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:
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
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.
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
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.
April 26, 2016
Options Industry Council Panel Discussion on Income Generation
4:30 – 5:30 PM ET
Link to follow
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%.
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])