Rolling up is a useful exit strategy for both covered call writing and put-selling. However, in my humble opinion, it rarely benefits us to roll up in the same contract month. The main reason for this conclusion is that we are dealing with a stock that has substantially appreciated in value in a relatively short time frame. The success of the rolling up strategy in the same contract month is dependent on that stock maintaining that share value or even accelerating even higher. In other words, we are asking a lot of this security while risking our unrealized gains from the initial option sale. In this article we will evaluate a trade shared with me by Preacher John of Mexico (they call him Preacher in Cancun where he teaches the BCI methodology):
The initial trade in one-contract format
3/22/2015: Buy 100 x PAYC at $51.10
3/22/2015: Sell 1 x $50.00 call at $2.10
3/22/2015: Initial returns are 2% with downside protection (of that profit) of 2.2% as shown in the screenshot below using the multiple tab of the Ellman Calculator:
PAYC: Initial returns using the Multiple tab of the Ellman Calculator
Position evaluation six days later
- PAYC price moves up to $56.69
- Value of the $60.00 call (“ask”) is $7.10
- Bid price of the $55.00 call (should we decide to roll up in the same month) is $2.55
Situation if we do not roll up in the same contract month
We are guaranteed a 2%, 1-month return as long as share value does not decline by more than 12% by expiration (move from $56.69 to under $50.00). This represents a safe scenario where our initial investment has been maximized.
Situation if we do roll up in the same contract month
Our maximum share appreciation is now up to the $55.00 strike which represents a credit of $3.90 from the initial purchase price of $51.10. We also have an option debit of $2.45 [($2.10 + $2.55) – $7.10]. Since we used the intrinsic value of the $7.10 buy-to-close option to enhance the value of our shares, our cost basis is now $55.00. Let’s calculate:
($3.90 – $2.45/ $55.00 = 2.6% with downside protection of that profit of 3%
Chart summary of two approaches
Rolling up comparison
This chart gives clarity to the two positions. Rolling up will generate an additional 0.6% profit and lose 9% of our position protection. The question we must ask ourselves is whether that amount of additional profit potential is worth the loss of a majority of our protection at that point in time. I’ll leave that for you to answer but also present it to you as to the reason why I rarely roll up in the same contract month.
Is there any other way to take advantage of a situation like this?
As Blue Collar Investors, this is the question we must ask ourselves and the answer is “you bet” Frequently, we can implement the mid-contract unwind exit strategy when share price has accelerated significantly in a short time frame. This is a topic I have written about in detail on pages 264 – 271 of the classic version of the Complete Encyclopedia and pages 105 – 111 and pages 243 – 252 of Volume 2 of The Complete Encyclopedia.
Discussion
Before implementing an exit strategy we must weigh its pros and cons as well as alternate approaches that may better meet our needs. For those of us who are conservative investors with capital preservation as a key focus, the mid-contract unwind exit strategy may be more appropriate than rolling up in the same contract month when share value has accelerated significantly early in the contract.
The Blue Collar Investor in Spain’s financial magazines
Live interview
On March 15th at 9 PM ET, I will be interviewed live on blog talk radio (Solutionsology Radio). I will provide the link to this event once I receive it. The focus of the conversation will be about my third book, The Complete Encyclopedia for Covered Call Writing.
Recently added
April 26, 2016
Options Industry Council Panel Discussion on Income Generation
4:30 – 5:30 PM ET
Link to follow
Market tone:
Global markets rose this week with signals of oil prices stabilizing and Chinese growth concerns having fewer international ramifications. The Chicago Board Options Exchange Volatility Index (VIX) fell to 16.8 from 19.5 this week. This week’s reports:
- Friday’s unemployment report showed solid job gains in February — but wage growth dipped to 2.2% year over year from 2.5% in January
- Overall, the data suggests that the US economy continues to expand at a steady but modest pace
- A number of the largest shale oil producers in the United States have announced production cuts of approximately 5% to 10% this year as crude oil prices, which have steadied in recent weeks, experienced modest gains this week in the wake of the announced cuts
- The People’s Bank of China cut its reserve requirement ratio to 17% from 17.5%, putting more money into the banking system
- Activity picked up in most regions, according to the Beige Book, which is prepared in advance of each meeting of the US Federal Reserve’s rate-setting committee
- Investors do not expect a hike at the March meeting. The market is currently pricing in just one rate hike over the next 12 months, as implied by futures contracts on the federal funds rate
For the week, the S&P 500 increased by 2.67% for a year-to-date return of (-)2.15%.
