Rolling our covered call trades involves multiple months of trading statistics. The calculations may be deceiving initially but on deeper analysis, rolling our options can represent an invaluable trading tool which enhances our overall returns. Some of our members have expressed concern when rolling out-and-up because the cost-to-close our near-month in-the-money call deducts the intrinsic value of the closing option and calculates only time value as the cost-to-close. However, when share value declines after the rolling trades, it appears that we are losing from the rolling decision. In this article, a typical hypothetical rolling example will be established and then we will rely of the math to help understand the pros and cons of rolling out-and-up.
Hypothetical rolling out-and-up trade
- 1/22/18: Buy XYZ at $48.00
- 1/22/18: Sell Feb $50.00 call at $1.50
- 2/16/18: XYZ trading at $54.00
- 2/16/18: Buy-to-close (BTC) the Feb $50.00 call at $4.10 ($0.10 of time value + $4.00 of intrinsic value)
- 2/16/18: Sell-to-open March $55.00 call at $2.00
- 3/5/18: XYZ is trading at $48.00
When we roll out-and-up, as opposed to simply rolling-out or allowing exercise of the near-month in-the-money strike, we are taking a bullish stance on the overall market and underlying security. Once the new positions are established, we now move to “position-management” mode.
Initial trade calculations using the “Multiple” tab of the Ellman Calculator
The calculations show an initial time value return (ROO) of 3.1% and a possibility of another 4.2% from share appreciation up to the $50.00 strike price. At expiration of the near-month option, this total 7.3%, 1-month return has been realized in this hypothetical.
Rolling out-and-up calculations using the “What Now” tab of the Ellman Calculator
The option side of the rolling trade shows a net debit of $2.10 per share ($4.10 – $2.00) as we roll out from the February to the March contract and up from the $50.00 strike to the $55.00 strike. However, the share value which originally was limited by the $50.00 strike, now has an unrealized gain up to the current market value of $54.00 (+ $4.00 per share). This results in a net credit of $1.90 per share or 3.80% on a cost basis of $50.00. Now, if share value moves up to the new $55.00 strike, we generate an additional 2% for a total potential 1-month return of 5.80%.
What is the cost-to-close the near month $50.00 strike?
Initially, it appears that the cost-to-close is $4.10 but that does not factor in the increase in share value from the $50.00 strike to current market value of $54.00. That $4.00 intrinsic value is factored into the $4.10 premium to buy back the initial call, so we must calculate in the form of “buying up” share value. So, our net debit to roll out and up is $4.10 – $4.00 = $0.10 per-share. Let’s view this from a different perspective: Let’s say we didn’t hold a position with XYZ in the near-month but wanted to use it in the upcoming month. We would pay $54.00 per-share and write the $55.00 call. Let’s calculate:
The results are virtually the same as when we roll options out-and-up, rounding decimal differences aside. If we allow assignment and enter the covered call trade the next week, we will also be incurring one additional commission compared to rolling the option.
Rolling out-and-up is similar to entering a trade at the start of the new option contract with a small time value cost-to-close debit ($0.10 in this example). As long as we have our position management arsenal ready to go, we should have many more successful outcomes compared to the number of break-evens or losses.
AAII National Investor Conference: Las Vegas Nevada
October 26 @ 8:00 am – October 28 @ 1:00 pm
October 26th – 28th, 2018 (Friday through Sunday)
This week’s economic news of importance:
- Advance trade in goods July -$72.2 billion (-$69.6 billion expected)
- Case-Shiller home price index June 6.2% (6.4% last)
- Consumer confidence index August 133.4 (127.2 expected)
- GDP revision Q2 4.2% (4.1% expected)
- Pending home sales July -0.7% (1.0% last)
- Weekly jobless claims 8/25 213,000 (212,000 expected)
- Personal income July 0.3% (as expected)
- Consumer spending July 0.4% (as expected)
- Core inflation July 0.2% (0.1% expected)
- Consumer sentiment index August 96.2 (95.4 expected)
THE WEEK AHEAD
Mon September 3rd
- None: Labor Day
Tue September 4th
- Markit manufacturing PMI August
- ISM manufacturing index August
- Construction spending July
Wed September 5th
- Trade deficit July
Thu September 6th
- Weekly jobless claims 9/1
- ADP employment August
- Productivity Q2
- Markit services PMI August
- ISM nonmanufacturing index August
- Factory orders July
Fri September 7th
- Nonfarm payrolls August
- Unemployment rate August
- Average hourly earnings August
For the week, the S&P 500 moved up by 0.93% for a year-to-date return of 8.52%
IBD: Market in confirmed uptrend
GMI: 6/6- Bullish signal since market close of July 9, 2018
BCI: Selling 3 out-of-the-money calls for every 2 in-the-money for new positions.
