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Understanding the Math of Unwinding Covered Call Writing Trades Early: A Real-Life Example with Invesco Solar ETF (NYSE: TAN)

On October 6, 2020, Alex from Mexico shared with me a covered call writing trade he executed with TAN. He was considering unwinding the trade using our mid-contract unwind exit strategy and wanted to know how I analyze these scenarios. This article will detail the calculations used in the Unwind Now tabs of the Elite and Elite-Plus Calculators to assist in these decisions.

 

Alex’ initial trade and status on 10/6/2020

  • 9/29/2020: Buy TAN at $61.95
  • 9/29/2020: Sell-to-open the 10/16/2020 $60.00 call at $3.36
  • 10/6/2020: TAN trading at $71.15
  • 10/6/2020: Cost-to-close the $60.00 call is $11.50

 

Initial structuring calculations using the Ellman Calculator

 

TAN: Initial Calculations on 9/29/2020

The spreadsheet show an initial 18-day time-value profit of 2.4% with 3.1% downside protection of that profit. The breakeven price point was $58.59.

 

Entering the unwind information into the Elite or Elite-Plus Calculators

 

TAN Trade Information on 10/6/2020

 

Unwind calculations if both legs of the position are closed on 10/6/2020

 

TAN: Final Unwind Calculations

 

The time-value cost-to-close (CTC) is 0.58%. There are 10 days remaining to contract expiration. We ask ourselves: Can we generate at least 1% more than the time-value CTC or 1.58% or more with a different security by 10/16/2020? If yes, we execute the mid-contract unwind exit strategy. If no or unsure, we take no action and continue to monitor the trade with possible rolling opportunities as expiration approaches.

 

Discussion

Exit strategy opportunities must be executed when beneficial to our overall portfolio success. To make these determinations, the BCI Calculators will assist as the formulas are built in to allow us the understand the mathematics of our trades. In the case of Alex’ TAN trade, a successful trade was executed with the possibility of establishing a second income stream in the same contract month with the same cash investment. Many thanks to Alex for sharing this trade with our BCI community.

 

Resources for more information on the mid-contract unwind exit strategy and all other exit strategies

BOOK I

BOOK II

ONLINE VIDEO COURSE

CALCULATOR

 

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 have recommended your site to a number of friends…. I’m very pleased with your approach and content… and more than I can say.

Best,

Bob

 

Upcoming events

1. Money Show Virtual Expo

July 13th – July 15th

2-hour Money Masters Course (paid event to The Money Show)

4 Practical Applications to Selling Cash-Secured Puts

Details to follow

 

2. Wealth365 Investor Summit

Week of July 12th – 17th

Multiple Applications of Invesco QQQ Trust (QQQ) in Our Option-Selling Portfolios

Details of this free presentation to be posted when finalized

 

 

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.

20 Responses to “Understanding the Math of Unwinding Covered Call Writing Trades Early: A Real-Life Example with Invesco Solar ETF (NYSE: TAN)”

  1. Barry B June 12, 2021 10:13 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 06/11/21.

    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:

    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.

    Please make sure that you review the new feature that we’ve added this week…Implied Volatility or IV. This is the At The Money (ATM) Implied Volatility for all of the stocks in the report. It is located in the column to the left of the “Beta’ metric. This will now be a permanent feature of the Weekly Stock Report.

    Best,

    Barry and The Blue Collar Investor Team

    [email protected]

  2. Dennis June 13, 2021 1:33 am #

    Hello Alan,

    I am going through your Videos in the membership for Cash Secure Puts.

    You mentioned in the “Yellow” on the reasonable premium to buy back (in Slide 3 – Stock Price Falls >3%) – May I know your reason for the amount?

    First Step in Exit Strategy Execution
    1. Always Buy Back The Option First

    Events Leading To Exit Strategy Opportunities
    1. In the 1st Half Of The Contract
    2. Stock price falls below the strike of the put by > 3%
    3. Stock price declines dramatically
    4. Stock price rises significantly

    Example When Stock Price Falls > 3% Below The Strike Price Stock
    1. Price = $51
    2. Sell the $50 put for $1.50
    3. Cash to secure the position is $5,000 ($150 of which is from the put sale)
    4. Initial return is $150/$4850 = 3.1%
    5. In the first half of the contract the share price is $48 or 4% below the strike
    6. Net one-month unrealized return = $150 -$200/$4,850 = (-)1%
    7. A reasonable premium to buy back the put would be $2.50 ($2 intrinsic value + $0.50 in time value)
    a. How do you get this value?
    8. Net loss = $2.50 -$1.50 = $1 equivalent to $100 per contract or 2.1%
    9. Use the freed up cash from closing the position to secure another put to help mitigate all or part of the $100 loss

