beginners corner

Analyzing and Calculating a Multi-Leg Rolling-Down Covered Call Trade

Exit strategies for covered call writing will frequently allow us to convert losing trades to profitable ones. To corroborate this concept, a real-life example with Nike Inc. (NYSE: NKE) will be detailed.

 

Initial trade structuring

  • On 6/22/2020, 200 shares of NKE was purchased at $97.72
  • 2 July 17, 2020 $99.00 calls were sold for $1.60
  • Buy-to-close limit orders were set up using the 20% guideline (BTC at $0.30)
  • The BTC limit order was changed to 10% ($0.15) on 7/6/2020

 

Initial trade calculations using the Multiple Tab of the Ellman Calculator

NKE: Initial Calculations

 

The yellow cells show an initial 1-month time-value return (ROO) of 1.6% with upside potential of 1.3% creating a maximum 2.9%, 1-month return.

 

Rolling-down exit strategies used during the July contract

  • The 20% threshold ($0.30) was not reached
  • The 10% threshold ($0.15) was realized for the first time on 7/16/2020
  • The $99.00 call was rolled-down to the $98.00 strike ($0.48) on7/16/2020
  • The new 10% threshold for the $98.00 call ($0.05) was reached on 7/16/2020
  • A sell-to-open order for the $97.00 call was executed for $0.13

 

Broker statement showing the 2 rolling-down exit strategy trades

NKE: Rolling-Down Trades

 

The yellow fields show the BTC orders and the brown fields reflect the STO orders executed.

 

Turning a losing trade into a profitable trade

Share price declined from $97.72 to $96.28 resulting in an unrealized loss of $288.00 for the 200 shares. We received per-share option credits of ($1.60 + $0.48 + $0.13) and option debits of ($0.15 + $0.05). This resulted in a net option credit of $402.00 for the 200 shares. Factoring in unrealized share loss and realized option credit, the trade resulted in a net profit of $114.00.

 

Discussion

Option-selling exit strategies will mitigate losses, enhance gains and turn losses into profits. This NKE real-life example demonstrates how multiple rolling -down exit strategies put cash into, rather than out of, our pockets.

 

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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.

34 Responses to “Analyzing and Calculating a Multi-Leg Rolling-Down Covered Call Trade”

  1. Avi July 25, 2020 2:47 am #

    Allen hi

    i have a basic and important question.

    Lets say i bought a 100 shares of xyz, and sold a CC on it.
    stock was down and i bought the call, and sold another one.
    and then it went down again, and i repeated the process.
    my question is, how do i know if i’m in profit or loss? how do i make the calculations?

    its so confusing sometimes… is it recommended to save all the process, because looking at the reports at interactive are even more confusing…

    thanks!
    Avi

    • Alan Ellman July 25, 2020 6:21 am #

      Avi,

      The best way to do this, is to use the formula I used in this article:

      1. Add up all option credits and debits = net option credit

      2. Subtract stock price at expiration from stock value when trade was initiated = share loss

      3. Add 2 figures = net gain (loss). If shares are sold, it is a realized profit or loss. If shares are retained, it is an unrealized profit or loss.

      Alan

  2. Clark July 25, 2020 6:13 am #

    Hey Alan,

    I have a screen shot below of GDXJ. Why is it that the 20 EMA on the top chart does not cross the 100 below it? However, on the histogram the 100 and 20 do cross. Which/what/how are these to be interpreted?

    Thank you as always,
    Clark

    CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

    • Alan Ellman July 25, 2020 6:27 am #

      Clark,

      It’s a bit blurry in the chart, but the time frames used for the exponential moving averages and the MACD histogram are different.

      For the exponential moving averages, 20-day and 100-day are used, a difference of 80 days.

      For the MACD histogram, 12-day and 26-day exponential moving averages are used, a difference of 14-days. Crossovers will occur more frequently with shorter-term time frames.

