, 2015 12:27 pm #

    Excellent advice as always Alan.
    I feel more confident after reading it.

    This dilema shows up almost every month in one or two of my positions, and the urge to roll up is very hard to resist.
    Fortunately my mind is now conditioned to accept that “a missed gain is not a loss”.

    Congrats on the All Stars, you certainly deserve it.

    Roni

  3. Iris July 26, 2015 1:17 pm #

    Alan,

    Great article. This is a mistake I’ve made more often than I want to admit. I’ve learned to focus in on the MCU strategy when stock prices rise a lot.

    Thanks.

    Iris

  4. Barry B July 26, 2015 1:50 pm #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor premium member site and is available for download in the “Reports” section. Look for the report dated 07/24/15.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Since we are in Earnings Season, be sure to read Alan’s article,
    “Constructing Your Covered Call Portfolio During Earnings Season”. You can
    access it at:

    http://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/

    Best,

    Barry and The BCI Team

  5. Roseann July 27, 2015 2:53 pm #

    Alan,

    I just finished reading the chapter on the greeks in the encyclopedia. Great stuff. Can you recommend a option calculator for calculating greeks for an option? Thanks a lot.

    Roseann

  6. Jay July 27, 2015 10:50 pm #

    I love popular music. I have spent too many hours in rush hour traffic listening to FM stations. I would be infinitely smarter if I listened to The Great Books in my cassette player instead :)

    Kenny Rodgers sang “You picked a fine time to leave me Lucille”. I feel that way about the market. I was all set for a summer rally.

    i figured the usual late August and September melt down was still weeks away. It came early this year. Maybe it will leave early too? But doubtful given China and interest rate rise near.

    No worries, options sellers always have alternatives! Load up on covered calls and sell call credit spreads above the market.

    Stay away from cash covered puts, They are dangerous in falling markets – if we indeed have one as opposed to a normal bull market hiccup. My two cents this blog! – Jay

  7. Martin July 28, 2015 1:28 am #

    Alan!

    I’m in the process of getting an account secured with Interactive brokers.. So I can trade options on the US market.

    Trading on the ASX is just frustrating with $45 for brokerage.

    What strategy do we use in a bearish market when it is no longer profitable to write out of the money calls? I am really having a hard time with this at the moment. I looked at going long and short on puts but I don’t feel safe with speculating.

    Can you advise or point me in a general direction?

    Would be much appreciated.

    Martin

    • Alan Ellman July 28, 2015 7:36 am #

      Martin,

      I agree…many more opportunities to trade on US exchanges than ASX. Commissions of $45 are egregious when selling options especially. You’re heading in the right direction.

      Some approaches in volatile markets:

      1- Use in-the-money strikes
      2- Sell out-of-the-money cash-secured puts to enter covered call trades (PCP strategy)
      3- Use low-beta stocks
      4- Use ETFs which have lower implied volatility, in general
      5- Set lower initial return goals (may go from 2-4% to 2-3% or even 1-3% depending on risk-tolerance. This will keep us away from securities with high implied volatility

      Once trades are entered, we must be diligent about executing exit strategies when those opportunities arise.

      For those members who are beginners and hesitant about entering the market in volatile conditions, paper-trading is a must. If we can learn to navigate challenging markets, we can succeed in all market conditions.

      Alan

  8. Adrian July 29, 2015 5:39 am #

    Alan, thanks for last weeks replies, and when I asked that question about how you find the best strike I think I am now starting to get it. So you’re really just basing this from the return which is made up of the I.V and risk with it, – this also would have made it quicker than calculating some % out from the price to find a suitable strike too.

    I now need to ask you some things about closing the positions:-
    1. When your in the last contract week are there any kind of signs that may make you want to close out the position, instead of holding on until expiry day?(maybe from price approaching breakeven or a certain % from it, a negative divergence on all indicators at a resistance level, or perhaps there is a big economic report due out, etc?)

    2. In Exit strategies book on page 20 you say to sell shares immediately if I have any concerns from news, technicals, etc.
    So focusing just on the chart technicals, how should they actually look for you to consider closing out your entire position “immediately”, – rather than wait for the 20%/10% value to be reached first? (for this I have so far found the RS line very reliable in my backtests of falling stocks.)

    3. Should we not close-out our positions and stocks in the last week of the contract if the price is falling?(it’s just that one or two of the book examples you said you took ‘No Action’ because of this event.)

