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Rolling Out-And-Up: Explaining the “Bought-Up” Value of our Stocks

One of our covered call writing exit strategies is rolling out-and-up. This involves buying back (buy-to-close) the current in-the-money option and selling the later-date higher strike price. For example, we may buy back the October $50.00 call option and then sell the November $55.00 call option. We would consider such action if the expiring strike is in-the-money, the stock still meets all system criteria and the initial return rolling credit meets our goals. One of the terms used in my books and DVDs associated with this strategy is “bought-up” value. This article will explain the meaning and significance of this term by using a hypothetical example and the “What Now” tab of the Ellman Calculator.

 

Hypothetical example with made-up stock “More Money Corp. (MMC)”

Current contract month

  • Buy MMC for $28.00
  • Sell the $30.00 call for $1.00
  • Near expiration, MMC is trading at $32.00
  • The cost-to-close the $30.00 call is $2.10 ($2.00 is intrinsic value and $0.10 is time value)
  • The next-month $35.00 call generates $1.50

 

The “What Now” tab of the Ellman Calculator

The blue cells of the calculator spreadsheet (left side) are filled in:

covered call writing exit strategies

What Now Tab of the Ellman Calculator

 

Once the information is entered, the white cells on the right side become populated:

rolling out-and-up

MMC Rolling Calculations

 

What is “bought-up value”?

The bottom (smaller) red arrow shows a bought-up value of $200.00 per contract or $2.00 per share. When we sold the $30.00 call our shares can be worth no more than $30.00 due to our contract obligation. However, when we buy back the option and no longer have that obligation in place, our shares are now worth market value or $32.00. This $2.00 difference or $200.00 per contract represents the “bought–up value”

 

Why include bought-up value in our calculations?

Since we are including the intrinsic value debit of $2.00 as part of our calculations in the $2.10 cost-to-close, we must also include this intrinsic value component on the asset side. This makes the actual time value cost-to-close $0.10.

 

Calculation results for rolling out-and-up with MMC

The calculator shows an option debit of $0.60 ($1.50 – $2.10) or $60.00 per contract. Factoring in the “bought-up value of $2.00 or $200.00 per contract, we have a net credit of $140.00 per contract. On a cost-basis (current market value with the contract obligation in place) of $30.00 or $3000.00 per contract, this represents a 4.67% initial return. Should share price rise to the new $35.00 strike by contract expiration, the total rolling out-and-up trade could generate a 1-month return of 14.67%

 

Discussion

When using the rolling-out-and-up exit strategy for covered call writing, we must factor in the increase is share price when removing the initial obligation. The new “bought-up value” will be current market value or the new strike price, whichever is lower.

 

Upcoming event

American Association of Individual Investors: Charlotte NC Chapter

Saturday June 9th 9 AM – 12 PM

“How to Generate Monthly Cash Flow and Buy a Stock at a Discount Using Two Low-Risk Option Strategies”

Myers Park United Methodist Church

1501 Queens Road

Charlotte, NC 28207

Click here for details

See all events

 

Market tone

This week’s economic news of importance:

  • Chicago national activity index April 0.34 (0.32 last)
  • Markit manufacturing PMI May 56.6 (56.5 last)
  • Markit services May 55.7 (54.6 last)
  • New home sales April 662,000 (682,000 expected)
  • Weekly jobless claims 5/19 234,000 (219,000 expected)
  • Existing home sales April 5.46 million (5.5 million expected)
  • Durable goods orders April (-)1.7% (-1.0% expected)
  • Consumer sentiment index May 98.0 (98.9 expected)

 

THE WEEK AHEAD

Mon May 28st

  • None scheduled

Tue May 29th

  • Case-Shiller home price index March
  • Consumer confidence index May

Wed May 30th

  • ADP employment May
  • GDP Q1
  • Beige book

Thu May 31st

  • Weekly jobless claims through 5/26
  • Personal income April
  • Consumer spending April
  • Core inflation April
  • Chicago PMI May
  • Pending home sales April

Fri June 1st

  • Nonfarm payrolls May
  • Unemployment rate May
  • Average hourly earnings May
  • Markit manufacturing PMI May
  • ISM manufacturing index May
  • Consumer spending April

For the week, the S&P 500 moved up by o.31% for a year-to-date return of 1.78%

Summary

IBD: Confirmed uptrend

GMI: 6/6- Buy signal since market close of April 18, 2018

BCI: Selling an equal number of in-the-money and out-of-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 neutral to slightly bullish tone. In the past six months, the S&P 500 was up 2% while the VIX (13.22) moved up by 36%. 

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.