Summary
IBD: Market in confirmed uptrend
GMI: 4/6- Buy signal since market close of March 2, 2016
BCI: Despite three consecutive positive weeks, I will remain focused primarily in defensive positions, selling out-of-the-money puts and in-the-money calls in a ratio of 3-to-1 over more aggressive positions.
Wishing you the best in investing,
Alan ([email protected])
Alan…
I own 400 shares of FCX @ 10.62. On 2/16, when the share price was $6.37, I sold calls (4 contracts) with expiration 1/20/17, $10 strike for a premium of $.90 ($360 total).
Since then FCX has been on a tear, and today (3/4/16) got up to $10.17 and closed at $9.72.
It looks like I may lose a lot of appreciation if I do nothing (although I’ll still make a small profit if the shares get called away).
Any suggestions?
Many thanks,
Lyn
Lyn,
When the trade was entered, the shares were worth $6.37. By selling the $10 LEAPS option, a 14.1% initial 1-year return was generated with the possibility of an additional 57% profit on share appreciation to the strike (see Ellman Calculator below). In return, there was an agreement to sell the shares at $10 by expiration. That was the deal.
At this point, share appreciation is near the strike, a positive but a long way to go. So much can happen in one year, a negative to selling LEAPS. Furthermore, by selling Monthlys, a higher annualized return will be achieved in addition to circumnavigating earnings reports.
In scenarios like this one, if our goal remains the same as when the trade was entered, there is no reason to take action. It is important to understand both the pros and cons of LEAPS and make informed decisions from there.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Thanks Alan. The way you put it it doesn’t sound so bad
Hello Lynn,
I agree 100% with Alan’s response.
But I can understand your feelings about this trade, because it has hapenned to me more than once, when experimenting with LEAPS.
You had 400 shares, bought at 10.62 = $4,248.00, wich went down to 6.37 = $2,548.00.
So you try to recover your loss by selling the Jan.20/17 calls.
now, with FCX at 9.72, it looks like it’s gooing to happen, but you will you will be looking at this trade every day, for 11 months, hoping it will succeed, and suffering all the time.
I think it is best to exit immediately.
Buy back the calls @ aprox. 2.6 = $1,040,00 (-$360.00) = $680.00 loss, and sell the shares @ 9.72 = $3,888.00, which will leave you $3,200.00 net, and be glad that your loss was reduced to $1,050.00, instead of the $1,700.00 loss you had in February.
This will spare you a lot of suffering, and you can use the money to generate income by following Alan’s method of selling monthly covered calls.
Good luck – Roni
I notice that with my Charles Schwab account platform and the market going up and down, it is very difficult to determine your exact call premiums earned, what do you recommend?
I have gone over my earnings, $4,200 Since Jan 1, 2016 but to look at the Schwab statement there is no number that reflects this earned premium, I had to go through every transaction to derive the exact number?
Sincerely,
Anthony
Anthony,
Brokerage statements can be tricky and may vary in formatting from broker-to-broker. Options that expire worthless and those that are closed are handled differently than those that are exercised.
As a premium member, you are entitled to a free copy of the Elite version of the Ellman Calculator. There are several tabs in the Schedule D section of the calculator to calculate long and short-term capital gains (losses) for each scenario.
Alan
I noticed in these small up turns the put Premiums are small if any?
Anthony
Anthony,
If we sold a near-the-money put and share price rises, that strike moves deeper out-of-the-money and therefore loses value. However, because of put-call parity, put and call prices remain aligned with each other. As an example, see the near-the-money $27 strike for SWHC currently trading at $27.05 and note now close the prices are in the screenshot below.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Thank you Alan for this great article.
It helps me very much, because I was always tempted to roll up in the same contract month, when a stock goes up fast.
