One of our key covered call writing exit strategies is rolling an option when the strike is in-the-money at expiration and we want to retain our shares. We can roll-out to the same strike at a later date or out-and-up to a higher strike at a later date. For both. there will be an intrinsic-value cost-to-close. When we roll-out-and-up, we will benefit from share value being worth more than prior to closing the original short call. In our BCI methodology, this gain is referred to as bought-up value. This article will detail all the explanatory calculations.
Hypothetical trade
- 5/24/2021: Buy 100 x BCI at $48.00
- 5/24/2021: STO (sell-to-open) 6/18/2021 $50.00 call at $1.50
- 6/18/2021: BCI is trading at $52.00 as expiration approaches
- 6/18/2021: BTC (buy-to-close) the 6/18/2021 $50.00 call at $2.10 ($2.00 intrinsic-value + $0.10 time-value)
- 6/18/2021: STO the 7/16/2021 $55.00 call at $1.00 (rolling-out-and-up)
Initial trade structuring (multiple tab of the Ellman Calculator)
BCI: Initial Calculations
The initial time-value return is 3.1% (yellow cell) with the possibility of an additional 4.2% of upside potential (brown cell) if BCI moves up to or above the $50.00 strike by expiration. As long as the contract obligation to sell at $50.00 is in place, our shares cannot be worth more than $50.00. This is how the trade is structured.
Rolling-out-and-up: information into the “What Now” tab of the BCI Calculators
Rolling-Out-And-Up Data Entries
Rolling-out-and-up: final calculations from the “What Now” tab of the Ellman Calculators
BCI: Rolling-Out-And-Up Final Calculations
The “bought-up value is $2.00 per share or $200.00 per-contract. This is because shares can only be worth $50.00 with the original short call in place but, once the short call is closed, shares are worth market value of $52.00. This bought-up value must be incorporated into our calculations since we paid for it in the form of intrinsic-value cost-to-close.
The final calculations show an initial time-value + bought-up value combined return of 1.8% (brown cell). If share price moves up to the new out-of-the-money $55.00 strike by expiration (an additional $3.00 per-share), the total 1-month return will be 7.80% (Yellow cell).
Discussion
When rolling an ITM strike out-and-up, there will be an intrinsic-value cost-to-close. There will also be an unrealized increase in share value by that intrinsic-value amount. In the BCI methodology, this is known as bought-up value and must be incorporated into our rolling calculations.
Our best option-selling calculator for both calls and puts click here.
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Hi Alan,
I hope you are well…
Can I run a Scenario passed you please:
• I purchased say XYW stock for $48 and sold and option Strike price at $50 and on the 11th hour price of the stock was say $51.
• If I want to keep XYW stock, when I select the Ask price, am I using the Strike Ask price of $50 (the same as the Bid)?
• And if I am trying to roll out and up – I assume I need to wait until that Ask price has been taken before I then say sell a Bid at $55 for the following cycle?
• Can those two transactions be done simultaneously? And as I am in Sydney Australia and do my trades during my day, ready for when your stock market opens, can these BOTH be “pre” ordered to occur simultaneously?
• And lastly, the advice you gave me the other day about offering in-between the Bid and Ask price, can that also be done when Rolling Out on the Ask price, lowering it slightly to ensure it gets taken fast?
I hope all that makes sense…
Thank you
Todd
Alan,
Feed-back:
My experiment with the repair strategy this last cycle failed.
I tried three repairs, but after the expiry, I noticed that I would be better off if I had sold mitigation CCs only.
Roni
Roni,
Yes, the final week of the October contracts was strong.
For new members (I know that you know this, Roni), the stock repair strategy, although it can be incorporated into our option-selling strategies, is meant for those who traditionally just buy and sell stock. It allows us to lower our breakeven without adding additional cash to a losing trade.
There is no mention of the stock repair strategy in the exit strategy sections of my books and online video courses. However, if we hold a stock with no option component and the price has declined significantly, the stock repair strategy can be quite useful.
Here is a link to an article I published on this topic. Note the comment in the first paragraph “with no option component”:
https://www.thebluecollarinvestor.com/stock-repair-strategy-a-real-life-example-with-lyft-inc-nasdaq-lyft/
Alan
Thank you, Alan,
when I read your article a few weeks ago, I did not comprehend the comment “with no option component”, so I had to learn it the hard way.
