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Factors to Consider When Closing a Trade Early: A Real-Life Example with ATVI

Exit strategies for covered call writing includes closing a trade when share price rises above the original strike price sold. When formulating these decisions, we must factor in the cost-to-close as it relates to the opportunity to generate more profit. On November 8, 2017, Marion shared with me a trade with Activision Blizzard, Inc. (NASDAQ: ATVI) that called for such evaluation. Marion wanted to know if the position should be closed or if no action is called for at this time. 

 

Marion’s trade

  • 11/6/2017: Buy 100 x ATVI at $60.34
  • 11/6/2017: Sell 1 x December 8, 2017 $61.00 call for $1.62
  • 11/8/2017: Date email was sent to me: ATVI trading at $64.55
  • 11/9/2017: ATVI trading at $63.30 as I respond to Marion’s email

 

ATVI option chain on 11/9/2017

covered cal;l writing exit strategies

ATVI Option Chain on 11/9/2017

 

The cost-to-close the $61.00 short call is $3.60 per-share. Next, we will populate the blue cells in the Elite version of the Ellman Calculator (free to premium members) to measure the actual time value cost-to-close.

 

ATVI calculating the cost-to-close

 

Elite Version of Ellman Calculator

covered call writing exit strategies

 

Although the buy-to-close premium is $3.60, $2.30 is intrinsic value. This means, we are benefitting by $2.30 as share value moves from the $61.00 strike price to the current market value of $63.30. This leaves a time value cost-to-close of $1.30 which represents a loss of 2.13% based on the current strike price ($61.00). That is the realistic amount it will cost us to close this entire position (less small trading commissions).

 

Practical trading based on these calculations

To close or not to close, that is the question. Shakespearean reference aside, this is a critical decision that we are faced with frequently as option-sellers. The brown field shows that we are spending 2.13% of our investment to close both legs of this trade. The cash can then be used to enter another trade. We ask ourselves if the new trade can generate more than 2.13% in the remainder of the contract month to justify closing. Since there is a full month remaining, it is not unreasonable to assume that this would be possible. A successful second trade in the current contract month may generate, let’s say, 3%, leaving a net credit of 0.87% for closing and entering the second covered call trade (less small commissions). The other choice is to take no action leaving us in a position where the initial trade is maximized at 3.8% ($1.62 option premium + $0.66 share appreciation up to the $61.00 strike). We also have downside protection of that 3.8% 1-month profit of 3.6% ($2.30/$63.30). Both are great choices…which would you select?

 

Discussion

More aggressive traders may opt to close and hope to generate an additional 1% net credit. More conservative investors (I’m guilty as charged) would lean to the latter choice of taking no action and relying on that 3.6% cushion to protect the healthy 3.8%, 1-month return. Of course, we continue to monitor our position which may lead to taking advantage of a position management maneuver later in the contract.

 

Upcoming event

San Francisco Money Show

August 23rd and 24th

Hilton San Francisco Union Square

1.Thursday August 23rd: 12:30 PM – 1:15 PM

All Stars of Options: “How to Select the Best Covered Call Options in Bull and Bear Markets”

2. Friday August 24th: 10:15 AM – 1:15 PM

Masters Class: “How to Generate Monthly Cash Flow and Buy a Stock at a Discount Using 2 Low- Risk Option Strategies (covered call writing and selling cash-secured puts)”

3. Friday August 24th: 6:00 PM – 6:45 PM

Workshop: “Converting Non-Dividend Stocks to Dividend Stocks using Stock Options”

Click for information

 

Market tone

This week’s economic news of importance:

  • NFIB small business index July 107.9 (107.2 last)
  • Import price index July 0.1% (-0.1% last)
  • Retail sales July 0.5% (0.1% expected)
  • Productivity Q2 2.9% (2.4% expected)
  • Industrial production July 0.1% (0.3% expected)
  • Home builders’ index August 67 (68 last)
  • Business inventories June 0.1% (0.3% last)
  • Weekly jobless claims 8/11  212,000 (215,000 expected)
  • Housing starts July 1.168 million (1.270 million expected)
  • Building permits July 1.311 million (1.292 million last)
  • Consumer sentiment August 95.3 (98.5 expected)
  • Leading economic indicators 0.6% (0.5% last)