In the last two years, I’ve got burned every time I rolled up.
Now I see clearly from this article, the risk reward situation.
Roni
Roni,
You are not alone. Frequently I will select a topic based on member feedback and where I feel the education is most needed. As always, thanks for your participation on this site.
Alan
Premium Members,
This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member website and is available for download in the “Reports” section. Look for the report dated 03/04/16.
Be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar Investor YouTube Channel. For your convenience, the link to The Blue Collar Investor YouTube Channel is:
http://clicks.aweber.com/y/ct/?l=GKxRM&m=3aFy1GMRVTIGQRW&b=zAHuGy8n7xih0us86.yg5w
Best,
Barry and The Blue Collar Investor Team
Why not book your profits, which after 6 days are handsome, and take the money and find another one? How often do you make that kind of profit in six days? Take the money and run.
Premium Members,
We are in the process of finalizing an enhancement of the Weekly Premium Report and need your feedback. The Premium Report has undergone dozens of updates since it was first published in 2008. These improvements have been incremental and have added many useful upgrades to help improve your stock selection. With this update, we are changing the format while keeping all of the key information.
The reasons for the reformat are:
– Questions and suggestions from subscribers
– Reduce confusion as to which portion of the report to use
– Eliminate redundancy within sections of the report
– Logically group data elements
We have combined the data in the first and second sections in order to present the data in a more efficient manner. You will be able to see a complete picture of the stock(s) you are interested in. This way, you won’t have to go back and forth between sections to get a complete picture of the stocks you are considering…in a sense, we’re eliminating some of the “hunt and peck’ effort (as one of our subscribers commented on).
The new format is organized as follows:
First Section – “Market Overview”
– This is the same front page that you currently receive.
– It contains Alan’s Market Tone that appears in the weekly blog
– It has a summary of the most recent ETF Report.
– It provides three independent views of the market, including Alan’s near term view and strategy.
– It will be the section where we may add future market related sections and data.
The Second Section – “Stock Screen and Watch List”
– This section will provide the data that you will need for stock selection…all the data for a given stock is now on a single row of the report.
– It is a combination of the old first and second sections.
– Any stock appearing in this section has passed the first three initial screens:
– Have monthly options and if available, weekly options.
– Have daily volume of 250,000 or more shares traded per day.
– Are not on the BCI “Banned List” (see the Resource Section of the website for
details).
– Stocks that have passed “all” screens will be in BOLD, while stocks with mixed technical indicators (“mixed technicals”) will appear in regular font. All are eligible if they have adequate open interest.
– We have set up the column order according the workflow that we follow while we are preparing the Weekly Report.
The Third Section – “Running List Symbols”
– This section remains as the symbol “cut and paste” list for subscribers own purpose built spreadsheets.
The Fourth Section – “Stocks Passed This Month”
– This section provides a listing of each of the weekly Running Lists that have appeared in the current month.
– This section is for informational purposes only since you will have already seen the data in this section in earlier weekly reports during the month.
Please take the time to download this week’s report with the new format so you can familiarize yourself with the new presentation format. Look for the report entitled:
Weekly Stock Screen And Watch List 03/04/16_REFORMAT FINAL
We believe that you will find the new format more efficient, easier to use, and more user-friendly. As always, please let us know your thoughts, comments, and suggestions for improvement.
Best,
Barry and The Blue Collar Investor Team
[email protected]
I’m one of John the preachers students in Cancun. He is your biggest fan and he has taught me so much. Thanks for all the information you put put out to help everyone take control of their own money!
Jill it’s great to have you part of our BCI community and honored to have Preacher John using our methodology to spread the word as to how retail investors can take control of our financial futures. Thanks for the generous feedback./
Alan
Alan
I state that I am still studying the covered call.
However I’m start to look in the Beginner Corner – Selling Cash Secured Puts but I’m find that TradeStation allow me only Writing Covered Put (Option Approval Level 2) because for Cash Covered Puts I need to get level 4.
Most probably I’m doing a big confusion. Can you help me to understand better?