26 Responses to “Rolling Out-And-Up: Explaining the “Bought-Up” Value of our Stocks”

  1. Duminda May 26, 2018 4:19 am #

    In your book “Complete Encyclopaedia for covered call writing (Volume 1)” you have clearly stated in chapter 9 the case against protective puts. However, the markets can gap down over the week end and share prices can fall more than 8-10% when the market reopens on Monday morning.

    – If the reason for such a huge fall across all markets is a catastrophic global event (I understand that these events occur very rarely) even if you had selected the best covered call writing candidates, it can leave a huge dent in your trading account because a numbers of stocks in your well diversified portfolio can get adversely affected by this, can’t it?

    – Have you ever experience that?

    – How long on average it will take to recoup such losses?

    – Have your ever used the collar strategy to avoid such huge losses?

    Thanks,
    Duminda

    • Alan Ellman May 26, 2018 7:07 am #

      Duminda,

      Protective puts (called a “collar” when used in conjunction with covered call writing) provide the advantage of placing a floor on maximum losses and result in the disadvantage of lowering potential returns. This means that a case can be made both ways and depends, to a great extent, on the risk-tolerance of the investor.

      I rarely use protective puts (exceptions include when I am traveling and cannot monitor my positions) but there are some members of my team who incorporate this strategy approach more frequently than I do…different strokes for different folks.

      Either way, there is an assumption of having mastered the 3rd required skill for covered call writing…position management. We must always have our arsenal of exit strategies ready for all potential scenarios, including gap-downs.

      Here is a link to an article I previously published on this topic:

      https://www.thebluecollarinvestor.com/price-gaps-and-the-need-for-exit-strategy-execution/

      Alan

    • Jay May 26, 2018 1:53 pm #

      Hi Duminda,

      As the name implies if you “collar” something it’s not going to run too far away :). As with most things in options it has it’s good and bad features.

      As for protective puts I use them all the time. But they are expensive so I use them situationally for very short duration. Let’s say you love a certain stock and want to hold it through earnings? OK – that was a bad use of the word “love” which is for family friends and pets :). “Like” would have been a better word :). Stocks need to earn their keep!

      A suggestion I offer for your consideration is, of course, NEVER have a covered call open during an earnings report but buying a protective put makes all the sense in the world for that week when keeping a stock you like. Implied volatility will be elevated due to earnings and you will pay for that because a lot of others will be doing it too but it helps mitigate the downside risk. Expect the air to go out of that balloon fast if earnings are good. You could lose almost everything you spent on the puts. Hopefully the stock appreciation and ability to sell a new OTM call at a higher strike more than evens all that out.

      I sometimes do it for Fed meetings and the monthly jobs number buying general market insurance with SPY puts. Like most insurance I don’t often need it but it has paid for itself enough it is still a tool I keep in the box. – Jay

      • Mel May 27, 2018 7:16 am #

        Duminda,

        I travel a lot for business and sometimes have no time to check my positions. Protective puts are especially helpful during these times.

        Mel

        • Duminda May 27, 2018 11:14 am #

          Alan,

          You have stated in your reply that some of the members of your team incorporate the collar strategy frequently. I would also like to do the same depending on the stock and the market outlook.

          Further, I can use the BCI guidelines to select the call option strike price. But how do you and your team select the put option strike price? What is guideline for that?

          Please advise.

          Many thanks.

          Duminda

          • Alan Ellman May 27, 2018 5:07 pm
            #

            Duminda,

            I view the purchase of protective puts in much the same way I evaluate insurance…how much insurance do we want and how much are we willing to pay for it? The closer the out-of-the-money (OTM) put strike is to the current market value of the underlying, the more expensive it is but the more protection we get to the downside.

            To determine the best which OTM put strike to purchase, we must first set our target initial time value returns because the strategy is based on producing cash flow. Let’s say that target is 2% for 1 month. Next, we select a combination of OTM call strikes and OTM put strikes that generate that return. Below is a screenshot of the new BCI Collar Calculator showing 2 such examples where initial returns of 2.25% (GDX) and 2.09% (ATHM) can be generated with the strikes shown in the white cells on the top of the spreadsheet.

            This calculator, along with 2 others, will be available when our new book, “Covered Call Writing Alternative Strategies” is published (I’m told by the publisher…very soon).

            CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

            Alan

  2. Barry B May 26, 2018 9:43 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 05/25/18.

    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

    Best,

    Barry and The BCI Team

    barry@thebluecollarinvestor.com

  3. Edwin May 27, 2018 2:26 pm #

    For anyone who does portfolio overwriting, how much does it add to your overall returns? How often do you have to roll the option to keep your stocks from being called away?

    • Art May 28, 2018 5:56 am #

      Edwin,

      I’ve been using covered call writing on stocks that give dividends and I don’t want to sell. I choose options far out of the money so I don’t have to roll my options very often (not sure of the percentage but small). So far this year my account is up just under 5% and doing way better than my mutual funds. So far so good.

