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Should I Roll-Out When My Option is DITM Mid-Contract?

Exit strategy opportunities for covered call writing must be recognized and acted upon when indicated. It is important to understand when and how to react to these situations and determine the best exit strategy, if any.  In October 2020, Patrick shared with me a covered call trade he had executed and was considering closing the option and selling a new one the following contract month. He was deciding if the cost-to-close justified the rolling-out exit strategy. This article will analyze the trade with JD.com, Inc. (NASDAQ: JD).

 

Patrick’s trade

  • 10/6/2020: Buy 100 x JD at $76.94
  • 10/6/2020: STO $75.00 call at $5.12
  • 10/13/2020: JD trading at $83.36
  • 10/13/2020: Cost-to-close (ask price) the $75.00 strike is $9.35

 

Initial structuring of the trade

 

JD Initial Calculations

The multiple tab of the Ellman calculator shows an 1-month initial time-value return of 4.2% with a 2.5% downside protection of that time-value profit.

 

What is the time-value cost-to-close (Unwind Now tab of the Elite and Elite-Plus Calculators)

JD: Cost-To-Close Calculations

The Unwind Now tab of the calculator shows a time-value cost-to-close of 1.32%. This action will reduce the original initial 4.2% time-value return to 2.88% while only 1-week into the 4-week contract.

 

Strategy considerations 

Rolling-out or out-and-up are generally reserved for in-the-money strikes as contract expiration approaches. We use the What Now tab of the calculators for these calculation decisions. Since we are early in the contract and the strike did move deep ITM as share price accelerated, we do use the Unwind Now tab but not for rolling considerations. Instead, we consider the mid-contract unwind exit strategy.

Based on Patrick’s calculations, we ask ourselves the following question: Can we generate more than 2.32% in option time-value premium by the current contract expiration (11/6/2020) if close the entire covered call trade and enter a new one with a different stock?   Our goal with this MCU exit strategy is to generate at least 1% more than the time-value cost-to-close. In this case, it’s a close call. I would lean towards taking no action and continue to monitor the trade. If the strike is still ITM as expiration approaches, we use the What Now tab to evaluate the benefit of rolling the option (assuming no earnings report in the upcoming contract period).

 

Discussion

Exit strategies are critical to the overall success of our option-selling strategies. We must identify when these opportunities arise, and which exit strategy to employ and when. Position management is the third of the 3-required skills for mastering option-selling.

 

Best calculator for these exit strategies

Click here

 

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:

Hi Alan,

I must tell you that you are an amazing teacher that knows how to simplify things. I have watched maybe 90% of your YT channel, all the course videos, about 60% of your main book. I will start trading with my demo account this week using Friday’s report.

Thank you!

Roy

 

Upcoming events

1. Wealth365 Summit: Free webinar

Thursday April 22nd

10 AM ET

Topic: Portfolio Overwriting: Covered Call Writing Long-Term Buy-And-Hold Portfolios

Register for free here

 

2. How to Trade It Podcast

May: A link to the interview will posted on this site and in social media when provided to BCI

Interview with Casey Stubbs

The focus will be on “my story” and analysis of my go-to strategies

 

Alan speaking at a Money Show event

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Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

26 Responses to “Should I Roll-Out When My Option is DITM Mid-Contract?”

  1. Carl April 10, 2021 3:02 am #

    Alan,

    I have read 3 of your books and listened to dozens of your videos. You explain and discuss implied volatility in detail but rarely talk about historical volatility. Isn’t HV important as well?

    Thanks for your time.

    Carl

    • Alan Ellman April 10, 2021 6:23 am #

      Carl,

      For our short-term option-selling trades, IV is where our focus should be (in my humble opinion). It measures risk, is forward-looking and will dictate our premium returns.

      To a lesser extent, I have written and talked about HV (or statistical volatility) and we do include beta stats (HV measured against a benchmark… the S&P 500, in the case of our premium reports) but I would consider beta a secondary factor in our trading decisions. I would tend to emphasize HV more in longer-term buy-and-hold trading decisions.

      Alan

  2. Barry B April 10, 2021 10:41 pm #

    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 04/09/21.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    On the front page of the Weekly Stock Report, we now display the Top Performing ETFs, the Top SPDR Sector Funds, and the 4 single Inverse Index Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close.

