On December 21, 2020, Donna shared with me a successful trade she executed with XLF. What made this trade interesting was that the option was exercised after expiration when the strike closed out-of-the-money. This article will examine the reasons for this unusual circumstance.
Donna’s trade
- 11/24/2020: Buy 300 x XLF at $28.59
- 11/24/2020: STO 3 x 12/18/2020 $29.00 calls at $0.50
- 12/18/2020 (expiration Friday): XLF trading at $28.52
- 12/18/2020: Since the strike was OTM, no rolling action was executed
- 12/18/2020: After-hours, XLF moved up to $29.63
- 12/19/2020: The 3 contracts were exercised and Donna’s shares were sold at $29.00
Initial trade structuring on 11/24/2020
XLF: Calculations with the Ellman Calculator
The initial time-value return on the option (ROO) was 1.7% with an additional 1.4% of upside potential for a total 24-day maximum return of 3.1%. That max return was realized when the shares were sold after contract expiration.
5-day chart around contract expiration
XLF Chart Around Expiration of the December 2020 Contracts
- Red circle: Contracts expire at 4 PM Et on 12/18/2020
- Green arrow: Price moves up at market open on Monday but never reaches the $29.00 previous strike price
- Purple circle: Price reaches as high as $28.85 before declining
2 explanations
1.After-hours news: Informal news about naming Janet Yellen as the new Treasury Secretary was initially met favorably by the financial community. Market-makers have until 5:30 PM ET to notify the OCC about exercising options.
2. XLF had an ex-dividend date on Monday 12/21/2020 making Friday 12/18/2020 a potential target for exercise. In general, the trading date prior to the ex-date is the most likely candidate for early exercise. Donna did not capture the $0.15 per-share dividend but did enjoy a hugely successful covered call trade.
Discussion
Out-of-the-money call strikes are rarely exercised. When they are, after-hour news and ex-dividend dates are 2 of the more prominent explanations.
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Hi Alan,
So recently I came across The Blue Collar Investor and was very surprised with the amount of information regarding Covered Call Writing.
I just ordered Alan Ellman’s Encyclopedia for Covered Call Writing, which I haven’t yet received. I am a greenhorn when it comes to options.
I am wondering if there is an article/blog on BCI website for setting up a Stop Loss exit strategy for Covered Calls? Or an equivalent exit strategy I can setup, in case my stock drops a significant amount and the position would close without me having to worry about it right away.
Hope this makes sense.
Thank You,
Miles
Miles,
Welcome to our BCI community.
We do have an answer for how to manage covered call positions when stock price drops. We call if the “20%/10% guidelines”
A covered call trade involves 2 positions: we own the stock (long position) and sell an option (short position). We must close the short call before selling the stock and frequently we close the short call but don’t always sell the stock immediately. We may sell a different option or the same option at a later date.
Here is a link to an article I published on this topic:
https://www.thebluecollarinvestor.com/automating-the-20-10-guidelines/
Also, since you are new to options, I invite you to watch our free beginner’s tutorial videos on covered call writing:
https://www.thebluecollarinvestor.com/beginners-corner/
Take your time to master option-selling strategies and then you will have years and decades to benefit.
Alan
Alan,
can you please tell us about the end result of your XLU trade?
Roni
Roni,
This trade was a rare scenario where I “hit a triple”… 3 income streams in the same contract month with the same security. Here is the breakdown:
On the ETF side, I bought 400 shares of XLU at $67.04 and sold them this past Monday for $66.36 at a loss of $272.00.
On the 3 option sales, I received credits totaling $708.00 and debits totaling $132.00 for a net credit on the option side of $576.00.
The total net realized profit from this series of trades was $304.00. This is a 1.13% 1-month positive return, 13.6% annualized on a stock that went down in value… position management… the 3rd required skill.
Alan
Thank you, Alan, and congrats on this successful trade.
Roni
Premium Members,
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Alan,
I have been selling covered calls quite actively since February 1. It has been quite profitable.
I have a question however. As we have had very rapid sector rotation, I am developing a portfolio of what I call “Orphan” stocks. These are not bad stocks, but are simply out of favor for now, primarily due to sector rotation, and not indicative of the fundamentals of the stock.
An example would be AAPL. I purchased and optioned AAPL several times quite successfully. On several occasions the stock was taken after the call expired, repurchased, re-optioned and taken again. My last batch of AAPL was purchased on 4.19.21 for 134.74 and optioned. It did not get taken, and I am still in possession of it at a current price of 124.61. I am not worried about AAPL, it is a great company with great earnings (and in my opinion) a strong future.
If I option it at the current purchase price $135, thirty three days out, my expected return is about 6% annualized. Not bad by most standards, but I have been spoiled with my 20-40% returns.
If I do not want to settle for a 6% return, my other options are as follows.
1. Sell at a loss and move on. This approach may make sense in some cases, but I feel that this drop in price is a temporary phenomenon, and I do not see a stock or sector that looks tremendously more favorable.
2. Initiate a stock repair strategy by selling in the money calls. I tried this with another couple of stocks and reduced my losses had the stock taken, and then saw sector rotation change yet again, bringing these stocks back into favor. If I had been patient, I would have been better off. An example of this Is Lamm research.
