The crafting and managing of our covered call writing trades are directly dependent on our pre-defined goals. In this article, we will analyze a TSLA covered call trade where the strike was about to expire in-the-money (ITM) and exercise was inevitable if no action is taken. This trade was shared with me by a BCI member.
Trade information
- TSLA is viewed as a long-term buy-and-hold with a bullish assumption moving forward
- TSLA was purchased at the end of September 2021 at a basis of $270.00 per-share (#1 in chart below)
- 1/9/2023: TSLA trading a $119.77 (#2)
- 1/9/2023: Sell 1 x 1/27/2023 $160.00 call (#2)
- 1/25/2023: TSLA reports favorable earnings (#3)
- 1/27/2023: TSLA moves up to $177.90, leaving the $160.00 strike deep ITM (#4)
- Should the option be rolled or allow exercise and re-purchase on Monday?
TSLA 6-month price chart
TSLA: Price Chart Before & After Earnings
Trade analysis
When writing covered calls on shares we intend to hold for the long term, the strategy approach is known as portfolio overwriting, where we use only deep out-of-the-money strikes to avoid exercise. That was properly structured in this case, with shares trading at $119.77 and the strike of $160.00 with a 2-week expiration.
However, the BCI earnings report rule was breached, with contract expiration occurring after the ER date. The favorable report caused share price to accelerate well past the $160.00 strike. Now what? Do we roll or allow exercise and re-purchase the shares on the Monday after expiration Friday?
To roll or not to roll
It is true, that if we roll the option, we are paying a miniscule time-value price (pennies) to buy-to-close the near-term option. However, if we allow assignment, we are exposing ourselves to weekend risk. If share price moves much higher by Monday, we lose. Of course, the opposite also holds true, but do we want to take the chance?
The elephant in the room
This dilemma was caused by writing a covered call through an earnings report. As an alternative, a 1/20/2023 weekly call could have been written with no covered call in place for the 1/27/2023 expiration date. After the week of the ER, calls could have been written at the new basis ($180.00 range).
Discussion
Before entering and managing our trades, we must identify our goals. We always avoid earnings reports. If we are portfolio overwriting, we only use deep OTM strikes and, if faced with exercise of ITM strikes at expiration, rolling the options will avoid weekend risk.
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Your generous testimonials
Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:
Alan,
I am watching your Youtube videos and appreciate all the knowledge you are sharing with the investing community. I have made money in covered calls for around 4 months, but your system will 100% make me even more money.
I am in Pennsylvania, working in New York as a surveyor and I am sincerely glad to have come across your website.
There are so many people on social media touting investing ideas from options to futures trading ideas to make money. They basically offer nothing where you are creating plans that will make money through a conservative approach.
Thanks for all you are doing,
John
Upcoming events
1. Your Mid-Year Portfolio Review Virtual Expo
June 27th 11:20 AM ET – 12 PM ET
Ultra-Low Risk Approaches to Covered call Writing and Selling Cash-Secured Puts
Adding Delta and Implied volatility to existing defensive concepts
Covered call writing and selling cash-secured puts are low-risk, option-selling strategies focused on generating cash-flow. Our trades can be structured to represent aggressive or defensive postures or somewhere in between.
This presentation will detail how to structure our trades to decrease risk, particularly in bear and volatile market conditions while still generating significant returns. It will also be of interest to investors who have a low personal risk-tolerance but still want to generate higher than risk-free returns.
Both Delta (an option Greek) and implied volatility will be spotlighted, and real-life examples will be utilized to demonstrate the process of establishing these conservative trades, while still allowing us the potential to generate significant annualized returns.
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Tuesday July 11th 10 AM ET – 11 AM ET
Covered Call Writing: Multiple Applications Based on Current Market Conditions
Real-life examples with Invesco QQQ Trust (Nasdaq: QQQ)
Covered call writing is a low-risk option-selling strategy geared to generating cash flow with capital preservation a key requirement. This presentation will demonstrate how the strategy can be crafted to benefit in all market environments. Market situations highlighted are:
- Normal to bull markets
- Bear and volatile markets
- Low interest-rate environments
A popular large-cap technology exchange-traded fund, Invesco QQQ Trust, will be used to establish rules and guidelines to benefit in these market circumstances.
