Rolling down is a frequently used covered call writing exit strategy to mitigate when share price declines. The original sold option is closed (bought back), while simultaneously opening another at a lower strike in the same contract cycle. When share price drops, the value of the associated call option will also fall by its Delta amount. As one example, if the original call option was sold for $2.00 per-share and had a Delta of 50, a $1.00 decrease in the share price will result in a $0.50 drop in option value, to $1.50.
Real-life trade with The Consumer Discretionary Select Sector SPDR Fund (NYSE: XLY)
- 7/22/2024: Buy 200 x XLY at $188.94
- 7/22/2024: STO 2 x 8/16/2024 $189.00 calls at $4.30
- 8/2/2024: BTC 2 x 8/16/2024 $189.00 calls at $0.46 (20% guideline triggered while share price gapped-down)
- 8/5/2024: STO 2 x 8/16/2024 $168.00 calls at $6.40 (rolled-down from the $189.00 strike to the $168.00 strike)
Had the shares (and overall market) not gapped-down, the short call could have been closed at the 20% limit order of $0.86).
6- month Price chart of XLY during this contract cycle
- The chart shows the point of the roll-down and subsequent share price recovery (red V-shaped pattern)
- This is classic for hitting a double, but since it occurred at the start of the 2nd have of the contract, rolling-down was appropriate
- I’m not sure which exit strategy I would have opted for, but I won’t challenge rolling-down
Which rolling-down strike should be selected?
- My preference is to always roll-down to an OTM strike, thereby allowing for some share price recovery
- If we were bearish on price performance moving forward (after the gap-down), we should sell the ETF
- By selling the $168.00 strike, we are locked into a huge loss of share value, despite the nice premium return
- On 8/5/2024, XLY was trading at about $174.00, meaning a deep ITM call was the selected rolling-down strike
- Let’s have a look at rolling-down to an OTM strike on 8/5/2024
XLY option-chain on 8/2/2024
- Sorry this chart is difficult to read
- The $180.00 8/16/2024 OTM call had a bid price of $2.45
- This would result in a rolling-down net option credit of $1.99 per-share
- The $180.00 strike allows share appreciation from $174.00 to $180.00 if there is recovery (there was)
- If share price continued to decline, another rolling-down trade could have been initiated, or shares could have been sold at a managed loss
Final trade results when rolling-down to the $168.00 ITM call
- Realized share loss: $20.94 per-share ($188.94 – $168.00)
- Net option credit: $10.24 ($4.30 – $0.46 + 6.40)
- Final realized trade loss: $10.70 per-share (-$20.94 + $10.24)
Final trade results when rolling-down to the $180.00 ITM call
- Realized share loss: $894 per-share ($188.94 – $180.00)
- Net option credit: $6.29 ($4.30 – $0.46 + 2.45)
- Final realized trade loss: $2.65 per-share (-$8.94 + $6.29
Discussion
Rolling-down is a viable exit strategy opportunity when share price declines in the latter half of a monthly contract (or weekly contracts, as well). If we are still bullish on the underlying security, we should roll-down to an OTM strike and receive a net option credit and preserve the opportunity for some share price recovery. If we are bearish on the stock or ETF, we can sell it and move on to a better performer.
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Barry and The Blue Collar Investor Team
Good morning Alan,
Hope all is well by you.
In this week’s report on the market overview, you mention that you are maintaining defensive positions until market uncertainty is resolved. Can you explain what you mean by defensive positions?
Are those ITM calls?
Or are you looking more at the Inverse ETF’s.
Thanks,
Audrey
Audrey,
I do not believe that inverse ETFs are justified at this time.
By defensive, I mean that I’m favoring ITM calls and deeper OTM puts.
This approach will lower our breakeven price points and provide greater protection to the downside, until the market stabilizes.
Alan
Hello Alan,
While I am not a paid subscriber to your great service, I have been following your posts via emails. In the past, you covered a lot of material on covered call writing and exit strategies, and I have purchased some of your books.
I now see that you have been covering cash covered puts as well. I am trying to understand how to protect the downside risk after I initiate a position before the position transitions to Deep ITM status. I can roll it down and out for some profit/loss. Other than that, I am seeking your guidance on the downside such as setting up a certain percentage loss or a fixed number, etc.
I would appreciate a response if you have the time.
Thank you,
Manohar
Manohar,
You are spot on that being prepared for all possible contingencies prior to entering our cash-secured put trades is essential and will guide us to the highest potential returns.
For example, we have the 3% guideline for monthly put trades. This states that if share price drops 3% or more below the OTM put strike, we close the trade and use the cash to secure a different put sale with a different underlying security.
In my latest management book, “Exit Strategies for Covered Call Writing and Selling Cash-Secured Puts”, there are 27 chapters of exit strategy information, 13 dedicated to cash-secured puts.
In our (essential) spreadsheet, the “Trade Management Calculator (TMC)” there are > 20 exit strategies inherent in the spreadsheet which allows for trade entries and adjustments.
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Alan
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Alan and the BCI team
Hello Allan,
Thanks for this wonderful insights into Rolling Down strategies. This article is very helpful.
Thanks
Kalyan