Thanks in advance
Mauro
Mauro,
I would suggest you call your broker for an explanation. It seems that it should be reversed with selling cash-secured puts a lower level of trading approval than covered puts. Covered puts involve selling the put option AND shorting (borrowing the stock from your broker and then selling it) the stock. Covered puts offer limited upside with unlimited downside…very risky…not for most retail investors. You want either covered call writing or selling cash-secured puts in my humble opinion.
Alan
Alan
I have a question.
If after having sold a covered call, the price starts coming near strike
Price, can I buy to close at a higher price for the same
Expiration date or a farther expiration date?
Or I need to buy for the same expiration date and strike and then sell another.
Thanks,
Praveen
Praveen,
Once an option is sold (STO- sell-to-open) it can be closed (cancelled) by buying-to-close (BTC). When doing so, we must use the very same strike and expiration date. For example, if we sold the March 15, 2016 $50.00 call for stock XYZ, then we BTC the March 15, 2016 $50.00 call for XYZ. The price will most likely be different than the one we received when the option was sold but the short option position will be closed.
Alan
Alan:
I have a number of Mar 18 calls that are in-the-money, some of which somewhat deep. Most I hope to retain & not have assigned, so I monitor the remaining time value (tv) carefully & regularly. I recognize that as the tv decreases & the Expiation date approaches, some action (escape strategy) on my part will be appropriate. My question is, as the remaining tv gets down around the levels of concern you mention in your book (.25 or so), about how close (days) to the Expiration date are you comfortable getting before taking action without unduly risking an early assignment?
Thanks,
Paul
Paul,
You’re definitely on the right track by keeping a close eye on the time value of the premium. Whenever there is a time value component, the option buyer will generate more cash by selling the option rather than buying and then selling the stock. In addition to that consideration, option buyers generally do not want to spend the money to buy the shares when they can control the shares with the options they already own. The cash can be used to generate interest income.
That said, there is no way to guarantee that options will not be exercised. Retail investors can and do make mistakes. It is one of the risks we agree to undertake when we sell covered calls on shares we want to retain. However, the odds are extremely small that exercise will take place prior to expiration unless there is an ex-dividend date prior to expiration…still the odds are small but greater. I generally, roll options on expiration Friday in the afternoon.
Alan
I have watched a lot of your videos on writing covered calls. I have not seen anywhere the meaning of buy and sell to open or close.
I want to place an order to write covered calls on stocks I own. Do I sell to open or buy to open?
Please help explain what these mean.
Thank you!
Chris
Chris,
We are initiating the trade and selling an option. Therefore, we sell-to-open (STO). If we buy back the option, it is buy-to-close (BTC). All trades should be executed after having mastered all 3 required skills…stock selection, option selection and position management.
Welcome to the BCI community!
Alan
Alan:
I’ve purchased and read two of your books. In addition to my own portfolio, I also manage my dad’s portfolio. His portfolio is concentrated in utilities, telco, and regional energy companies. He’s held these positions for long enough to generate substantial built-in long-term capital gains. To complicate matters a bit, 75% of the portfolio is in a taxable account.
When I initially sold the covered calls, I recognized that doing so all at once against the portfolio positions would increase “timing risk” substantially. And, it definitely managed to demonstrate that in spades. The calls were sold in the midst of the market correction and the positions have run wild since that time. To make matters a bit more dicey, Mario Draghi has driven capital out of Europe into the U.S. Markets most especially into “safe dividend yielding stocks” which dominate my dad’s portfolio.
My initial strategy was to sell each option at 2.1 – 3 standard deviations above the current price based on the 20-day Bollinger Band.
In my bit of trial by fire (or call it an educational opportunity), ETR had declined several points from where I sold the call. The call lost a substantial amount of the value and I was tempted to buy the call back and book the gain, possibly selling more aggressively down a couple of strikes. (Note, if it wasn’t clear, I was and still remain a bit bearish on the market, entirely driven by my expectations that we’re built up on excess liquidity and relative valuations). I stood pat, and the stock ran up far past my strike and remains 1 strike above my sell point with the option expiring 4/15.
I learned that I, perhaps, should have BTC more quickly before it ran up quite that far and evaluated selling forward (30+ days). So, qualification is a seemingly difficult thing to dance around, and I may be doing it wrong.
