The use of exit strategies will elevate our profits to the highest possible levels. Mastering the skill of position management is one of the main reasons why Blue Collar Investors outperform other covered call writers. A favorite exit strategy of mine is the mid-contract unwind exit strategy used in the first half of an options contract when share price has risen well above the strike sold. In this article I will show a real-life example of a trade I made last year using TAN, an exchange-traded fund that was a top-performer on our Premium Member ETF Report at the time.
- 8/19/13: Buy 500 x TAN @ $25.83
- 8/19/13: Sell 5 x September $26 calls @ $0.90
- 9/6/13: Share price rises to $29.66, leaving the $26 call deep in-the-money
Accessing the options chain
Since there were still 2 full weeks remaining in the contract, I investigated the options chain to see how much time value was associated with the $26 call option and whether it paid to unwind. Here’s the option chain on 9-6-13:
The bid-ask spread was $3.50 – $4.00. I leveraged the Show or Fill Rule to negotiate the cost to buy-to-close down to $3.80 of which $3.66 was intrinsic value ($29.66 – $26). This left $0.14 of time value, the actual cost to close. This is about one half of 1% ($0.14/$26). This means that if we can generate significantly more than .54% with the cash freed up by closing our position ($2600 x 5 =$13,000), it makes sense to move forward with this exit strategy. With 2 weeks remaining until expiration, this goal should be easily achievable.
The Ellman Calculator
That said, let’s use the “Unwind Now” tab of the Elite version of the Ellman Calculator to calculate our results prior to generating our second income stream:
Entering the stats
Once the information is entered into the blue cells, the white cells on the right become automatically populated:
We see that we have generated a 19-day return of 3.60% which annualizes to 70%. Next we take the $13,000 cash from the sale of TAN and use it in a new covered call position to generate a second income stream. In stage 2 of this exit strategy, our goal (in this case) is to glean a significantly higher return than .54%. All this is thought out in advance of closing the position. If for any reason, we couldn’t generate a return that meets our goal for this second position, using this exit strategy would not make sense. In that unlikely event, we would leave the original position as is and re-evaluate as contract expiration approaches.
The use of the mid-contract unwind exit strategy is most appropriate in the first half of the options contract when the time value of the premium approaches zero and the ability to generate a second income stream greater than the cost to close the first one is apparent. Using the “unwind now” tab of the Elite version of the Ellman Calculator will make the process much easier.
We are in Orange County California this weekend. The next presentation is:
July 17, 2014
Link to register will be uploaded to this site once received from The Money Show.
The Complete Encyclopedia for Covered Call Writing: Hardcover version available only on this site:
We have had a great many members ask if we would consider publishing the Complete Encyclopedia for Covered Call Writing in hardcover format. I decided to make it available only on this site to our general and premium members (premium members enter the Blue Collar store from the link found in the premium site to get your member discount @ checkout). It will not be available on Amazon.com. My team has created a choice to purchase either the hard or soft cover versions in the Blue Collar store.
This past week was a light but generally positive week for economic reports as the markets responded to rising oil prices and destabilization in Iraq:
- Business inventories increased by 0.6% in April above the 0.4% anticipated
- Retail sales rose by 0.3% in May from revised April stats that went from 0.1% to 0.5
- The Producer Price Index (PPI), an important measure of consumer inflation, declined by 0.2% in May while economists projected a rise of 0.1%
- On a year-to-year basis PPI rose by 2.0%
For the week, the S&P 500 declined by 0.7%, for a year-to-date return of 5.8%, including dividends.
IBD: Confirmed uptrend
BCI: Moderately bullish, selling an equal number of in-the-money and out-of-the-money strikes as we await to see how the Iraq situation plays out.
My best to all,