    Best,

    Barry and The Blue Collar Investor Team

    [email protected]

  3. James April 11, 2021 2:11 am #

    Alan & Barry,

    Here is a question for you guys that not only myself but I’m sure many others would get value from an answer to.

    What is your strategy when it comes to writing covered calls on stocks when there is an ex date in the contract period?

    Would you write it deeper out of the money to try to avoid early assignment on the ex date?

    Would you write it closer to the money in hopes that on the ex date the market price is below the strike and you have an opportunity to capture a decent premium AND the dividend amount?

    Or do you simply BTC the position before the ex date?

    I’m interested to know your thoughts on this.

    Thank you so much.
    James

    • Alan Ellman April 11, 2021 12:24 pm #

      James,

      Ex-dates become important only if share retention is critical to the strategy goals. If not, early exercise due to an ex-date may actually benefit us in that we have maximized our trade and have the cash back early to re-invest in a second income stream.

      Early exercise due to ex-dates is rare but more likely when:

      1.The ex-date is close to contract expiration
      2. The strike is ITM
      3.The dividend that will be distributed is > the time-value remaining in the premium

      The best way to avoid early exercise due to ex-dates is not to have a short call in place the day prior to the ex-date.

      Alan

      • James April 15, 2021 1:40 am #

        Alan,

        Thank you Alan for your time. I appreciate it. Portfolio overwriting is my preferred strategy so I do tend to write contracts on many stocks with ex-dates occurring during the contract cycle. Share retention is important to me but I only hold in registered, tax sheltered accounts (TFSA & RRSP in Canada) so even if my stocks were to be called away early I could simply buy them back without much concern.

        I am more interested to know how you factor in potential dividends or the possibility of early assignment into your calculations when you are screening a stock for a potential covered call trade.

        James

        • Alan Ellman April 15, 2021 6:48 am #

          James,

          Since exercise is not an issue, the only potential concern is dividend capture. Not having a short call in place the day prior to the ex-date will eliminate this possibility in 99.9% of trades.

          To guide us, we should understand that the most likely sewt of circumstances that may lead to early exercise due to an ex-date are:

          1. Strike is ITM
          2. Ex-date is close to the contract expiration date
          3. The dividend about to be distributed is > the time-value remaining on the premium

          Bottom line: Early exercise due to ex-dates is extremely rare but can occur.

          Alan

  4. Jim April 11, 2021 7:12 am #

    Hi Alan –

    Would you please take a look at my MU trade? I’m happy to pay you for your time because I am frustrated.

    I was assigned MU on 03/02/2021 @ $89 (see below or attached spreadsheet.) Stock then went up, down, up. I rolled a few times (weeklies) then sold the stock today @ $94.93.

    I’m frustrated because in hindsight if I had done nothing, just held the stock, I’d have a 7.7% return. ($94.93 – $88.10)/$88.10 = 7.7%

    See spreadsheet.

    Instead, my rolling/exist strategies ended up raising my cost basis from $88.10 to $92.33. Leaving me 2.8%. ($94.93 – $92.33)/$92.33 = 2.8%)

    What did I do wrong? Am I overtrading using weekly options?

    Thanks,

    Jim

    CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

    • Alan Ellman April 11, 2021 12:58 pm #

      Jim,

      Let’s start with this: You generated a 2.8% profit in a few days… annualize that!

      Now, I’m going to give you an “A” for effort and another “A” for too much effort. Let’s eliminate that 2nd “A”

      Instead of day-trading option-selling, let’s set up a structured plan with specific target goals and position management in place. Let’s set ourselves up for success with a system that is practical and time-efficient.

      We enter our trades based on a specific initial time-value return goal range that aligns with our personal risk-tolerance. Then we place BTC limit orders based on our 20%/10% guidelines. This will assist us as when to close the short positions for calls.

      One of the best points regarding these MU trades is that a lesson can be learned while making a sweet short-term return… congratulations!

      Alan.

  5. Trace April 11, 2021 4:35 pm #

    Alan,

    I’m a new member. I also bought your PMCC book and webinar. Plus read through everything inside the member’s area.