Roni
Premium Members,
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Alan,
Here is my situation:
I started writing covered calls on Upstart (UPST) on Jul 29 this year. I paid $124.39 for the stock and now it’s at $390. These are my trades:
Jul 29 – wrote CC Jul 30 125 strike for credit of $2.29 (yes only one day ’til expiration)
Jul 30 – rolled out to Aug 6 125 strike for net credit of $3.33
Jul 30 – rolled out to Aug 13 125 strike for net credit of $6.25
Jul 30 – rolled out to Aug 20 125 strike for net credit of $1.20
(Yes I did these three trades all on the same day.)
Aug 12 – rolled out to Sep 17 125 strike for net credit of $1.25 (then UPST share price started really taking off – in hindsight I guess I should have paid some to close out the trade but who knew the share price would soon double)
Aug 16 – rolled out and up to Jan 21 2022 130 strike for net credit of $4.396
Sep 22 – rolled out and up to Dec 16 2022 140 strike for net credit of $0.535 (very low premium but was afraid of being called so thought the additional time value being sold would offer some protection)
Sep 22 – rolled out and up to Jan 2024 150 strike for net credit of $4.985 (was uncertain about rolling out that far in time but took the plunge anyway)
So here I am ridiculously deep in the money with last Friday’s closing price of UPST at $390 and my expiry more than two years away. Starting in early August the share pricing really ran away from me.
Do you believe there is a good chance I’ll be called being this deep in the money? Surely someone owns a call that they got at a good price relative to current option and share pricing.
I’m hoping to catch some additional upside beyond my $150 strike. I can buy up to $200 strike (same Jan 2022 expiry) for debit of $28.75 assuming the trade would execute – so I can buy up $5000 in value for $2875. Then if I am called I’ll get some additional $$ and my downside protection is still substantial as I wait out this trade. I plugged the numbers into your elite calculator for the buy up and ran them on handheld calculator as well. There is no option pricing beyond Jan 2024 so rolling out even further cannot happen at this time. Surely I’ll get called some day on this trade unless there is a massive share price correction.
Do you have any thoughts and comments on my situation and what might make sense? If I did something that was really ill-advised in this scenario where was it that I went wrong? Thank you in advance.
Kelly
Kelly,
Your focus on position management is a sure recipe for long-term success.
It is also important to define our goals after we have decided on a specific trading strategy, covered call writing in this case. We are seeking to leverage stocks and ETFs to generate monthly or weekly cash-flow. Unless we are leveraging long-term buy-and-hold stocks (portfolio overwriting), we have no loyalty to the underlyings as long as the cash-flow keeps coming. Let’s also incorporate our rule about avoiding earnings reports.
UPST went to the moon quickly. There are 2 ways to view this:
1. We missed out on share appreciation by capping the upside with a covered call option. This is saying that if we used a different strategy, we could have made more money. We are all much smarter looking back. I reject this evaluation.
2. We established a trade with a high initial maximum return and was successful. This is where I reside.
In this series of trades, you used the same approach I used when I started teaching myself these strategies in the 1990s… I tried to chase share appreciation and lost focus on cash-generation from option-selling.
Breaking down this series of trades into 2 time-frames should be helpful in analyzing the big picture:
7/29/2021 – 8/20/2021 (if we “allowed assignment of our shares on 8/20):
Net option credits = $13.07
Cost-basis = $124.39
22-day return = 10.5%; 174.3% annualized
There was a positive earnings report on 8/10 that resulted in a huge share price appreciation. Rather than have that 8/20 call in place, we could have owned the stock through the report (if we liked it and I’m assuming you did) and then written the call after the report passed. From there, we could have rolled-out-and-up until the next report in November. This allows us to re-evaluate our bullish assumption on the stock rather than be tied to it for another 2+ years.
8/12/2021 (rolling the 8/20 option) – 1/19/2024
Net option credits + unrealized share appreciation of UPST up to the $150.00 strike = $36.76
Cost-basis = $150.00 (what share are currently worth)
882-day return = 24.52%; 10.1% annualized
How many earnings reports are we subjected to?
Our 22-day and 882-day returns were about the same. We can do way better than 10.1% over the next 882 days.
Bottom line: We must focus on the strategy goals which is generating maximum cash-flow in a low-risk manner. We have no loyalty to the underlying but will leverage these securities to the maximum when they remain elite-performers. Avoiding earnings reports is a key rule that cannot be compromised.
Money was made so there is no need to break out the Kleenex. More important than the premiums generated is the fact that we all can learn from our trades and how to tweak our approach to become even better investors.
I’m impressed with your concentration on position management. Keep up the good work.
Alan
Hi Alan:
I hope you are well.. I appreciate all your articles. I have a question on rolling down selling a covered call below my breakeven/cost basis price.
Let’s say I sold a covered call on a stock for $25 per share for 1 contract and I took in $0.75 per share (or $75 in premium) for expiration date of 11.26.21 so my cost basis/breakeven point is $24.25.