July 11th 10 AM ET – 11 AM ET
Covered Call Writing: Multiple Applications Based on Current Market Conditions
Real-life examples with Invesco QQQ Trust (Nasdaq: QQQ)
Covered call writing is a low-risk option-selling strategy geared to generating cash flow with capital preservation a key requirement. This presentation will demonstrate how the strategy can be crafted to benefit in all market environments. Market situations highlighted are:
- Normal to bull markets
- Bear and volatile markets
- Low interest-rate environments
A popular large-cap technology exchange-traded fund, Invesco QQQ Trust, will be used to establish rules and guidelines to benefit in these market circumstances.
Presentation time to follow.
3. Orlando Money Show Live Event
October 29th – October 31st
Details to follow.
4. AAII Orange County, California Chapter
Saturday November 11, 2023
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Alan,
I’ve been selling csp puts for years but never thought to use the exit strategies you describe in your book.
I have a question about rolling up the strike when stock price moves up a lot. Is there a way to measure the risk of exercise since I don’t want to take possession of the stocks?
I know there is always some risk, but is there a way to determine how much?
Thanks a lot,
Stuart
Stuart,
Yes, there are 2 reliable methodologies we can use to quantify the risk of rolling-up our cash-secured puts trades:
1. Delta: Check the option-chain for the new rolled-up strike and look for the Delta column. That stat gives us the “approximate” probability of the strike expiring in-the-money or with intrinsic-value. That would be our risk of exercise. Of course, we always have our exit strategy arsenal to mitigate exercise of in-the-money strikes.
2.Implied volatility: Use a mean or at-the-money strike’s implied volatility (IV) to calculate an expected trading range, with high and low price points.
BCI has developed a spreadsheet (Expected Price Movement Calculator) that can be used for such a calculation. It is available to premium members in the “resources/downloads” section of the member site. Since the calculation formula is based on a standard deviation bell curve, the probability of accuracy of the trading range is 84%. The risk of the rolled-up strikes expiring in-the-money, using the low end of this range, is approximately 16%.
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 06/23/23.
Also, 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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Reminder: Premium members are grandfathered into your current rate and will never see a rate increase as long as the membership remains active.
Best,
Barry and The Blue Collar Investor Team
barry@thebluecollarinvestor.com
Hello Alan,
This month I divided my $100,000 dollar portfolio evenly between 5 companies ( all bold and on the list) and wrote calls for july 21st ( 3 otm, 2 itm).
I plan to utilize exit strategies such as mid contract unwind, hitting a double … or if its the last half of the contract perhaps even rolling down depending on what the stock price dictates…. my question to you is when do you cut your losses on the underline security? If the stock declines and you buy back the option (at 20%) and you patiently wait to hit a double ( that does not materialize) and then the last half of the contract cycle rolls around so you roll down and then the stock continues to decline and then you re-purchase the option at 20%.
At what point do you cut your losses with the underlying security and move on to something else? I know you’ve said in the past it varies from person to person but I’m wondering if you could tell me from your experience is there a certain percentage that is easier to recover from (this is assuming there’s no bad news in particular about that stock, because if that’s the case, I have no problem cutting my loss if the news is obviously bad)….
In general I have no problem cutting my losses, but deciding exactly when too cut them is probably the biggest Blindspot or weakness in my trading… I thrive with guidelines… like bowling with the side rails up ( i know you love sports analogy’s). any help would be greatly appreciated.
Thank you
Tony
Tony,
Glad to help.
Let’s start with this: The July monthly contracts still have 4 full weeks until expiration (this was a 5-week contract). This past 1st week of the 5-week contract was a down week, which was to be almost to be expected after so many positive weeks. No reason to panic.
Now, to your question regarding when to close both legs of a covered call trade. I’ll give you 2 guidelines to consider:
1. The underlying is under-performing the S&P 500 significantly.
2. The underlying has declined by 7% or more from the price when the trade was entered.
Most stocks that were down this past week, declined because of the overall market trend. Over time, following our system guidelines (which you are doing quite well), will put us in a position to beat the market consistently, many years significantly.
Alan
Hello Tony,
good question.
It is very difficult to decide to cut your loss each time your equity gaps down more than 7%. I know, because it happened to me many times, and almost always regretted it when I held on to the stock hoping for a rebound.
So, I believe that the best time to cut them is immediately after the 10/20% buyback order is filled. Chances are you can recover the loss with new and better trades using the remaining cash.
My reasoning is: If the stock rebounds after I sold it, I am not losing money, I am just NOT GAINING, but if I don’t sell and it goes down further, then I am LOSING MORE, and it hurts more.
Roni
Roni,
Well put. My feelings, exactly.
Hoyt
Thanks, Hoyt. 🙂
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Alan and the BCI team