Recognizing successful covered call writing trades is just as important as executing them. On January 17, 2020, Mark wrote to me about a covered call trade that he was analyzing with SolarEdge Technologies, Inc. (NASDAQ: SEDG). He was concerned that if he bought back a deep in-the-money call, he would suffer a significant loss.
- 12/27/2019: Buy SEDG at $94.27
- 12/27/2019: STO (sell-to-open) the 1/17/2020 $90.00 call at $6.30
- 1/17/2020: SEDG trading at $104.85
- 1/17/2020: Cost-to-close the 1/17/2020 $90.00 call is $14.90
Mark was concerned that if he closed the short call to retain the shares, there would be an option loss of $8.60 per share ($14.90 – $6.30) or $860.00 per contract. Let’s first look at how the trade was structured and see if it can be categorized as successful both before and after closing the short call.
SEDG initial calculations
The calculations show a maximum return of 2.3% with downside protection of 4.5% of that initial time-value profit. On January 17th, that maximum return is realized prior to closing the short call.
Will closing the short call result in a substantial loss?
At expiration our shares can be worth no more than $90.00 due to our contract obligation. Let’s use the “unwind Now” tab of the Elite version of the Ellman Calculator to see the time-value cost-to-close the $90.00 short call:
SEDG unwind- information entered
SEDG unwind- calculations
The brown field highlights the fact that the actual time-value cost-to-close is a mere $5.00 per-contract or 0.06%. The bulk of the $14.90 cost-to-close is intrinsic-value which is negated by increase in share value once the original contract obligation is removed.
Mark executed a successful trade where the maximum return was realized. If the short call is closed prior to expiration, the actual time-value cost-to-close is a miniscule 0.06%. Nice going, Mark!
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1: Private webinar (California investment club)
Covered Call Writing with 4 Practical Applications
Saturday September 17th
9 AM – 12PM PT
2: Free webinar for entire BCI community
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Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.
I’ve been selling covered calls on QQQ for the last several months and that has lowered my cost basis a lot. If I’m still bullish should I use the current price or the lower cost-basis when doing my calculations?
In order to make the best trading decision at any given point in time, we always use current data. Let’s say you paid $250.00 per share for QQQ and wrote $20.00 per-share worth of premium over the past few months, lowering cost-basis to $230.00 and Monday QQQ is trading at $287.00, we must use $287.00 as our cost-basis when calculating initial time-value return (ROO), upside potential (for OTM strikes) and downside protection (ITM strikes).
Using older results, no longer applicable to current positions, will skew the calculations and result in less effective analysis.
Hi Alan –
I have the mother of all “Winning/Losing Covered Calls”…Any suggestions?
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Excellent description of your trade. The good news is that you are currently in a maximum return position based on the initial structuring of the trade. If you bought AMZN at $$2100.00 and sold the ATM $2100.00 call, your initial time-value return would be 4.2% for the number of days until contract expiration.
When the strike moves deep ITM, the first exit strategy we think of is the mid-contract unwind exit strategy where we evaluate the time-value cost-to-close and ask ourselves if we can generate significantly more by contract expiration in a new trade. In this case, can we generate much more than 1.9% by January 2021? That should be quite easy but the overall cost-to-close including intrinsic-value is huge. If we can’t, we take no action and continue to monitor the trade.
There are always lessons we can learn from our trades. In this case, by using an expiration months away, we are taking additional risk related to multiple earnings reports, receiving lower annualized returns than shorter-term options and decreasing the number of times we can reassess our bullish assumption on AMZN.
That said, if we can learn lessons while maximizing our trades, no Kleenex will be required.
Thank you Alan! Great to have a professional eye on it..
Hope all is well!
The last week of a monthly expiration, do you monitor the working orders set at the 10% rule?
For example, KWEB triggered the 10% order, but in hind site, I may have been better off to cancel the order earlier in the week and let it expire on it’s own.. I bought the stock at 66.46 on July 20 and the 68 call strike. Today it was at 68.64. It was an excellent covered call for the month, and it made sense to roll it using the what now tab, but I noticed that KWEB has not been on the BCI ETF report in a while, so I chose to just sell the stock and will use the funds for a new covered call with a stock or ETF listed on the newest BCI stock report.
Just wanted to run this by you please!
Thanks and have a great weekend!
You made a reasonable decision given the information available at that point in time. It also resulted in a successful covered call trade… congratulations.