      Alan

  3. Tay July 25, 2020 3:34 pm #

    Hi Alan,

    A question please….

    I had 300 shares of PYPL in each my three Charles Schwab accounts: Brokerage, Roth IRA and Rollover IRA accounts as of yesterday with all 900 shares having a July 24, 2020 expiration date at a $172.50 strike price (a total of 9 contracts short).

    The PYPL market closed yesterday at a price of $172.56 (July 24, 2020 at 4 PM ET) or 6 cents ITM. The 9 short option contracts were weeklys and not monthlies.

    Today none of my 900 shares were assigned. Of course the initial premium was mine to keep. Now my 900 shares of PYPL are unencumbered (meaning without any options short).

    It seems where I read somewhere that any stock or ETF at least 1 cent in the money at 4 PM ET on expiration Friday…. will be assigned on the expiration date. I was again 6 cents ITM with 900 shares PayPal of stock on expiration date at 4 PM ET.

    What am I missing? At this point I would prefer to have been assigned on all 900 shares of PYPL based on my current assessment of the normal factors we consider…. this individual stock, stock fundamentals, stock earnings/sales, the market, etc, etc. Plus there is a PYPL earnings report (8-20-20) prior to
    8-21-20, so I went with a weekly and not a monthly.

    I look forward to your response.

    Thank you.

    Tay

    • Alan Ellman July 26, 2020 7:46 am #

      Tay,

      I would expect all shares will be sold. It may be a matter of when the sale will be posted in your online account. I would check again today or tomorrow morning. If not, you can always sell the shares on Monday.

      Here is a link to an article I published on this topic:

      https://www.thebluecollarinvestor.com/will-my-broker-automatically-exercise-options-that-expire-in-the-money/

      Alan

      • Tay July 27, 2020 1:19 pm #

        Hi Alan,

        Glad to let you know what my broker Charles Schwab said and the action I took today….

        Schwab told me today that their policy is: One cent ITM triggers an automatic assignment of the stock involved, on Expiration Friday based on the 4 PM (ET) stock final “shake out” price at the close of the market at 4 PM ET.

        EXCEPTION: The Schwab assignment policy….If the other party (the buyer of my 9 PYPL contracts) contacts their broker within one hour after the Friday Expiration Date close and requests the PYPL contracts not be assigned. Schwab says they randomly assign the 900 shares not to be assigned.

        It seems very odd that my 3 separate accounts with each 300 PYPL shares (same Expiration Date and same Strike Price) were all three picked at random not to be assigned???? Schwab basically said that was the luck of the draw???? But the good news is directly below…..

        “The Paul Harvey Rest of the Story”: I sold my 900 PYPL shares 1 1/2 hours after the stock market opened today…. with a profit of approximately $X.75 per share!! The Earnings Report for PYPL is due to be reported on Wednesday, thus my desire to get rid of the 900 PYPL shares for now. .

        I hope the above makes sense. Schwab also said the OCC informs Schwab when this “Do not assign” issue occurs and tells Schwab to randomly assign the “Do not assign” contracts/shares to their various clients, like me.

        Tay

        • Alan Ellman July 28, 2020 7:00 am #

          Tay,

          This is quite unusual but you were the beneficiary of this aberration and that pleases me. Go BCI!

          Thanks for sharing.

          Alan

  4. Ron July 25, 2020 6:32 pm #

    Hello Alan,

    Does the Blue Collar Investor recommend Collar Options?
    They seem to me to be the safest options. My question is , if not why not? The only reason I can think they might not be good is that the reduction of downside risk is just too costly to make the strategy worthwhile? Is this correct?

    Thanks! As you can tell, I’m going to school about options.

    Ron

    • Alan Ellman July 26, 2020 7:54 am #

      Ron,

      Yes, you are 100% correct. Collars offer an “insurance policy” against catastrophic share price decline but at a a cost. I have no issue with members who are more comfortable with this downside protection and are willing to accept lower returns.

