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.
- 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
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
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?
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.
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”
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 20th
- None scheduled
Tue August 21st
- None scheduled
Wed August 22nd
- Existing home sales July
- FOMC minutes
Thu August 23rd
- Weekly jobless claims 8/18
- Markit manufacturing PMI August
- Markit services PMI August
- New home sales July
Fri August 24thth
- 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%
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