KWEB had been on our eligible list for ETFs for quite a while but was bumped because it has been under-performing the S&P 500 in the more recent 1-month time-frames. Your position management trades resulted in protecting against further decline. Nothing wrong with that.
Now, KWEB subsequently recovered and, looking back, we could have made even more money by allowing the position to remain until expiration. We are all so much smarter after-the-fact.
Successful trades should be celebrated. Let’s celebrate your KWEB trade as well.
Keep up the good work.
Thank you Alan!
Mark, as you say, had difficulty recognizing his very successful trade.
He invested $8,800.00 and made a $200.00 profit in 21 days, while he had downside protection of 4.5% during this short time.
I mean, WOW!!!! That is a very nice result.
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 08/21/20.
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:
On the front page of the Weekly Stock Report, we now display the Top 10 ETFs, the Top 3 SPDR Sector Funds, and the 4 single Inverse Index Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close.
Barry and The Blue Collar Investor Team
Love all your teachings, big thank you
How do i deal with my TSLA and AAPL investments right now due to the impending stock splits.
For all corporate events that change option positions, the Option Clearing Corporation (OCC) makes sure that all buyers and sellers of calls and puts are “made whole” We will not be impacted in either direction.
There is no one set of formulas that all contract adjustments fall into. We must locate the information that applies to our positions. here’s how to do this:
Search on top left (magnifier)
Information memos on right
Search by keyword (Place ticker) on left
Click on search on bottom
Here’s what comes up for AAPL:
I sold 1 put contract for AAPL last week for a premium of $1050.
PUT (AAPL) APPLE INC COM AUG 28 20 $455 (100 SHS)
Current AAPL price is $497 with only 5 days left until expiration. Since I’ve extracted most of the premium out of the contract, I wanted to get your opinion if it makes sense to buy a put to close out the gains on the current contract (~$117). Then, sell another put around for 480 with Aug 28 expiration to collect another ~$500 premium. If it were to go down, AAPL is a stock I would be happy to own at a discount.
Appreciate your thoughts.
The advantage of this approach is that you will generate an additional per-share initial 0.7% time-value profit ($4.85 – $1.30)/($480.00 – $4.85). This is reasonable given that you wouldn’t mind taking possession of the shares “at a discount”
The disadvantage is that you will be required to add additional cash to the position since the strike is higher and the premium lower than the initial trade. Also, there is an increased chance of exercise but that doesn’t appear to be a factor in your situation.
Good Morning Alan & Barry,
First, Thank You for putting such a great program together. I knew nothing about options or covered call writing in April and after taking the course and reading the material in your site I have made returns of 4.5% in both July & August contracts. I continue to listen, read and improve my knowledge.
I have 2 questions as I am preparing my September’s portfolio:
1. VIRT – BOLDED Stock in this week’s report. I looked at the option chain and noticed that the OTM 30 Strike is at $0. How do I approach that?
2. ENSG – Another BOLDED stock yet open interest is very low and under the 100 – How do I approach that?
Thanks so much and have a great week,
VIRT: Based on the option-chain today, the strike to consider is the $25.00 call which generates $1.00 or a 2.12% 1-month initial time-value return with 1.8% downside protection of that profit.
ENSG: Check the 3rd column from the right in our stock reports. That will tell us if there is adequate liquidity for the near-the-money strikes as of market close on Friday. A “Y” means adequate open interest (OI). An “N” means poor liquidity. We leave those stocks, like ENSG, without adequate liquidity because that can change. Also, we do have members that use our reports for stock selection only, without the option component.
Thanks Much Allan,
VIRT has an ex-dividend date on 8/31. Should I sell the option now or wait closer to the ex-dividend date?
Ex-dates are important only if capturing the dividend or preventing early exercise (let’s say for potential negative tax implications) is critical to our strategy goals. If so, we must sell the option on or after 8/31. If VIRT had Weekly options, we can sell options, working around the 1 week of the ex-date but it doesn’t.
If neither of those 2 parameters are critical to us, then ex-dates can be ignored. That’s the case with my approach to option-selling. Early exercise is incredibly rare. But when it occurs, it means we have maximized our returns and now have our cash in our account to then create a second income stream in the same contract month.
I see that your weekly report says that you at present favor OTM vs. ITM calls 2-to-1 for the best-performing stocks.