      In the BCI methodology, we have our exit strategy arsenal which includes the 20%/10% guidelines as when to buy back the short call and, in some cases, a 7% – 10% guidelines as when to sell the stock. We also avoid earnings reports, the main reason for sudden price decline.

      There is no right or wrong here. Covered call writing is an effective strategy with or without protective puts as long as we have mastered the 3rd required skill (position management).

      Alan

  5. Barry B July 25, 2020 9:35 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 07/24/20.

    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:

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

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

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

    The BCI team has added additional information, improved the format of our weekly ETF Reports, enhancing the quality of these reports, and making them more user-friendly and time-efficient. Here is a link to a video overview of these new upgrades:

    https://youtu.be/-wgqoyjP5bQ

    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.

    Best,

    Barry and The Blue Collar Investor Team

    [email protected]

  6. Cort July 26, 2020 11:11 am #

    Hey Alan,

    Thank you for these lessons. This latest one reflects a common situation. The covered call is profitable while the stock price goes down. My reaction has been to sell more calls after the first set expires. Rolling down is something I need to study more closely. I tend to worry about the “background” issues of the stock. In or out of favor, good or bad outlook, the buzz among other investors, how analysts see the stock, is the stock under or overvalued, is the market under or over valued. Once I crank that in, then I try to make a decision.

    That said, is it a mistake to ignore paper losses while continuing to sell more covered calls? On more than one occasion I have managed to recoup my losses and then some by persisting in selling covered calls over time.

    Also, there is still this puzzling phenomena. It is common for an option which is expiring in a week to offer a better return at the same strike price than one expiring in the next two or three weeks. If there is greater risk over a longer period of time, that seems contradictory.

    Why is that?

    Best, Cort

    • Alan Ellman July 27, 2020 6:38 am #

      Cort,

      With our covered call trades, we are in 2 positions… long stock and short call. We must focus in on both legs. When stock price declines, despite our rigorous screening process, we have opportunities to re-evaluate our bullish assumption. This should not be ignored.

      When share price declines, the loss is “unrealized” and so our exit strategy arsenal comes into play. Rolling-down is one of our choices but so is selling the stock. If we had 100 shares of a $50.00 stock and now share prices is $45.00, we have $4500.00 worth of stock. Where is that $4500.00 best placed? In that same security or a new one? In my view, this is a better approach than how can I use this same stock to mitigate my unrealized losses. It may be, but not always. We should have no loyalty to a stock that has disappointed us. It’s all about the cash, not the stock itself (tax issues aside).

      Implied volatility tends to be greater for shorter-term options than longer-term options because it is more difficult to make longer-term projections of volatility. This is known as “horizontal volatility skew”

      As an example, the IV for INTC 8/7 $50.00 call as of this morning is 0.4793. The same strike for 8/21 expiration is 0.4144.

      Alan

  7. Alan Ellman July 26, 2020 12:39 pm #

    FREE WEBINAR: AUGUST 13, 2020

    8 PM ET

    https://youtu.be/U-kSYSf0KZM

    Alan & the BCI Team

  8. Dana July 27, 2020 5:35 am #

    Alan,

    Would you invest in puts if last quarterly report showed significant reduction in earnings and sales.

    Thanks,
    Dana

    • Alan Ellman July 27, 2020 7:00 am #

      Dana,

      I assume you are considering buying puts? I am always on the sell-side of options. I view myself as the “casino”, not the gamblers at the slot machines. Nothing wrong with buying options as long as it meets our personal risk-tolerance.

      If I did buy puts, looking for stocks with failing fundamentals is a good start. Technical analysis would be a “must” as well, as it is for selling options.

      There is no one strategy that is right for every investor. We must make sure that the risk involved aligns with our strategy goals and personal risk-tolerance.

      Alan

  9. Ron July 27, 2020 6:44 am #

    Alan,

    I can’t imagine how tired you must get answering the same newbie questions over and over!