Today, I had a CMCSA 60 Call that is expiring 4/1 (Friday of this week) that peeled back and was trading around the 60 price point for the past few weeks. I was letting Vega work for me and watching the value erode while keeping an eye on Delta. As Janet Yellen spoke, the price had declined to the $59.88 range and then as she affirmed a dovish, slower glide path to higher rates the stock began to take off. At about $60.65 range, I decided it was time to roll out and forward. The reason for this decision is that I could still have a “qualified call” based on the Monday closing price of $60 and go out to 4/29 (31-days minus one day for settlement keeps it qualified at 30-days, if I understand correctly).
My net position is that I bought back the 4/1 expiration at $82 and quickly sold the 4/29 expiration at $171 for a net position of +$89 (less $16.50 in commission).
If it was solely my portfolio, I’d be more inclined to simply go by the hard and fast numbers and not be emotional about the tax impact of selling. I’d probably turn right back around and sell a put to attempt to reclaim the stock if I believed in it, anyway. I think letting the tax man wag the decisions is a more difficult way to go with it, but it’s not my decision.
Because I still expect this market to pull back at some point due to some central bank adjustments or valuation concerns, I’m willing to carry the trade forward for awhile. Granted, if the market keeps moving violently up I have to either accept that I buy something out at a loss and remain content with that, potentially wind up consuming cash buying up stock gains (which is the direct opposite of my goal of generating cash into the portfolio), or show my dad some numbers that may demonstrate that paying the capital gains won’t ultimately hurt that bad at 15% (though he could be pushed into the worse 20%/23.8% range with enough gains).
So that brings me to this, I have already learned a lot and my mind keeps churning on ideas and strategies for generation. The reason I “carried forward” the trade is that if what I understand about call qualification stands, I basically had someone else pay for the capital appreciation and received some added time premium less commission.
I can provide more concrete details if necessary. I’d like to know what you think about these trades so far. I know I haven’t performed optimally, but what can I do differently? Or, what haven’t I thought about?
Geoff,
It may be useful to take a slightly different philosophical approach to your Dad’s portfolio ( I do the same thing for my Mom). In this scenario, we are “portfolio overwriting” where the shares are already present and we are looking to generate additional income outside share appreciation and dividend distributions. Writing OTM calls even with a bearish outlook…perfect…now for the philosophical take:
We are selling an option with a given return goal and still allowing for share appreciation up to the strike price. Our shares during the contract cannot be worth more than the strike…this is the deal we entered. Now, if the strike is in-the-money as expiration approaches, we buy back the option which should be trading near parity (almost all intrinsic value) and this cost to close will be mostly alleviated by the increase in share value from the strike to current market value. Our contract return has been maxed out and shares will not be sold…on to the next month.
You may not have factored in ex-dividend dates…it wasn’t clear from your question. If the strike is ITM and expiration is near the ex-date and the time value component of the option premium is less than the dividend about to be distributed, the chance of early exercise is increased. See the “portfolio overwriting” chapters and segments in our DVD programs as to how to manage these events.
So nice that you are helping out your Dad.
Alan
Alan,
Thank you so much for your reply. I do factor in ex-dividend dates as that is a danger, most decidedly with these rich dividend stocks like AT&T (T). One that I “rolled-forward” is pushing me very near an earnings announcement which could make the buyback a bit more expensive (likely Vega increase).
Do you have any good sources for tax advice? I have a CPA for my business, and my dad has his but I’m trying not to bother them during their worst season of the year.
Geoff
Apparently, I misunderstood what you had written about regarding the ex-div date. I can try to buy back the option in the AM and avoid the early exercise on CMCSA. Seeing as this is the last day before ex-div it’s going to be dicey, and it’s anybody’s guess what will happen. I would consider the loss of $28 very minimal, the early expenditure of a few grand in taxes very serious.
Thanks again.
Geoff,
Owen Sargent is a CPA/Attorney/seasoned stock market investor. He assisted me in developing the Ellman Calculator and has written the tax chapters in several of my books:
[email protected]
Alan