Then on expiration date the price of the stock is $20 per share and I want to keep the shares.
Is it ok to keep selling calls above my cost basis price (i.e. $25 per share) and take in less premium? Or is it ok to sell a call at like $22 per share which is below my overall break even point but take in more premium?
A friend of mine advised me to almost never sell the call below my breakeven point. Just wanted your thoughts.
Thanks,
Troy
Troy,
Let’s assume there are no tax issues associated with these trades.
When a stock price moves from $25.00 to $20.00, there were probably some exit strategy opportunities prior to the end of the current contract. Whether yes or no, here we are with a stock now worth $20.00 per-share and a security we still like for the next contract period.
The price we originally paid for the stock has no influence over our current trade decisions. We once has a stock worth $25.00 but now it’s worth $20.00. Our trade decisions is based on what we have today, not at some point in the past. How are we going to manage that $2000.00 per-contract?
Since we are still bullish on the stock, we sell out-of-the-money calls based on our stated initial time-value return goal range. That amount will vary from investor-to-investor. For me, it’s 2% – 4% per-month. More conservative investors seek lower returns; more aggressive investors higher returns.
Bottom line: We base our current trade decisions on the value of our securities today, not a any point in the past.
Alan
Wonderful explanation! Thanks! I appreciate your time on replying back to me!
Troy
Dear Alan;
1) With so few stocks from the BCI current stock screen and watchlist to choose from because of earnings reports how long after the ER date to place the trade ? ie How many weeks left in the cycle still will generate decent returns?
2) How do we determine which are monthly expiration dates? There are so many expiration dates in a month now but no indication which are monthlies or quarterlies.
3) What to do and how to determine triple and quadruple witching expiration dates. Does it work to choose expiration dates prior to these or just confine to selling covered calls on ETF’s
Thank you
Donna
Donna,
1. We can turn to our ETF reports where earnings reports are not a factor.
Also, the stocks that report this week will still have 4+ weeks remaining until expiration which will allow for meaningful initial time-value returns. After the report passes, wait for any volatility to subside, usually 1 day, 2 at the most. When we are down to 3 weeks remaining in a contract, I cut my goal to 1% – 2% but, for these November contracts, there should be enough available securities to generate 4 weeks of time-value. It’s a bit of a challenge during the height of earnings season, but one we can overcome.
2.Monthly expiration dates are always the 3rd Friday of the calendar month at 4 PM ET.
3. Triple and quadruple witching expiration dates are always the 3rd Fridays of March, June, September and December.
Alan
Hi Alan,
Continue to play the C/C game for profit using lots of your advice and concepts.
This past Friday I had a bit of a surprise when a covered call on WPM was exercised. The SP was $41.00, and the stock closed at $41.01.
The Ex-Div date isn’t until next month. So I didn’t BTC because I didn’t think a 1¢ above SP would result in assignment, but it was.
What are the reasons such a modest ITM closing would result in exercise/assignment?
Thanks,
Charles
Charles,
The Options Clearing Corporation will automatically exercise any option in-the-money by $0.01 or more unless the broker issued different instructions.
If it is critical to retain shares when share and strike prices are close at expiration, we should roll the option to the next contract cycle.
Market-makers have until 5:30 PM ET to issue exercise notices so even strikes that are OTM at 4 PM can technically be exercised if there is a news event that comes out after hours. This is rare but can occur.
Here are links to 2 related articles I published:
https://www.thebluecollarinvestor.com/will-my-broker-automatically-exercise-options-that-expire-in-the-money/
https://www.thebluecollarinvestor.com/pinning-the-strike-a-covered-call-writing-consideration/
Alan
Alan,
It is our understanding from your books that you generally sell all your stocks going into earnings if you do not have a covered call option on them. Is that correct?
This eliminates the risk of earnings and allows for a new covered call position after earnings on the stock you sold or alternatively selecting a new stock from your BCI list.
Thanks,
Tom
Tom,
Yes, this is accurate.
There are rare times when we can hold a stock through an earnings report and write the call after the report passes. This is an approach we take with securities we want to retain in our portfolios for the longer haul. For our option-selling portfolios, holding stocks through ERs is an exception to the guideline.
Alan
Hi Alan,
Quick question p[lease:
Can I run a Scenario passed you please:
• I purchased say XYW stock for $48 and sold and option Strike price at $50 and on the 11th hour price of the stock was say $51.
• If I want to keep XYW stock, when I select the Ask price, am I using the Strike Ask price of $50 (the same as the Bid)?