    Do you have any feel for the percentage return penalty one pays for a collar versus the methods you use? Is it simply the cost of the collar versus the cost of a call?

    One of your suggestions is to have good tracking software to track how well the options have performed. What is the best one you have found?

    Position sizing. Do you recommend limiting positions to a percentage of one’s portfolio say 5% or 10%? You probably have answered both of these questions in your extensive list of webinars/discussions but I couldn’t find the answer. This leads me to a request.

    Thanks for all you do. Hopefully, it is at least less boring than peering into people’s mouths prospecting for caries all day.

    My inlaws/brothers in law are all dentists!

    Thanks again.

    Ron

    • Alan Ellman July 28, 2020 6:30 am #

      Ron,

      My responses:

      1. Yes. The cost of the protective put will decrease the initial time-value returns. For traditional covered call writing, it is (TV/cost of shares – any intrinsic-value). For collars, it is (TV of call – TV of put)/(cost of shares – any intrinsic value).

      2. You can check out our Trade Planner:

      https://thebluecollarinvestor.com/minimembership/the-bci-trade-planner/

      We also have a new product, soon to be available, called the Elite-Pro calculator for both calls and puts:

      https://youtu.be/yaZVb8XJdd0

      3. Diversification is critical. The amount of positions will depend on the cash available. No one stock or industry should represent more than 20% of our portfolio. More diversification is even better. We can also turn to ETFs for better diversification if cash is limited.

      Alan

  10. Peter July 27, 2020 1:04 pm #

    Dear Alan

    I am looking forward to join your webinar on 13th of August.

    I would like to check something with you.
    Is it only me but it seems there is a huge options price difference between sell puts out of money prior November election and after. In some cases big.

    Electronic arts for example
    December 20 Strike $110 @ $3.60
    vs
    September 20 Strike $110 @0.95

    Election seems to be a big milestone that will even determine if FEDs will continue quantitative easing or return to capitalism with consequences of recession…

    Peter

    • Alan Ellman July 28, 2020 6:37 am #

      Peter,

      I agree with you. The election will create increased market volatility as it did in 2016. It is unclear how the “market” will react to the results.

      Premiums are directly related to 2 factors: implied volatility and time-to-expiration. The September contracts expire prior to and the December contracts expire after the election, so we would expect IV to be greater for the December contracts.

      Also, the September contracts expire in 2 month while the December contracts expire in 5 months.

      Alan

  11. Jim July 27, 2020 1:11 pm #

    Alan,

    I an curious why we do not see Lockheed Martin (LMT) on the list of possible investments. I checking the Technicals and looking at Schwab’s peer group it would appear that for a 30 day holding period using a covered call this might be moderately safe investment.

    It is not a company I would want to hold long-term because of its sensitivity to political whims.

    When I checked over the weekend I am able to do an ITM call, with a 2.9 downside protection and a 24+% annual yield.

    Jim

    • Alan Ellman July 28, 2020 6:53 am #

      Jim,

      LMT may be a useful underlying. It’s just not an elite-performer that passes the BCI rigorous screening process at this time. This security definitely has an improving technical chart.

      One of the screens we require our stocks to pass is the IBD Smart Select screen where we require 6 green circles in the “checklist” In the screenshot below, I highlighted the 3 areas of concern.

      Again, selling options on LMT could turn out to be a profitable trade but our lists consist only of the very top-performers each week. This does not guarantee successful trades but it does throw the odds significantly in our favor.

      CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

      Alan

  12. Roni July 28, 2020 11:45 am #

    To all,

    I strongly recommend rereading Alan’s last week’s article “Automating the 20%/10% guideline”.

    During this challenging and volatile market period, rolling down to mitigate, and sometimes even replace a losing trade and turning it into a winning trade, is an invaluable tactic.

    Now that I have more time to adjust my portfolio, I have done several rolling down exit strategy successful moves after reading Alan’s article.