    My question is, when calculating potential ROI, should I be subtracting theta decay on my LEAP?

    I don’t remember seeing much about it in your trainings.

    Thanks for all the great education,

    Trace

    • Alan Ellman April 12, 2021 7:08 am #

      Trace,

      Excellent question. The answer is no.

      One of the unknowns with the PMCC strategy is the value of LEAPS option when the trade is closed or the long position is rolled. LEAPS value will depend, to a great extent, on the implied volatility of the underlying. This is undetermined at the time the PMCC trade is initially structured.

      We do use Theta when determining the best time to roll the LEAPS. In our BCI methodology, it is 3-months prior to contract expiration.

      Alan

  6. Marcus April 11, 2021 5:56 pm #

    Alan,

    1) Every time you roll up, down, or out, do you pay a commission fee?

    2) Under which condition would you simply let your weekly short-put expire? Likewise, under which condition would you look to roll your short, either up, down, or out? (And does the commission fee for orders play a roll in this decision?)

    Thanks!
    Marcus

    • Alan Ellman April 12, 2021 7:16 am #

      Marcus,

      Trading commissions are at all-time lows. They are never a factor in our trading decisions… never.

      Whenever we buy or sell option contracts, there are commissions (not for stocks) of $0.50 – $0.75 per-contract).

      When a short put expires OTM there is no need for any action as it expires worthless (we keep the original premium).

      We roll-out when we still like the underlying, the strike is ITM and the calculations meet our target initial time-value return goal range.

      We roll-up or roll-down in the same contract month when share price moves significantly in either direction and the calculations will enhance our portfolio returns (see the exit strategy chapter and section in our put book and online video course).

      Alan

      • Marcus April 12, 2021 12:23 pm #

        Thanks, Alan. You are quick good at explaining all things option.

        Say, a few more for you:

        1) Can one buy a call and sell a call against it WITHOUT OWNING THE STOCK ITSELF? If so, what kind of set-up does one need from his broker? (I have a TD Ameritrade account.);

        2) What kind of Delta is best to sell covered calls at on stocks YOU DON”T WANT TO HAVE CALLED AWAY? And are there any other MUST-KNOWS about how to do this successfully? (That is, not to do it around ex-dividend days or earnings weeks…)

        Thanks,
        Marcus

  7. Tom C. April 12, 2021 12:24 pm #

    Dear Alan,

    Joined your BCI package last month and am very much enjoying it. Quick question on selling a one month call on a long term holding in your portfolio. Do you still use the 20%/10% strategy to go for a double? Thanks for your time.

    Tom C.

    • Alan Ellman April 13, 2021 7:06 am #

      Tom,

      Yes, the 20%/10% guideline BTC limit orders should be in place when using portfolio overwriting. The thresholds will be lower because the premiums will be lower but we need to have the protection in place.

      Alan

  8. Lindsay April 14, 2021 1:12 am #

    Hi Alan,

    I sold puts on MU and BLDR.
    MU started off with a bang and was going nicely on day 1. However, it dropped 3.6% on Tuesday trading.
    My strike price was 93.50 with a premium of 0.64.
    Current price is now 92.26, below my break-even of 92.84
    Original price when i went in was 96.08.

    My dilemma now is whether to BTC option or take the stock and then write calls.
    Can’t see any obvious reason for the drop – perhaps profit taking.

    BLDR dropped close to 2% but is still above my strike.

    Regards,
    Lindsay

    • Alan Ellman April 14, 2021 5:06 am #

      Lindsay,

      Our decision to close a short put versus “allow assignment” of the underlying security depends on our assessment of the underlying as expiration or our 3% guideline approaches.

      We ask ourselves this question: Would I buy this stock today at this price based on sound fundamental, technical and common-sense parameters.. If yes, allow assignment. If no, close the short put prior to expiration.

      The former is known as the PCP (put-call-put) Strategy, sometimes called the “wheel strategy” Here is a link that describes this strategy:

      https://www.thebluecollarinvestor.com/using-put-selling-to-enter-a-covered-call-trade-at-a-discount/

      Alan

  9. Alan Ellman April 14, 2021 8:18 am #

    Premium members:

    A new Blue Chip (Dow 30) Report has been uploaded to your member site in the “resources/downloads” section (right side).