• And if I am trying to roll out and up – I assume I need to wait until that Ask price has been taken before I then say sell a Bid at $55 for the following cycle?
• Can those two transactions be done simultaneously? And as I am in Sydney Australia and do my trades during my day, ready for when your stock market opens, can these BOTH be “pre” ordered to occur simultaneously?
• And lastly, the advice you gave me the other day about offering in-between the Bid and Ask price, can that also be done when Rolling Out on the Ask price, lowering it slightly to ensure it gets taken fast?
I hope all that makes sense…
Thank you
Todd
Todd,
1. When buying-to-close the original strike, we are using the “ask” price of that $50.00 strike which is a bit higher than the “bid” price. We buy at the “ask” and sell at the “bid”
2. When rolling out-and-up, we must first close the original short call. That frees up the underlying shares to protect the new strike for the next contract.
3. Some brokerages may offer “OTO” trades… one-triggers-other. Check with your broker if they offer that service. More commonly, we accomplish rolling in 2 steps.
4. Yes, we can leverage the “Show or Fill Rule” when buying back the option. Locate the “mark” or midpoint and slightly bump up the limit order in favor of the market-maker. If the spread is $2.50 – $3.00, the mark is $2.75 so we place a buy-to-close limit order at $2.80 – $2.85.
Alan
Of all the trade management strategies of BCI covered call writing, the mid contract unwind is the most psychologically challenging for a lot of people. I think this is because most focus on the “losing leg” without considering the unrealized stock gains that will most of the time wipe out the loss, and in many cases will still show a small profit. Also, there’s that other “Well, if I had not capped my profit by selling a call, I’d really have hit a home run.” The fact is that nobody can really predict what direction anything is going to go…I don’t care how many technical indicators show this or that. I have been at this for a while now to know that what makes sense for the directionality of the underlying is often not what reality bears out. I have seen too many news stories, etc. that should be devastating to an underlying, only to see skyrocketing prices – and vice-versa. I think if one views selling ITM calls as an insurance policy for downside protection instead of making windfalls, it’s easier to deal with. For example, right now, I am in 200 shares of ORCL (purchased at 95.45) – then sold an ITM strike of 93, and an OTM strike of 97. I’m going to let both of these get assigned on 10/29 (unless ORCL craters). My profit on the ITM will be $110, my profit of the OTM will be $285. The way I see it, I have the best of both worlds in these trades. And, thank you Alan for teaching the world these strategies!
Joanna,
As always, I agree with you 100%.
As for the MCU, I believe that it is a great opportunity and should be done always when the underlying stock is deep ITM and you are close to your maximal expected result. Of course, you will leave some money on the table, but a bird in the hand …
Roni 🙂
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Hi Alan,
I cannot tell you how much I enjoy your videos and book on covered call.
You claim that I could generate income on covered call.
It seems to me that I am loosing money on covered call with respect to just keeping the stock, when stock goes up above the strike value?
Best,
Yael
Yael,
We are not losing money in the scenario you describe.
Once we have decided on a strategy and accepted the pros and cons of that strategy, we now move to establish our trades. When we have achieved the maximum return based on the initial structuring of our trades, we are not losing money. We have experienced a successful result, the best we could have achieved.
In my view, there is no point in saying that we could have made even more money using a different strategy.
Let’s turn this around. Let’s say we buy a stock and it goes up in price but we would have made even more money had we also sold the option. Do we say that we lost money?
Bottom line: When we generate cash flow and enjoy successful trades, let’s celebrate those results.
Alan
Alan,
For a sophisticated investor like yourself, are you more inclined to sell puts or sell ITM Calls when you want a little less risk as the market gets higher?
Thanks,
JP
JP,
When the market is accelerating, I favor OTM calls.
In mildly bearish markets, I favor ITM calls.
In confirmed bear and volatile markets, I favor OTM puts.
I have several option-selling portfolios at all times. These will include both calls and puts. The above summary is how I allocate my positions based on overall market tone.
Alan
Hi Alan,
What about selling covered calls on inverse ETFs in confirmed bear and volatile markets? I live in Canada, where they do not allow selling puts (cash secured or otherwise) in registered accounts. Would inverse ETFs be appropriate during those times?
Thanks,
Roger
Roger,
Yes, using inverse ETFs in confirmed bear and extreme volatile markets (the crash of 2008, as an example) is a choice available to us. Since market historically go up, we must be cautious and quite selective when we use these securities. Just imagine how well we could have done in 2008 has we leveraged inverse ETFs.
Here is a link to one of the articles I published on this topic:
https://www.thebluecollarinvestor.com/covered-call-writing-and-inverse-etfs-generating-cash-in-extreme-bear-markets/
Alan