Mastering exit strategies is one of the three required skills for covered call writing as well as selling cash-secured puts. In this article I will review and evaluate a real-life trade executed by one of our members. The trade involves rolling up in the same contract month with BWLD when share price accelerates significantly.
The initial trade
- 11/12/2014: Buy BWLD at $144.53
- 11/12/2014: Sell-to-open (STO) the December $145.00 call at $4.70
One week after initial trade
- 11/19/2014: BWLD trading at $150.00
- 11/19/2014: Buy-to-close (BTC) the $145.00 call at $7.40
Two weeks after initial trade
- 11/26/2014: BWLD still trading at $150.00
- 11/26/2014: STO the $150.00 call at $3.00
The question we are evaluating is whether the best path to take was to roll the option up from the $145.00 strike to the $150.00 strike. Here is the Ellman Calculator showing results if no action was taken:
If no action was taken and share price did not decline below $145.00, a 3.6%, one-month return would be realized. This profit is protected by $5.00 (down to the $145.00 strike) or 3.3%. This is a great position and return for conservative investors.
Calculations after rolling up
- Option credits: $4.70 + $3.00 = $7.70
- Option debit: $7.40
- Net option credit: $0.30
- Share appreciation: $5.47 ($150.00 – $144.53)
- Net credit: $5.77 = 4%
- Downside protection of this credit: $0
By taking no action we generate a 3.6%, one-month return with 3.3% protection of that profit. By rolling up we generate a slightly higher 4.0%, one-month return with no protection of that profit on a stock that has accelerated significantly in a short time frame. For most conservative retail investors taking no action is the prudent approach.
Other exit strategy possibilities
Should share price rise causing the $145.00 strike to trade near parity (all intrinsic value), the mid-contract unwind exit strategy may come into play (see pages 264 – 271 of the Complete Encyclopedia for Covered Call Writing). Also, should the strike remain in-the-money as expiration approaches we may still consider rolling out or rolling out and up.
Next live appearances
1- St. Louis, Missouri
September 15, 2015
6:30 PM – 9 PM
Link to follow
September 16, 2015
New York Stock Exchange
4:20 PM – 5:15 PM
Stocks declined reacting (over-reacting?) to weak corporate earnings for Apple, IBM, Caterpillar and Microsoft. However, Morgan Stanley and Amazon beat expectations. The big picture shows that more than 75% of companies have exceeded earnings forecasts, while 52% have surpassed revenue expectations. This week’s economic reports:
- In June, US home resales hit their highest point since February 2007. Existing home sales rose 3.2% to an annual rate of 5.49 million units. Sales were 9.6% higher year-over-year
- However, new single-family home sales fell 6.8% in June to a seasonally adjusted annual rate of 482,000, a seven-month low. However, sales were 18.1% higher than in June 2014
- The median price of US existing homes sold in June reached a record $236,400. The median June sales price was 6.5% higher than a year earlier
- Initial jobless claims declined by 26,000 to 255,000 for the week ended 18 July, the lowest level since November 1973
- Continuing claims dropped 9,000 to 2.21 million for the week ended 11 July
For the week, the S&P 500 fell by 2.21% for a year-to-date return of 1.01%.
IBD: Uptrend under pressure
GMI: 6/6- Buy signal since market close of July 14, 2015
BCI: Cautiously bullish using an equal number of in-the-money and out-of-the-money strikes. Although there have been more positive surprises than negative ones this earnings season, some of the disappointments have been major players (AAPL, MSFT, IBM). Keep in mind that these reports weren’t egregious ones but rather didn’t meet market consensus. We also have the possibility of an interest rate hike of 25 basis points in September if our economy continues to improve.
Wishing you the best in investing,
Alan ([email protected])