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 8% while the VIX (12.86) down by 30%.
Wishing you much success,
Alan and the BCI team
this is a touchy subject for me.
I can see the value of Rolling Out-And-Up, but it somehow feels like I’m not being cautious.
You look at your trade the whole month, and you feel good because it is ITM a few days before expiry Friday. Now, you will strech your luck further?
Also, I prefer to wait for Sunday, when Barry’s new Stock Screen is published, and see what the research has come up with.
The Stock Screen is my guide. I’m just an amateur.
Just got back from a beautiful 10 day bus tour of Nova Scotia and Prince Edward Island. Beautiful land, lots of history and scenic views.
For trading state on my vacation, In my 4 accounts, I left one long position (SPLK) with a long Protective Put at 102 when the Underlying was at 104.33. Premium 2.90 per contract. All else in Cash. To exit the Protective Put, being greedy, I waited for a dip in the underlying price for the right time to exit to get a higher premium. But instead the price started climbing against me. Exited quickly when that happened with a Sell To Close of the Protective Put. I did exit the trade just before Expiration Friday at 104.. (Gapped up from 107 to 124 on Earnings – did not help me.)
In my Joint Trust, since I am just trading ETF’s, I felt comfortable with the 4 Covered call and and one long position and just placed orders for the 20% rule exit strategy if a stock dipped in price. One did fill during that time I was away, leaving a long position in HACK. On 8/20 after Expiration on 8/17, I add a sold a new option leg.
On 8/30, the HACK ETF gapped up and I exited with an MCU at a price of 40.31 with a 0.2% Cost to close. Net ROO = 1.7%.
Checking Finviz portfolio of my ETF Run list, I noticed the EWW (IShares Mexico) was at 50.71 and was paying 1.99% OTM Strike 51 with a BEP of 49.70 (good chart). Filled the order.
Regarding Rolling out and up, maybe touchy for some of us but it all depends on your goals, risk tolerance, and what is comfortable to you. It was nice in 2016 and 2017 when the market was rising gracefully with great results..
For myself, I am a little shaky after a relatively flat first 6 months (no losses) so I decided to trade only ETFs this month in my Individual and IRA accounts. Have all ITM IBB (2.0%), EWW (1.8% – 2 strikes down), and XRT (1.3%) and now I am 80% invested. I verified the Breakeven points fall at a good points on the price chart of each position. Hopefully this strategy will give me some free time to work on all my other action items.
nice to know about your vacations and smart trading.
good to have you back with us.
I had 3 positions expired on Friday (leftovers from last cycle), and therefore I’m 25% in cash.
Looking at Barry’s new Stock Screen today to find tickers for CC trades in the Feb. 21 options cycle.
Have a nice holiday – Roni
At this point I can comfortably say that you are much more than an amateur. We all can learn more, me included.
If we are rolling options on Thursday or Friday prior to expiration, we are saying that this is a stock we would consider on the Monday after expiration.
We will not have the new stock screen available when making that decision so we have to decide how much the fundamentals and technicals may have changed since the last report. I, too, depend heavily on our weekly reports but have been successfully rolling option for over 2 decades.
Fundamentals change mainly after an earnings release which would not apply when considering rolling.
Technicals can change but we are dealing (as you astutely pointed out) with in-the-money strikes so price decline would not be egregious if at all. We can also pull up a technical chart to double-check (see page 73 of “The Complete Encyclopedia for Covered Call Writing- Classic Edition” for setting up a technical chart for option-selling).
If we decide to roll-out, we have the intrinsic value protection of the premium that offers additional downside protection. If we decide to roll-out-and-up, we can do so to an in-the-money, at-the-money or out-of-the-money strike depending on how bullish or bearish our outlook is at the time.