An example so I can understand this better… DHI stock current price 76.15. For expiry 9/18, call strikes available are 76 (ITM) and 77(OTM). Is this what you mean by 2:1 ratio is that you are at present writing more of the OTMs than ITMs for calls? Also, do you go deeper than the nearest available strikes (your books have examples suggesting you might)? Also, do you use covered puts and would the OTM/ITM ratio be the same in the case of puts?
Thank you very much!
When I comment in our premium reports that I am favoring OTM calls 2-to-1 over ITM calls, it is a total portfolio overview. For example, if I sold 75 contracts for the September expiration, 50 would be OTM and 25 ITM.
Each individual position may or may not consist of a combination of ITM and OTM. If I sold 3 contracts of DHI and the technical chart was all bullish and conforming (bold in our reports), I will probably go all OTM. If the chart was mixed, I may go 2 OTM and 1 ITM.
I also take into consideration the overall market tone in my strike selections which is an art as much as a science.
Once I enter my covered call positions, I immediately enter my 20%/10% guidelines buy-to-close limit orders.
In the BCI methodology, we only use OTM cash-secured puts unless our goal is to buy a stock at a discount and have that security in our portfolio as soon as possible rather than simply cash generation.
To our BCI community:
Due to the recent announcement of the 4-for-1 Apple Computer stock split, the Dow 30 will be restructured to balance the benchmark’s tech presence:
These changes will be reflected in our next Blue Chip (Dow 30) Report prior to the October contracts.
We are also enhancing this report by reporting 1-month price performance instead of 1-year price performance. 3-month price performance data will remain.
This week’s 4-page report of top-performing ETFs and analysis of the top-3 performing Select Sector SPDRs has been uploaded to your premium site. One and three-month analysis are included in the report. Weekly option and implied volatility stats are also incorporated.
The mid-week market tone is located on page 1 of the report.
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Alan and the BCI team
I hope this finds you well.
Apologies in advance but I have another burning question for you, if you don’t mind…
When looking at Rolling Out & Up to an O-T-M strike, there is unrealised share appreciation from the obligation to sell to the current market value, which is included in the ‘initial profit’ of the new contract ( together with the net option position ).
Is it not the case that this “bought up value in the closing option” is only a theoretical gain since unless the share value increases to the new O-T-M strike ( in the new contract period ) the contract will expire worthless and the only real profit ( or loss ) will be on the options side of the trade?
Therefore when using the ‘What Now’ tab of the calculator is it not misleading/incorrect to include the “bought up value in the closing option” in the calculation of the ROO for Rolling Out & Up w/o upside potential, as this component of the ROO is unrealized and only a gain on paper?
Indeed I can’t see how Rolling Out & Up O-T-M would ever produce real cash gains unless the share price increased all the way to the new strike price.
I understand that the unrealized initial profit becomes realized at the end of the new contract period when it’s I-T-M, but can’t see how the unrealized initial profit can be assumed as actual cash generated when it’s O-T-M strikes, where the share value may not reach the strike price and the share gains remain unrealized.
What am I missing here???
Sorry for such a long-winded question but I’ve been racking my brain with this all day & have only ended up with a headache…! 🤕
Let me see if I can cure that headache.
As we approach expiration and the strike is ITM, our shares will be sold at the original strike price if we take no action… that strike price is what the shares are worth at that point in time.
If we buy back the option prior to expiration, the shares are now worth current market value because we no longer have a contract obligation. That is what we call “bought up” value and is represented by the intrinsic-value component of the option. The remaining time-value is approaching zero as we approach 4 PM ET on expiration Friday. Let’s create a hypothetical:
Buy 100 x BCI at $28.00
STO $30.00 call at $0.80
BCI trading at $34.00 on expiration Friday
BTC the $30.00 call at $4.05
STO the next month $35.00 call at $1.00
The bought up value is $4.00 (from $30.00 to $34.00). It does not have to move up to the $35.00 strike to have that unrealized gain of $4.00.
To bring home this point, let’s say we bought back the option for $4.05 and then sold the stock (just to make a point). Shares are sold for $34.00, $4.00 more than the shares are worth prior to rolling. Pay $4.05…. benefit by $4.00… the time-value cost-to-close is $0.05.
Bottom line: The intrinsic-value cost-to-close is negated by the unrealized “bought up” value of the stock.
For a real-life example of rolling-out-and-up to an OTM strike, here is a link to an article I published a few years ago:
How’s the head?