    Only 4 of the Dow 30 stocks have out-performed the S&P 500 in the 1-month and 3-month time-frames. I anticipate more clarity after the upcoming earnings season.

    Alan

  10. Alan Ellman April 14, 2021 5:59 pm #

    Premium members:

    This week’s 4-page report of top-performing ETFs and analysis of the top-performing Select Sector SPDRs has been uploaded to your premium site. One and three-month analysis are included in the report. Weekly performance has also been incorporated into the report although not part of the screening process. Weekly option availability and implied volatility stats are also incorporated.

    The mid-week market tone is located on page 1 of the report.
    For your convenience, here is the link to login to the premium site:

    https://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    https://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  11. Paul April 15, 2021 3:11 am #

    Alan,

    After reading your Encyclopedia and watching many of your videos, I’ve been writing covered calls according to the BCI system, I hope correctly, for coming on 2 months now this expiration Friday.
    I’ve used a total of 12 stocks from the watchlist, most of which I know nothing about, other than what’s on the watch list.

    Is it correct that on the stock watch list, though nothing is a recommendation, I know, but pretty much anything on the list is a sensible bet the next Monday after the report comes up, barring any significant changes? Ie, does the BCI system expect that I would do any other research beyond what is provided on the watch list? Nothing there is a bad pick (but of course anything on the list could go bad). Do I have that right?

    I ask this question because I’ve had to use nearly every exit strategy you describe already!
    Hit some doubles, gave up on some, rolled down, down and out, mid contract unwind when went to the moon, etc.
    Still making a profit each month, 2-4%, but wondering if this is normal activity or perhaps I’m picking from the report wrongly, or without proper extra diligence.

    Any thoughts on this would be greatly appreciated.

    Paul

    • Alan Ellman April 15, 2021 7:02 am #

      Paul,

      Yes, you can make the assumption that the stocks and ETFs on our watchlists are appropriate for option-selling strategies (and others) based on our fundamental, technical and common-sense screening process. They are elite-performers when these lists are crafted. No additional analysis is needed although if a trade turns against us, checking the news is a good idea. An excellent resource for that is:

      http://www.finviz.com

      I have experienced the same need for more exit strategies than usual lately as the market is “churning”, moving in and out of securities. My expectation is that a more “normal” environment will return after the current earnings season.

      The main takeaway, in my opinion, from your email is that you are prepared for any and all scenarios and I congratulate you for that. Education is power.

      Keep up the good work.

      Alan

  12. Barry B April 15, 2021 12:50 pm #

    Premium Members,

    The ETF Report for 04/14/21 is correct although it is dated 04/07/21. There was a typo on the report title line in the report. It should read 04/14/21 instead of 04/07/21.

    Jim, thank you for spotting the typo.

    Best,

    Barry and The Blue Collar investor Team

  13. Yungchi April 16, 2021 5:52 pm #

    What happen if JD rolled to near ATM of $82 or $83?

    • Alan Ellman April 17, 2021 6:37 am #

      Yungchi,

      Your calculations reflect a deep understanding of the structuring of our trades… nice going.

      Now, the question you pose is should we consider rolling out-and-up to a near-the-money strike?

      The short answer is usually “no”.

      Here are reasons why I would favor the MCU exit strategy over the rolling-out strategy 1-week into a 4-wwek contract:

      1. We are converting a 1-month contract into a 2-month contract. Although a near-the-money strike will generate significant time-value premium, the annualized return of 1-month contracts is > that of 2-month contracts.

      2. We are sacrificing the current down side protection we have (from $83.36 to $75.00 which is protecting our 4.2% initial time-value profit. This is a fantastic position to be in.

      3. With substantial share appreciation in a short time-frame, there is risk of profit-taking and near-the-money strikes offer little or no protection of that 2nd time-value return. In essence, we are moving from a well-protected great 1-month return to a risky longer-term commitment.

      4. By implementing the MCU strategy or taking no action, we have an opportunity to reassess our bullish assumptions on our underlying more frequently.

      To sum up: My preference, in this case, is to consider the MCU exit strategy or take no action and then consider rolling strategies as expiration approaches.

      Keep up the good work.

      Alan

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