      Art

      • Jay May 28, 2018 9:15 pm #

        Hi Art,

        Congrats on your YTD success doubling SPY!

        It has taken me time, trial and error but I am coming to the conclusion over writing Divy stocks (blue chips) is a reasonable way to go.

        Reading your and Edwin’s posts got me curious about how the covered call ETF’s do relative to their index. So I Googled it. Apparently not that great:

        http://etfdb.com/type/investment-style/buywrite/

        This is one of those rare conservative strategies where a knowledgeable hobbyist can beat SPY. – Jay

  4. Andrey May 28, 2018 4:20 am #

    What if the stock price does not go to our new strike price of 35$? Wouldn’t it be better to select a less “risky” strike price, for example ATM, so that our stock is surely taken away from us and we make an additional income due to its appreciation?

    • Terry May 28, 2018 10:23 am #

      Hi Andrey;

      By using an ATM strike price you receive a higher premium. You do not make additional income due to appreciation of stock rising in price. You have capped your upside potential for the higher premium amount. It is a trade off.

      Best;

      Terry

    • MarioG May 28, 2018 7:44 pm #

      Terry,

      You can always capture the capital appreciation whether or not the stock is taken away. It is captured as either a realized or an unrealized gain. The gain is lost only if the stock price takes a dive in the future when you ultimately sell the stock.

      Case 1:
      If it is ITM at Expiration and you do nothing, the stock is assigned and sold at your strike price. Your net income is the income you received at entry and the additional appreciation to the strike price.

      But, If earnings reports are not due next cycle, your goal normally is not to let your option be assigned but to roll it out (buy back BTC the option, STO new leg) at an ITM or OTM strike price, even if the underlying is not in the current run list. The share appreciation is still yours as unrealized gain, to the new strike (ITM leg) or to the the current share price (OTM leg).

      The above incurs only one combination order commission (roll), as well. You could argue that you can let it be assigned, save the BTC buy back loss, and then open a new Covered call position on Monday after expiration. But that incurs an additional commission charge (maybe more, depending on the broker), and as Alan points out the BTC cost is negligible in the transaction or is compensated by the STO premium received. The underlying price on Monday could also have changed to your disadvantage.

      Case 2:
      If it is OTM and their is share price appreciation, but not above the strike, the option expires, on Monday opening after Expiration friday, you can sell the stock at the current price which should be near Friday closing and you realize the appreciation from your underlying entry price at the sale of the option. This you would do if you are not interested in keeping the stock.

      But, If earnings reports are not due next cycle, your goal is not to sell the underlying even if it is not in the current run list (unless you know of some reason to sell it). You just write instead a new STO option leg for additional income, ITM or OTM. The share appreciation is still yours as unrealized gain, to the new strike (ITM leg) or to the the current share price (OTM leg).

      Mario

    • Alan Ellman May 29, 2018 6:36 am #

      Andrey,

      Here is a link to an article I published on this topic:

      https://www.thebluecollarinvestor.com/selecting-a-specific-strike-price-for-our-covered-call-positions/

      Alan

  5. Barry B May 28, 2018 1:00 pm #

    The BCI Team wants to thank all of our Veterans who have served and sacrificed for our country. We appreciate and thank you for your service.

    Members of the BCI Team placing flowers and honoring our fallen Service Members at the NJ Viet Nam War Memorial today.

    Best,

    The Blue Collar Investor Team

    • Jay May 29, 2018 6:12 pm #

      Hey Barry,

      Thanks for your post and kind gesture. A long time ago in a galaxy far away I was a pilot in the U.S. Army Air Cavalry. I missed Vietnam by a few years being too young but I flew with guys that were there and they all knew their stuff! On peace time field deployments they would tell their stories and the newbies like me listened raptly. – Jay

  6. Joanna May 29, 2018 3:29 pm #

    Just out of curiosity, do you ever simply trade call options? Meaning just basic buy the call, wait until it shows profit, and then sell it? I realize your website is about covered call writing, but I was just wondering if you also just do that as well sometimes?

    Thanks,
    Joanna

    • Alan Ellman May 30, 2018 6:12 am #

      Joanna,

      Buying and then selling call options has the advantage of creating opportunities to generate higher returns but also comes with more risk. No surprise here…the greater the risk, the more the potential returns and the greater the chance to lose money.

      “Theta” (time value erosion) causes option value to decline once the call option is purchased. The hope is that Delta (share appreciation) counteracts Theta as well as the time value cost to buy the options and moves up even higher to generate a profit.