Rolling is an important tool in our exit strategy arsenal which should be used as long as it meets our personal risk-tolerance and trading style.
Thank you Alan,
After reading your post, I will certainly review my attitude to Rolling- out-and up.
Your kind words make me feel more assured, and therefore I will act a little bit more agressively when faced with these decisions.
I’ll share a trade of mine that may help. I have owned 300 shares of GLD for a long time over writing it OTM every month. It’s been in a slide and I kept premiums and shares. “Who da thunk of GLD as an income ETF?”
I am covered at 112 for Sept and lo and behold GLD has gone up! I’ll look at my position on expiry and decide whether to allow assignment or roll. Heck, it could be OTM worthless again by then?
I have often thought covered call writers and fishermen have a common trait: patience. – Jay
gold has stayed kind of stable lately, but it seems you have found a good way to trade it. Interesting.
Happy end of your weekend + labor day holiday. – Roni
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 08/31/18.
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:
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:
Barry and The BCI Team
Maybe I am missing something, but isn’t this article supposed to address for when the stock goes down after rolling out and down? I don’t see a mention of the price going down or of the calculation to make for that.
you are right. The calculations do not include the eventuality of the stock going down.
But in the first paragraph, it is mentioned.
Also, further you can read:
“When we roll out-and-up, as opposed to simply rolling-out or allowing exercise of the near-month in-the-money strike, we are taking a bullish stance on the overall market and underlying security. Once the new positions are established, we now move to “position-management” mode.”
And in “discussion”, Alan says :
“As long as we have our position management arsenal ready to go, we should have many more successful outcomes compared to the number of break-evens or losses.”
Therefore, clearly, “Position-Management” is the tool we must use when the stock goes down.
To add to Roni’s outstanding response:
Once a decision has been made to roll the option, we can immediately go into position management mode and put our 20%/10% guidelines in place. Here is a link to an article I published relating to this topic:
Why is the comparative basis in the stock $50 on the roll out and up analysis? It seems like it should be $54 since you “bought up” to this price.
The section of the What Now Tab labelled “What if I let the stock get called away” explains why.
“The basis of the stock appearing on this page is for comparison purposes ONLY. It is the lower of the expiring option strike price or the current stock price. If you allowed the stock to be called away the amount you would have to invest on Monday is the proceeds. DO NOT USE THE FIGURES BELOW FOR TAX PURPOSES.”
So Strike 50 (Contract $5000) reflects the Proceeds you receive if you let it be assigned.
If the Price of the stock is lower than 50, say 47, the program selects 47 as the reference price and your proceeds are $4700, which is the amount you will get if you unwind your position.
The other point is you can also pick lower strikes and still be Up and Out.
The purpose of the What Now Tab is to compare is to compare a Roll Out trade return versus a Roll Out and Up trade return so you can make a better informed decision for the roll out. So you could conceivably pick Strikes 54 or even 53 to Roll Out and Up and get lower returns. To view the results for the other Up and Out strikes you have to enter new values in the spreadsheet, since it only handle one Up and Out strike at a time. Then do your comparison of the results based on a constant reference value.
I am a little confused about what to do with downside protection. From encyclopedia example, buy stock at 32, sell 30 call, have protection down to approximately 30. Exit strategies book doesn’t seem to address this. If stock falls to protection point (30) early in cycle, closing the position seems like it would result in paying back some of the time value credited when option sold. Is this correct? There would be some profit but not as much as originally obtained.
“Downside protection” (DP), as defined in the BCI methodology, represents protection of the initial time value profit. It is different from “breakeven” which is stock price – entire premium.
DP applies only to in-the-money strikes where intrinsic value protects time value. Let’s go to the example you alluded to:
If we buy a stock at $32.00 and sell the $30.00 call for $3.00, $2.00 is intrinsic value and $1.00 is initial time value profit. This means that we are guaranteed a 3.3% returns ($1.00/$30.00 as we use $2.00 to “buy-down” our cost basis) as long as share value does not decline by more than 6.3% ($2.00/$32.00).
Closing the position if share price is declining is based on our 20%/10% guidelines or when option value declines to $0.60 in the first half of a contract or $0.30 in the latter part of a contract.
There are other guidelines for share price acceleration.
The Weekly Report for 08/31/18 has been revised and uploaded to the Premium Member website. Look for the report dated 08/31/18-RevA. The reason for the revision is that we received updated risk/reward data today.
