Evaluating the Time Value Cost-To-Close to Assist in Covered Call Trade Decisions

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We enter a covered call trade and share price rises exponentially, leaving the strike deep in-of-the-money (ITM). Should we close the position since we cannot benefit from additional share appreciation? Should we take no action and continue to monitor the trade with our 20%/10% guidelines in place? In this article, a real-life example, shared with me by a premium member, with Broadcom Inc. (Nasdaq: AVGO) will be analyzed. In addition to the huge share appreciation, this trade stood out because a LEAPS option was originally sold and still had 13+ months to get to contract expiration.

The AVGO covered call trade

• 5/25/20243: Buy 100 x AVGO at $728.80
• 5/25/2023: Sell-to-open (STO) 1 1/19/2025 $940.00 LEAPS call at $300.00
• 12/12/2023: AVGO trading at $1030.00
• 12/12/2023: “Ask price” to close the 1/19/2025 $940.00 call is $196.70
• Should both legs of the trade be closed?

Understanding the math behind closing deep ITM call strikes

Prior to closing the short call, shares of AVGO can be worth no more than $940.00, our contract obligation to sell. By closing the “ceiling” of the call strike, shares are now worth current market value, $1030.00, in this scenario. This unrealized increase in share value must be factored into our trade decisions. The BCI Trade Management Calculator (TMC), has a worksheet tab called the Unwind Now tab at the bottom of the spreadsheet. This will calculate for us the time-value cost-to-close. We must focus on this number when making our potential exit strategy decisions.

The Unwind Now tab of the TMC

• If the trade is closed, a realized return of 55.50%, 97% annualized concludes the trade (red ovals)
• The time-value cost-to-close is 11.35% (red arrow). This is how much we are actually paying to close both legs of the trade. This calculation gives us a basis for making our trade decision

Discussion

If we feel that we can generate > 11.35% over the next 13 months after closing both legs of the trade, unwinding should be considered. If not, we will continue to monitor the trade with our 20%/10% BTC GTC limit orders in place.

Two additional factors stand out with this AVGO trade. First, by selling LEAPS options, we are minimizing our annualized returns even though this trade was so successful. Second, over the next 13 months, AVGO will be enduring the risk of 4 earnings reports, which have the potential to hammer share price value. For me, I would take the money and run and close both legs of the trade.

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