      Back in the 1990s when I was teaching myself option strategies, I did spend some time on the buy-side of options. I made a lot of money and lost even more. This does not mean that buying call options is not appropriate for all but it should be approached with caution and all the risk must be understood and appropriate for the investors personal risk-tolerance.

      My success with options has been on the sell-side and has been consistent and successful for over 2 decades.

      Alan

      • Hoyt T May 30, 2018 10:57 pm #

        Joanna,

        Alan’s reply is spot on.
        I too only traded options until I came across Alan’s website about six months ago. Buying and selling options does offer the opportunity for higher returns as well as higher losses. Higher returns because less money put at risk per shares of stock controlled.
        I have found that the higher losses come from not following risk management rules and letting initial success go to one’s head.
        Many account executives at the brokerage firms are former option traders who made one too many “wild” bets and are now on salary to pay off their margin account losses.
        I set options trading rules like:
        1. No position larger than $5,000.00.
        2. Close position at 30% decline.
        3. Sell 50% if position appreciates 100%
        and so forth.
        Do I always follow my rules? No, but I usually regret not doing so.
        I also found that I had to spend a lot of time doing research, keeping up with business news in general and position management. When I did all of this well I did very well indeed.
        If you can catch trends like the financials from November 2016 through January 26, 2018 you can do very well.
        I seem to remember somewhere that you are still working. That may make it a little difficult to manage more than a small number of positions.
        You might create a spreadsheet of the price for which you sell your covered calls, their price at expiration or a few days before and the percentage of profit/loss on the calls you sold. This would tell you how you would have done if you had been on the other side of the trade.
        I do both. I am retired and have traded stocks for 35+ years and options for six years.
        The BCI methodology is spot on for covered call writing. I would not be doing it if not for BCI. You can follow the methodology with very little time involved and can limit your research to the companies on the Run List. With price possibly being a constraint your research can be reduced to just a few qualified stocks.
        I find the Run List to be an excellent source of potential option buying opportunities.
        Just remember that the game is tilted in favor of the seller. Selling is much more conservative than buying. Rarely are options under priced. You can always check them out on CBOE’s Options Calculator.

        Sorry to be so long winded but I love what I do.
        Hoyt

        • Roni May 31, 2018 1:26 pm #

          Hoyt,

          Bravo !!!

          Roni

          • Hoyt T May 31, 2018 6:12 pm
            #

            Roni,

            Thanks,

            I had written a long epistle on a current FB position where I violated all of my rules. Too much money invested, didn’t close out after 30% decline, didn’t sell 50% after 100% increase and now setting on 142% gain. But I hit the wrong key and lost all I had written. Maybe later if I have more time I will chronologically detail the steps and where I failed to take the appropriate actions to properly manage the position.
            Suffice to say my opinion that FB would weather the storm in the short term, at least, has been correct to this point.My contract expires Sept 21 ’18. Current Delta is .80. Current Theta is -.03.
            FB was down $1 Tuesday, up $0.80 Wednesday and up $4.11 today. My decision will be what do do ahead of 7/24/18 earnings.
            Take care,
            Hoyt

          • Roni June 1, 2018 6:38 pm
            #

            Hoyt,

            Yes, you hit the spot. FB is so huge, almost too big to fail, and now generating so much ad revenue, and the whole world uses WhatsApp.

            You too, take care.

            Roni

  7. Alan Ellman May 30, 2018 7:12 am #

    Premium members:

    The BCI team has “tweaked” the formula in one of the cells in the “Daily Covered Call Checkup” spreadsheet. The cells impacted are titled “Option Expires Worthless or Exercised Profit (Loss) Per Contract” as shown by the red arrow below.

    I suggest that those of you who are using this spreadsheet upload the updated version which is located in the “resources/downloads” section right side) of your member site.

    CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

    Alan

  8. Alan Ellman May 30, 2018 5:17 pm #

    Premium members:

    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:

    https://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    https://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  9. Raam June 1, 2018 12:17 am #

    Alan,

    Thank you. on the Blue chip report published weekly, if a previous stock does not appear on the current list, would we then focus on the new list and exit the one that did not make the cut. Reason is if the list changes weekly (some stocks can change and not all) are we to alter our holdings on a weekly basis?. just looking for approaches on how best to use this report.

    Regards
    Raam

    • Alan Ellman June 1, 2018 4:22 am #

      Raam,

      Our Blue Chip Reports (Dow 30 stocks) are published monthly, prior to the new monthly contracts. Our stock and ETF reports are published weekly. Once a position is entered from any of our reports, they are managed as detailed in my books/DVDs, not by their removal from the reports. All new positions should be selected from the most recent reports.

      Here is a link to an article I published regarding our Blue Chip Reports:

      https://www.thebluecollarinvestor.com/establishing-a-blue-chip-covered-call-portfolio/

      Alan

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