Three stocks were impacted:
GRUB moved from “Pass” to “Fail”
IRBT moved from “Pass” to “Fail”
MTCH moved from “Fail” to “Pass”
Barry and The Blue Collar Investor team
Kyle, Roni, Alan,
It was interesting how Alan related the Roll Out and UP analysis to using the Multiple Tab of the elite Calculator to calculate the return for an equivalent trade when analyzing the roll out.
This gave me the idea of using the Multiple Tab of the calculator to calculate the Net Return of each step of the trade, which you can do by knowing the Cost basis, the Breakeven (BEP), the relevant Stock price at each step of the trade.
I have attached the analysis, including the actual trade ROO return if there is no position management with the 20%/10% to handle the drop to 48.
I also added for the Rollout and UP, which used a strike of 55, an additional analysis for the return for a strike of 54.
When I enter a covered call or a long position, i document the Return Cost Basis (RCB) and the Breakeven point of the position. Using the current Stock price or exit Stock price, you can calculate the return fo the position. If I receive a dividend, I calculate the per share benefit and adjust the breakeven point. For a Covered call RCB cost basis is the Strike for an ITM call and the RCB is the Stock price for an OTM call using Alan’s system.
The attached image of the Multiple Tab shows the NetROO at each step. For the Trade the Return Cost Basis is 48. If you enter a value of 48 for both the Stock $/sh and Strike prices, you can enter the Gain in the Option $/Sh at each step and see the NetROO of the position calculated correctly.
I also found you can let Excel calculate totals for you by entering = and then the variables to add or subtract in the input cells. Very convenient.
Here is a summary of each step:
Line 15: Initial trade ROO 3.1%, Upside 4.2, Total 7.3%
Line 18: As a check, to show you get the same result, I recalculate for the current price, the NetROO from the BreakEven and cost basis of 48
Time 2A and Time 2B (Strike 55 and 54 Rollout Up comparison):
Line 23: Strike 55: I totaled the BTC, Share Apprec, and Sell to Open (1.9) and calculated the ROO (3.5%, Upside 1.9%) using the current price of 54 and Strike 55. Compare this result with the Strike 54 case where the ROO is 1.9% in Line 30.
Line 25: With the new Break Even, I calculate the Net ROO for the position as 11.3%. You will get this same number also if you total the Initial trade (7.3% total) to 1.9/48=4.0% = 11.3% of the rollout using the 48 cost basis.
Lines 30 and 32 compare the Strike 54 case, where I assumed some premium values.
Time3: Drop to 48
Line 36, I show the percent drop in price is -11.1%
Line 37, I show the NetROO of the position is -1.3% with no position management (option has not been bought back). At expiration that will be the position loss if the price stays at 48 and and the option expires worthless.
Another useful calculation to know is if you know your Return ROO, you can calculate the Gain in dollars by multiplying the ROO, Return Cost Basis and the Number of shares.
For the above trade:
11.3% (Rollout) = $542.40 (0.113 x 48 x 100)
-1.3% (Drop to 48) = -$62.40 loss (0.013 x 48 x 100)
That’s very sofisticated and detailed stuff.
I will have to spend some time with my spreadsheet advisor to fully understand and apply your great tip.
My Excell skills are close to nill.
I did not modify any Cells in the Multiple Tab of the Elite Calculator.
You can just try duplicating what I entered and you will see what I mean. Be glad to help with any questions.
You can type any text in Column A and it will extend across the other columns.
Thanks for this outstanding analysis when taking a macro view of a multiplicity of trades. One key point you made in time frame 3 that I want to re-iterate for new members is that the stats reflect a loss based on “no position management”
Great work as always!
There was a typo in the updated premium member report sent out last night. JAZZ does not have weekly options. A thank you to Doug for spotting the typo.
This week’s 8-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options as well as the implied volatility of all eligible candidates.
New members check out the video user guide located above the recent reports.
For your convenience, here is the link to login to the premium site:
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Alan and the BCI team
All I got to say is I’ve been hitting doubles left and right this month. This strategy is ridiculously lucrative.
When market volatility increases with subsequent sizable moves in both directions, more exit strategy opportunities present themselves. Congratulations on being prepared to take advantages of these situations.