    Good luck – Roni

    • Mariog July 29, 2020 7:32 pm #

      Very good, Roni, on you rolling down success. Yes, it requires management time if you hold many positions.

      I am now mostly in cash as I need to time to concentrate on some other important matters. Does make a difference on the time I have available.

      Mario

      • Roni July 30, 2020 10:00 am #

        Thanks, Mario,

        I hope you and your family are doing well during this health crisis, and expect you will be back to trading soon.

        Roni

  13. Alan Ellman July 29, 2020 5:17 pm #

    Premium members:

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

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

    NOT A PREMIUM MEMBER? Check out this link:

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

    Alan and the BCI team

  14. MarioG July 29, 2020 7:17 pm #

    Trading Experiences 7/29/2020

    Alan – Minor error:
    Please correct your blog so the list of rolled down exit strategies (2nd bullet) shows the 10% threshold was reached on 7/8/20, not 7/16/20.

    Comments on 7/25/2020 Blog: Rolling Down Covered Call Trade

    Alan,

    I reviewed your blog example on a NKE covered call trade where stock gapped down, you bought back the option (9 days left) and then performed two rolled down trades (2 days and 1 day left). It was a perfect example of managing a position which still ended up with a small profit of $114 and a net return of 0.583%.

    I want to add below how I document your example trade so I know what my Net Return for the entry trade and after a roll down the trade and the position is in the money and assigned at expiration. I do this by keeping track of Return Cost Basis (RCB) and my new Break even point after each buy back and sale of a call and then calculating the Return very easily for each sold trade.

    Helps me to know what my results will be if at expiration the stock price exceeds the strike and I lose the stock. Gives me the possible option, if I do not want to lose the stock at a loss, to hold selling the call till the price rises higher.

    Calculating Gain (or Gain/Loss) and Net Return:
    * Return Cost Basis (RCB) = Stock price for OTM sold call, Strike for an ITM sold call
    *Break even = Stock price – Premium of sold call (original trade)
    *New Break even = Old Break even – premium received (STO). I also use this for dividends received on stock I own.
    *New Break even = Old Break even + premium paid (BTC)
    *Gain = Exit stock price – Break Even
    *Gain% or Net Return = %(Gain / RCB)

    Calculations:
    6/22/20 – Entry Trade:
    *Stock at 97.72; Sell call STO 2Cn 99 Ca Exp 7/17 @ 1.60 (Sell to Open 2 contracts 99 strike Expiration 7/17 at 1.60 premium)
    *Out of the Money call, Return cost basis (RCB) = 97.72 (used for calculating all returns)
    * Break even = 97.72 – 1.60 = 96.12
    * Gain if stock price at 97.72: 1.60, %Return = % (1.60 / 97.72) = 1.64%
    * Gain if stock price at strike price: Gain = 99 – 96.12 = 2.88, Return = % (2.88 / 97.72) = 2.96%

    7/8/20 – Buy back at 10% threshold executed
    * BTC 2CN 99Ca Exp 7/17 @ 0.15
    * New Break even = 96.12 + 0.15 = 96.27
    * Hold position for possible recovery of price to sell another call and hit a double.
    * If one exits trade at this point and assume stock has declined in price 5% (92.8 / shr), the final Gain = 92.8 – 96.27 = -3.47/shr (loss) ($694 for 200 shares) or G% = -3.55% loss

    7/16/20 – Roll down to Strike 98 (1 day before Exp.)
    * STO 2Cn 98 Ca Exp 7/17 @ 0.48
    * New Break even: 96.27 – 0.48 = 95.79
    * If at Expiration price is at 98 or above: Gain = 2.21/shr or $442.00, G% = 2.26%

    7/17/20 10:22am – Expiration Day – Stock declines with time decay, Buy Back call at 10% threshold
    * BTC 2Cn 98Ca Exp 7/17 @ 0.05
    * New Break even = 95.79 + 0.05 =95.84