    4. And to put in a BTC and sell order combination then should my order for this to only be instructed for after 11am because of volatility? (if it’s not then they may execute it at anytime), – is it even possible for the brokers to put in a sell order if the price is dropping rapidly, or is this just not possible?
    I have included a chart of 2 big share price drops to show you what I mean here.(the 2nd drop was close to 50% – would have been a good idea to have put options in place I think.)
    Thanking you for your help again.

    • Alan Ellman July 29, 2015 6:01 pm #

      Hi Adrian,

      1 and 2: The main reason to consider selling a security in the final week of a monthly contract is when it is declining and also significantly under-performing the overall market. A comparison chart with the S&P 500 is an easy way to evaluate. It is estimated that 70% of the price movement of a security is related to overall market sentiment and performance.

      3: The degree of price decline and the relationship of that decline to market performance is helpful in guiding us to decisions like this. If we sell a stock on Monday and its up 15% by Wednesday, closing doesn’t look too good.

      4- Entering trades between 11 AM and 3 PM is a good idea as it does avoid market volatility associated with computerized institutional trading. Setting limit orders to close at 20/10% cannot be narrowed into specific automatic time frames.

      See below for a chart on LOCK.

      Alan

  9. Adrian July 29, 2015 6:00 am #

    I couldn’t manage to upload example chart as the file is in a ‘png’ image. Anyway the stock was just of ‘LOCK’ if you want to have a glimpse of it. Thanks

    • Alan Ellman July 29, 2015 6:04 pm #

      Here is a chart of LOCK showing the price decline Adrian alluded to. Please note that this stock does not currently meet BCI requirements. The reason for the dramatic price decline was related to a securities fraud case filed on the day of the decline. CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

      Alan

  10. Alan Ellman July 29, 2015 5:15 pm #

    Premium members:

    This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options.

    For your convenience, here is the link to login to the premium site:

    http://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    http://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  11. Tim July 30, 2015 12:35 pm #

    Have any of you found stocks this month with decent returns for ITM? As in around 2%.

    • Alan Ellman July 31, 2015 11:39 am #

      Tim,

      On quick glance, here are a few (not necessarily recommendations…as of 11:30 AM Friday):

      1- ALXN: $185 strike @ 6.40
      2- FB: $94.50 strike @ $3.20
      3- ELLI- $75 strike @ $4,80
      4- CELG- $131 strike @ $3.70

      I am currently out-of-town with not much time to scour our list but I’m sure there are more. Keep in mind that there are now 3 weeks remaining in the August contracts and theta is rearing its ugly head depreciating the time value of our premiums. As a result we will not be going too far in-the-money and still generate a 2%, 3-week return…34% annualized. Use the multiple tab of the Ellman Calculator to generate these stats.

      Alan

  12. Christina July 31, 2015 4:52 pm #

    Hi Alan,

    I have a question for you, I have a stock is earning coming up on 5th Aug next week I have a covered with the stock my intention to keep the stock, shall I close the covered call before earning?

    Thanks in advance.
    Christina

    • Alan Ellman July 31, 2015 4:57 pm #

      Christina,

      When I own a stock that I want to hold through an earnings report, I will not write the call until after the event. If I inadvertently sell a call before the report and then realize the situation, I will buy back the call prior to that report and re-sell it after the report. This will allow for full share appreciation from a positive surprise which is the expectation if we decide to hold through that report.

      Alan

  13. Judith Growsen October 19, 2015 3:08 pm #

    Hi Alan,

    I’m curious to learn more about the Bid-Ask spread recommendation of $0.30 or less.

    Specifically, I was wondering, the following:

    What does it mean to me as the spread widens?

    Why should I avoid large spreads when selling a call option?

    * I know that the $0.30 is a recommendation from reading your books, so I am basing the above questions with spreads that start to be like $0.50 on up.

    From reading your books, I know that a large spread will make it more expensive for me to buy back an option if I need to.

    Thank You

    • Alan Ellman October 19, 2015 3:51 pm #

      Judith,

      You are astute enough to answer your own question. A large spread may present a problem getting a favorable price execution if an option needs to be bought back to institute an exit strategy.

      Larger spreads are indicative of low option liquidity and therefore we have less leverage when trying to negotiate better prices. Remember to leverage the “Show or Fill Rule” when spreads are greater than $0.15.

      The $0.30 guideline just gives us as idea as to when the spread is becoming a concern but that, too, is partially dependent of the amount of the total premium. In addition to watching the spread, also keep an eye on the open interest (I like to see at least 100 contracts).

      Alan

Leave a Reply

Optionally add an image (JPEG only)