Market volatility can cause our covered call trades to whipsaw up and down, much like a roller-coaster. In this article, a real-life trade with The Industrial Select Sector SPDR Fund (NYSE: XLI) will be analyzed. In this series of trades, shared with me by premium member, Charlie, share price declined triggering a roll-down exit strategy and then recovered, leaving the rolled-down strike in-the-money (ITM). Charlie turned to the What Now worksheet tab of our Trade Management Calculator (TMC) to evaluate rolling-out and rolling-out-and-up opportunities.
XLI trades from 7/26/2-24 – 8/16/2024
- 7/26/2024: Buy 200 x XLI at $126.76
- 7/26/2024: STO 2 x 8/16/2024 $127.00 calls at $1.97
- 8/5/2024: BTC 2 x 8/16/2024 $127.00 calls at $0.19 (1o% guideline)
- 8/5/2024: STO 2 x 8/16/2024 $123.50 calls at $1.82 (roll-down)
- 8/16/2024: XLI trading at 126.96, leaving the rolled-down $123.50 strike ITM
- 8/16/2024: To BTC the 8/16/2024 $123.50 strike, the ask price is $3.60
- 8/16/2024: The bid price to roll-out to the $124.00 (close to $123.50) strike is $4.45
- 8/16/2024: The bid price to roll-out–and-up to the $127.00 strike is $2.42
What price do we enter for the stock when evaluating rolling opportunities after rolling-down?
Charlie rolled-down from the $127.00 strike to the $123.50 strike, which is now ITM since share price as expiration approached was 126.96. The correct entry into the Unwind Now worksheet tab of the Trade Management Calculator (TMC) is $123.50, because that is what the shares were worth at the time of the rolling considerations.
Unwind Now worksheet tab calculations for XLI trades (Note: # contracts in the screenshot should read “2”)
- Rolling-out to the $124.00 strike results in a 2.06% 1-month return with 2.30% downside protection of that time-value profit. This would be an appropriate choice for a defensive position that yields significant returns
- Rolling-out-and-up to the $127.00 strike results in a 3.26% initial time-value + unrealized share appreciation return with an additional 3.22% upside potential should share price accelerate to the $127.00 strike or higher. This path should be considered when bullish on the market and the stock
- Since 200 shares were purchased, 1 contract of each strike can also be sold
Discussion
After rolling-down a strike that is expiring ITM as expiration approaches, we use the rolled-down strike price to enter into the Unwind Now worksheet tab of the TMC. The spreadsheet will calculate initial and unrealized returns to asst us in these exit strategy decisions.
BCI Expected Price Movement Calculator
The Expected Price Movement Calculator is designed to generate an approximate projected trading range for the underlying security, specifically for the selected contract expiration date. The at-the-money implied volatility (IV) of the stock or ETF (exchange-traded fund) is used to achieve this valuable information.
Inherent in the spreadsheet is a conversion formula that recalibrates the annualized IV stat into one specific for the contract being traded. Easily accessed option-chain data is entered into the white cells at the top of the spreadsheet and calculations will appear in the yellow cells below.
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Alan,
I have a question and I’ll try to state it in a way that even I can understand itl, because I recently asked Fidelity and they got confused.
Does your firm, or does any one else on the internet, have a service whereby an investor can compare the premiums possible to sell (Covered Calls), vs the cost of 100 shares of the stock, in percentage form.
I ask this because I have noticed a wide variance in the premiums sold vs the basis price of 100 shares of the underlying stock. I’ve collected over 7% and I have collected as low as .17%.
Any help is appreciated.
Best Regards
William (Bill)
Bill,
You are seeking critical information we must have prior to entering our trades … % reruns.
I know of no such services available to retail investors, as it would require live feeds from the exchanges in real time as share price and option premiums are constantly changing.
That said, the information is easily calculated by many covered call writing calculators, like our Trade Management Calculator (TMC).
Simply enter the option-chain information (top row below) and the calculations will appear.
The screenshot below was sent to our premium members this week as a sample covered call trade.
At the time of the trade, DOCS was trading at $55.41. The $57.50 out-of-the-money call had a bid price of $1.23. The spreadsheet calculates for us a 19-day return of 2.22%, 42.64% annualized.
It also shows another possible income stream (upside potential) of 3.77%, if DOCS moves up to or beyond the $57.50 strike.
We must have this information prior to making our investment decisions.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
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 01/24/25.
Be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
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Barry and The Blue Collar Investor Team
Alan,
When a stock price goes way up after starting a covered call trade, it costs a lot to buy back the option to close out the trade. How do we figure out if its worth the cost?
Thanks,
Pat
Pat,
When share price accelerates exponentially, leaving the covered call strike deep in-the-money (ITM), the cost to buy back (close-CTC) the option is significant.
However, the bulk of the CTC premium is intrinsic value (IV) which is negated by the increase in share value when the limiting ITM strike is removed.
Here’s an example: Buy a stock at $48.00 and sell the $50.00 call at $2.00. Share price moves up to $60.00. The CTC the $50.00 call is $10.00 IV + a small time-value component, let’s say $0.25 for a total premium of $10.25.
Now, the shares that could be worth no more than $50.00 with the original strike in place, are now worth $60.00 with the option obligation no longer a restriction.
The actual time-value CTC is therefore, $0.25.
The appropriate spreadsheet to use is the Unwind Now” tab of the BCI Trade Management Calculator. The tab is located at the bottom of the spreadsheet, and you may need to use the arrow at the bottom to scroll to it. See screenshot below.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Hey Alan.
I’m unsure whether you want input from your members, but in case you do, here is something you may want to consider:
Buy UPS shares today at +/- $135.50
Sell calls expiring 1-31 at $136 for $3.90
Earnings release 1-30
My downside protection is $131.60
My upside is getting called in 2 days with a $4.40/share profit in an $131.60 investment, an annualized return of over 600%.
Mark
Mark,
Although this trade may work, it is dangerous.
Earnings reports should be avoided, in my humble (extremely strong) opinion.
Covered call writing is a low-risk, conservative option-selling strategy. If earnings are made part of the equation, it becomes a high-risk strategy with potential higher returns, due to the increased implied volatility associated with earnings reports.
For me and most retail investors, the risk to the downside, if a report disappoints, makes the trade potentially perilous.
We must understand that the risk in the trade is directly associated with the option returns. The greater the returns, the greater the risk and the greater the potential losses as well.
When making final determinations regarding the structuring of our trades, we should factor in returns and risk … both.
Alan
Alan:
Thanks for getting back with me. That makes sense to me.
Mark
Alan:
Regarding the UPS earnings report, released this morning – you were correct re the unpredictability that can stem from an earnings release.
The stock is down $23/share this morning.
Lesson learned.
Thanks again for your insight.
Mark
Premium members:
This week’s 4-page report of top-performing ETFs, along with our sample trade of the week, has been uploaded to your premium site. The Select Sector SPDR section is now crafted to align with our streamlined (CEO) approach to covered call writing. The report also lists Top-performing ETFs with Weekly options, mid-week market tone as well as the implied volatility of all eligible candidates.
We have also included a sample trade taken from one of our BCI watchlists.
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