THE WEEK AHEAD

Mon August 13th

  • None scheduled

Tue August 14th

  • None scheduled

Wed August 15th

  • Existing home sales July
  • FOMC minutes

Thu August 16th

  • Weekly jobless claims 8/18
  • Markit manufacturing PMI August
  • Markit services PMI August
  • New home sales July

Fri August 17th

  • Durable goods orders July

For the week, the S&P 500 moved down by 0.59% for a year-to-date return of 6.60%

Summary

IBD: Market in confirmed uptrend

GMI: 6/6- Bullish signal since market close of July 9, 2018

BCI: Using an equal number of in-the-money and out-of-the-money strikes. Not willing to get more aggressive at this time.

 

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The 6-month charts point to a bullish tone. In the past six months, the S&P 500 was up 5% while the VIX (12.64) down by 39%.

Wishing you much success,

Alan and the BCI team

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

4 Responses to “Factors to Consider When Closing a Trade Early: A Real-Life Example with ATVI”

  1. Jay August 18, 2018 12:56 pm #

    Good morning friends,

    Alan, I am with you, I would take the latter choice!

    I covered most of my ETF’s for Sept. on the Thursday bounce. And you heard it here first, folks, this retail hobbyist thinks the market will be lower a month from now! That said, you will find no better contrary indicator than me :).

    I read several articles this week all drawing similar conclusions – dangerous in itself.

    The irony of the Trade War is it has forestalled a larger crash or correction in the market by injecting pessimism, restraint, caution and even fear into the minds of investors. Markets don’t crash at these sentiment levels. Crashes require “irrational exhuberance”.

    Markets may melt down and we are seeing that with price action but it is unlikely we will have a “Big Bang”. Water torture is the more likely scenario :).

    There is a funny saying “the more unpredictable things become the more people rely upon predictions”. Sounds like now….

    A nice weekend and successful new week to all. – Jay

    • Hoyt T August 18, 2018 11:08 pm #

      Good evening Jay,

      I agree. This market has me frightened for a variety of reasons. Your analysis of the Trade War makes a very good point. I too feel like it’s going to be water torture rather than a big crash. Death by a thousand cuts.
      I have not analyzed all the big crashes but I tend to agree that crashes to not occur when we have a wall of worry such as we have now.
      However I am a fan of Nassim Taleb’s theory of the Black Swan. His book is a compelling read. The gist of the theory (from Wikipedia) is “The black swan theory or theory of black swan events is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight”.
      It is the Black Swans that I fear. 9/11 was a Black Swan. Nov. 8, 2016 was a Black Swan. Dow futures were down 900 points at one point overnight. However things then turned on a dime. I fear we are in the Bermuda Triangle of potential Black Swans.
      Now is the time to be disciplined, follow our guidelines, and/or rules and pay attention. Each of us has unique antennae which need to up. My major mistakes were made when I didn’t listen to what myself was telling me.:)
      Take care and good fortune,
      Hoyt T.

  2. Alan Ellman August 18, 2018 6:49 pm #

    Great crowd at my Denver presentation this morning.

    Click on image to enlarge and use the back arrow to return to this blog.

    Alan

  3. Barry B August 18, 2018 9:16 pm #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 08/17/18.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Since we are still in Earnings Season, be sure to read Alan’s article,”Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:

    https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season

    The report for 8/24/18 will be out before the market opening on Monday, 8/27/18. Most likely, I should be able to get it out to you late on Sunday evening, 8/26/18, upon my return back to the US.

    Best,

    Barry and The BCI Team

    barry@thebluecollarinvestor.com

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