    7/17/20 2:55pm (Roll down to 97 Strike)
    * STO 2Cn 97 CA Exp 7/17 @ 0.13
    * New Break even = 95.84 – 0.13 = 95.71
    * If at Expiration price is at 97 or above: Gain =97 – 95.71 = 1.29 / shr or $258, G% = 1.32%

    7/17/20 – Option expires worthless, stock price = 96.28
    * Final Return of NKE trade is: Gain = 96.28 – 95.71 = 0.57 / shr $114 for 200 shares, G% = 0.57/97.72 = 0.583%

    Mario

    • Alan Ellman July 30, 2020 7:11 am #

      Mario,

      Here’s how the trades went down:

      July 16th:

      BTC $99.00 call at $0.15 at 2:59 PM

      STO $98.00 call at $0.48 at 3:40 PM

      July 17th:

      BTC $98.00 call at $).05 at 10:22 AM

      STO $97.00 call at $0.13 at 10:44 AM

      Thank you for sharing all your valuable information.

      Alan

      • MarioG July 30, 2020 10:05 am #

        Alan,

        You are correct. I read the wrong line for the date.

        Great example of options in action.

        A more general question:
        I believe you recommend cancelling the BTC open order for the last week of the cycle.

        Was that an oversight in leaving the open order in place, which was executed one day before Expiration Friday? That is one issue I have in remembering to change the 20% to 10% guideline, and then also making sure I cancel the order for the last week.

        After the BTC order for 0.15 was filled, your profit was 0.01 / shr or $2 for the $200 shares if you had done nothing else and the last price was 96.28.

        You then saved the day with the next 3 trades and ended up with an overall $114 profit.

        Mario

        • Alan Ellman July 30, 2020 11:35 am #

          Mario,

          When market volatility is on the high side, as it has been for the past several months, I will leave the 10% guideline in place through the end of the contract. This article is a perfect example of how we may benefit from this approach.

          You may remember that a few weeks ago, I posted a series of trades I executed with QQQ where I actually “hit a double” on the last day of a contract.

          Taking advantage of every and all exit strategy opportunities is one of the reasons we are able to out-perform the market on a consistent basis.

          Alan

          • MarioG July 30, 2020 12:32 pm
            #

            Alan,
            Excellent. Thanks for the clarity.

            What I also do for normal mid-cycle BTC executions (maybe not last minute few days before expiration) is always try to record the price of the stock (or look at the price charts in detail) at the time my last STO Sell to Open was executed (may not be an entry trade).

            Remember at the BTC the stock has dropped in price. So knowing the last price of an STO means I can look at the Option Table at a higher relative strike near current ATM to get a feeling at what premiums are being paid if the price of the stock did rise back up to my sell strike levels.

            I then setup a new STO with preferably my original strike with maybe a 80% or 90% of the premium (time if decaying) to go for a double. If I originally bought an OTM strike, I may switch to an ITM strike as well, taking account the “intrinsic” loss. You can make later final up and down adjustments in the limit premium if the stock is gracefully climbing back up. No time to get greedy either – may lose the opportunity!

            Hope the above makes sense.

            Mario

    • Roni July 30, 2020 10:25 am #

      Mario,

      that was a full and detailed description of your reasoning process, and it matches exactly my methodology for each trade during the monthly cycle.
      It shows how much effort is really involved in trading for a successful outcome.

      But we do it with pleasure and fun. 🙂

      Roni

  15. David July 30, 2020 10:57 pm #

    Hi Alan,

    Have loved your work for many years. I have read your books, dvds and CDs…

    It is wondering if you knew of a software I could use for entering buy and sell information of stocks. Thus, so I can very easily keep track of profit/loss records.

    I used to use a program called ‘OTrader’, but its no longer available…

    Any help would be appreciated…

    Thanks Alan

    Dave

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