3. Be patient and wait for the stock to get back closer to the purchase price and then begin re-optioning.
I think that covers the alternatives. My question for you is how do you evaluate which of those alternatives to utilize? What heuristic thought process do you follow?
Thank you for your assistance with this question, and thank you for what you have taught me about this form of investing.
Gordon
Gordon,
I can’t give specific financial advice in this venue but I can make some general comments you should find useful:
1.Before entering a covered call trade define the strategy: traditional covered call writing (where we turn over our portfolio securities frequently) or portfolio overwriting (where we want to retain these shares as part of a long-term buy-and-hold portfolio).
2. Once we have solidified our portfolio approach, moving forward decisions are clear.
3. If we have defined our security as a long-term buy-and-hold and share price has declined, we sell OTM options based on our pre-determined initial time-value return goal range. A reasonable range for portfolio overwriting is (this is a guideline) 1/2% per month; 6% annualized.
4. If we are using traditional covered call writing and share price has declined but we still have a bullish assumption, we sell OTM calls based on initial time-value return goals and current (not past) share price.
5. It is important not to allow previous stats (prices) cloud our decisions as to the best trades to execute today. The same would apply if the price had moved much higher than the original purchase price.
Alan
Allen,
Question for you, What determines if a stock is a weekly or monthly option and does this change over time. Say its been a monthly and then becomes a weekly or vise versa.
Thanks
Mike
Mike,
It’s a matter of supply and demand. All stocks with weekly options have monthly options but many securities with monthlys do not also have weekly options.
If the demand is there, the Options Clearing Corporation may add weekly options to a security that already has monthlys.
The last week of a monthly contract represents the weekly option if that security has weeklys. In other words, there is not both the final week of a monthly plus another weekly… only one.
Alan
Alan,
Last month, I purchased 300 shares of RIO and sold three contracts which expired OTM. In looking at this month’s opions, the 87.50 strike retuns a ROO of 2.8% / upside of 0.1%. The 90 strike returns a ROO of 1.8% / upside of 2.9%.
Is it an unacceptible breach of the method to use the smaller ROO for a much higher potential return.
Fred
Fred,
No breach at all. We each must set our initial time-value return goal range based on our strategy goals, personal risk-tolerance, market assessment and chart technicals.
I share with our BCI community my goals but that may or may not align with that of others. I actually set lower goals in my mother’s portfolio (1% – 2%) for near-the-money 1-month initial time-value returns..
If your assessment is bullish, the $90.00 strike is perfectly reasonable.
Alan
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Alan
Hi Alan,
Had some success with CCs since I’ve been using your system. Thank you. Have an issue with one of the securities on a recent stock selection report.
I bought QFIN and sold a 30 strike last month. I’d like to sell more but the stock is rising quickly. I’d like to sell a strike higher than is offered. The highest strike offered is 35 for the next two months. The shares have shot up to 33. Id like to see some higher strikes like 37.5, 40, 42.5.
How are the strikes created? Why aren’t there more available for this stock?
Cheers,
Mike
Mike,
QFIN had a substantial increase in price (> $5.00), blowing past most of the existing strikes. As a result of this, the OCC added additional strikes today as shown in the screenshot below.
Additional strikes are created by supply and demand.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
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Alan,
I have been doing PMCC’s following your guidelines very successfully the last couple of months. I learned the importance of the initial set up when the underlying went up too far too fast and I lost money. My question today is on when to roll up when the underlying goes past the short strike. The calculator tells me how much it costs to roll up but I’m looking for some guidance or parameters on when to roll up or when to just leave it alone. I think I might be getting led astray by using the analyze tab on Think or Swim as it shows the potential profit falling off as the underlying continues up.
I have been selecting the short strikes by using the charts and projecting where I anticipate they will be at expiration. I have found it better that way than trying to get a higher initial return. Am I on the right track?
Thanks,
Mark
Mark,
Glad to learn of your recent success.
The active management leg of the PMCC trade is the short call. If rolling out-and-up, we wait until the contract expiration approaches as we would for traditional covered call writing.
If we are rolling-up in the same contract month, we want the time-value component of the initial short call to be approaching zero such that by re-selling the 2nd higher-strike short call, we end up with a credit. The key here is the time-value approaching zero.
For a real-life example, see pages 158 – 160 in our book, “Covered Call Writing Alternative Strategies”
We base our initial short call strike selection on our initial time-value return goal range. We use the initial trade tab of the BCI PMCC Calculator and look for the row titled “Initial Short Call Return % (No Price Chg)” The key here is for the strike selection to align with our strategy initial return goal.
Alan
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Scroll down and click on arrow
Hi Alan,
Thanks so much for the spreadsheet as it really helps me make sure I set up the PMCC correctly. Do you have a spreadsheet I can enter my PMCC info into that will keep track of the break even price change as I sell Covered calls against the PMCC?
Thanks,
Glenn
Glenn,
There is a BE calculation when using the initial trade structuring tab of the BCI PMCC Calculator as shown in the screenshot below.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan