Options calculations will give us an accurate assessment of our covered call writing profits. It’s more meaningful to use percentages rather than dollar amounts when executing these calculations. For example, a $1000.00 profit on a $10,000 investment (10%) is much more significant than a $1000 return on a $100,000 investment (1%). That’s why percentages forms the foundation for both versions of the Ellman Calculator (Basic and Elite).
A few months ago, one of our members, Jonathan, shared me with one of his successful covered call writing trades and inquired about percentage returns month-to-month. In this article, I will breakdown that trade and use the Ellman Calculator to demonstrate the second leg of the trade where Jon rolled out and up:
The trade in 100 share format
- 2/10/14: Buy 100 x AGN @ $120.36
- 2/10/14: Sell 1 x Feb. $120 call @ $2.52
- 2/21/14: Share value = $125.59
- 2/21/14: Buy back Feb $120 call @ $6.20
- 2/21/14: Roll out and up to the March $125 call @ $4.10
- 3/21/14: Option expires in-the-money and shares are sold for $125
You will note that the trade was established mid-February contract. Here is the final returns from the first 12 days of the trade as shown in the “multiple tab” of the Ellman calculator:
Jon achieved a very nice short-term return (1.8% in 12 days) and then decided to roll out (next month) and up (higher strike price). For this computation we use the “what now tab” of the Ellman Calculator and first fill in the blue cells on the left:
The option was bought back @ $6.20 and the next month’s higher strike was sold for $4.10. The key point here is that our cost basis is now $120, not $120.36 or $125.59. The reason is that we are deciding whether to roll the option or allow assignment we must compare “apples-to-apples” If we permit assignment we will receive $120/share as per our initial option obligation. If we roll the option, our cost basis must be the same so we can decide which approach is in our best interest. Once the blue cells on the left side of this tab our filled in as shown above, the white cells on the right side become populated with results:
Once the shares were sold as a result of option exercise on 3/21/14, a 2.42%, 1-month return was realized and Jon had $12,500/contract in cash to use the following week for the April contracts.
2-month final returns
In reality this is a 6-week return because the trade was initiated mid-contract in February:
1.8% + 2.42% = 4.22% = 36.6% annualized
Although calculations can be challenging for many of us, using percentages and the Ellman Calculator will make our covered call writing decisions more meaningful and help elevate our returns to the highest possible levels. For a detailed discussion of covered call writing calculations see pages 99 – 152 in the Complete Encyclopedia for Covered Call Writing. Also, for a free version of the Basic Ellman Calculator see the “free resources” link on the black bar at the top of this page…just enter your email address and download this tool to your computer.
Next live seminar:
Saturday July 19th
Washington DC Chapter of the American Association of Individual Investors
9 AM – 10AM Dr. Eric Wish will speak (outstanding presenter)
10 AM – 12PM I will present a covered call writing seminar
This was an extremely light week for economic reports but The Federal Reserve officials did make some significant comments. For the first time they set an end date of October to end the bond-buying program as long as the US economy continues its expansion. The program has been reduced from $85 billion to $35 billion at a pace of $10 billion per month and plans to decrease by the final $15 billion in October. The Fed funds rate should remain near zero for the foreseeable future even past the termination of the bond-buying program. The latter depends on inflation remaining below the 2% target rate. This week’s reports:
- Consumer credit [a report of the dollar value of consumer debt, including categories such as credit card use and store charge accounts (known as revolving debt) as well as longer-term loans for autos, education, recreation vehicles, etc. (known as non-revolving debt). The level of consumer credit is considered a barometer of consumers’ financial health and an indicator of potential spending patterns] rose by $19.6 billion in May mainly due to strong auto sales
- April stats for consumer borrowing was adjusted higher to a gain of $26.1 billion, the largest increase since December, 2010
- Initial jobless claims for the week ending July 5th came in @ 304,000, near expectations
For the week, the S&P 500 declined by 0.8% for a year-to-date return of 7% including dividends.
IBD: Uptrend under pressure
BCI: Moderately bullish, expecting another favorable earnings season and favoring out-of-the-money strikes 3-to-1
Wishing you the best in investing,
Alan ([email protected])