    Events Leading To Exit Strategy Opportunities On Or Near Expiration Friday
    1. The strike price of the put option we sell is in-the-money on or near expiration Friday, and no earnings report due out the following month
    2. The strike price of the put option sold is in-the-money on or near expiration Friday,and an earnings report is scheduled in the following month
    3. The strike price of the put option sold is out-of-the-money on or near expiration Friday (option expires worthless)

    Example When The Strike Price Is In-The-Money On Or Near Expiration Friday, With No Earnings Report Due The Following Month: Rolling The Option Stock
    1. Price = $51
    2. Sell the $50 put for $1.50
    3. Cash to secure the position is $5,000 ($150 of which is from the put sale)
    4. Initial return is $150/$4850 = 3.1%
    5. On expiration Friday, the stock price is $49.75 (leaving the strike price in-the-money) with no upcoming earnings report the next month
    6. Cost to buy back the $50 put is $0.50, or $50 per contract
    7. Selling the next month $50 put generates $2.50, or $250 per contract
    8. Cash required to secure the $50 put is $4,800 per contract ($5,000 -$200 option credit)
    9. Initial one-month return for rolling this option = $200/$4,800 = 4.2%

    Summary
    1. All exit strategies begin with buying back the put originally sold
    2. Relationship between stock price and strike price will be 1 factor in identifying ES opportunities
    3. Time to expiration is another factor
    4. Keep an eye out for earnings reports dates
    5. Mastering position management will maximize returns

    Regards
    Dennis

    • Alan Ellman June 13, 2021 8:01 am #

      Hi Dennis,

      This is a hypothetical example which reflects a strike moving in-the-money by $2.00.

      The premium would be intrinsic-value (2.00) + time-value (I allotted $0.50 to this component). My rationale for the time-value is that the original time-value was $1.50 which consists of implied volatility + time-to-expiration.

      Now, days or weeks after entering the trade, Theta has eroded the time-value to some extent. In this hypothetical it was down to $0.50 from $1.50. Certainly other stats between $0.00 and $1.50 are possible but this is a reasonable hypothetical for this example.

      Alan

  3. Marsha June 13, 2021 12:52 pm #

    Alan,

    Thanks to you and Barry for adding IV stats to the member reports. Another time saver.

    I did have a question that puzzles me. I have looked at beta stats from different sources and they never seem to be the same. Can you explain why there is a discrepancy between these beta numbers and which one do you use for our reports?

    Thanks,
    Marsha

    • Barry B June 13, 2021 2:14 pm #

      Hi Marsha,

      Yes…there are a number of ways different organizations define “Beta”. Many of the other definitions look at a longer time frame for comparison…typically five (5) years. Since our trades are shorter-term trades, after reviewing available Beta metrics, we selected the metric that is available from IBD. The IBD version uses a one (1) year time frame and better matches our methodology.

      Best,

      Barry

  4. Roger June 14, 2021 6:09 am #

    Hi Alan,

    I could use some guidance on this one:

    – Purchased CCS on May 26th for $79.49
    – Sold the Jun 18 $80 strike calls for $3.07
    – Price of the stock was holding steady hovering around the $79-$80 mark
    – Since Jun 9th the price started dropping pretty rapidly
    – On Jun 19th my 10% BTC was triggered.
    – Current price of CCS is $66.32 and we are now in expiration week

    Considering this is a 4 week cycle and the 10% BTC was triggered late in the 3rd week of the cycle, I made the decision to see if there was an opportunity to hit a double. Now that it is expiration week, I am considering rolling down. Any guidance as to how I have managed things thus far in my decision making or how I could have done things differently would be greatly appreciated.

    Thanks,

    Roger

    • Alan Ellman June 14, 2021 8:16 am #

      Roger,

      Here is a general response to situations similar to this one:

      The BCI guidelines are to consider “hitting a double” in the first 2 weeks of a 4-week contract and favor rolling-down in the final 2 weeks of a 4-week contract. When we roll-down, we do so to an out-of-the-money strike when possible to allow for some share recovery.

      Exceptions exist especially in volatile market conditions (volatility low right now) where we may have an opportunity to hit a double in the latter part of a monthly contract.

      Here is a link to an article I published highlighting an extreme example of such an exception taken from one of my portfolios:

      https://www.thebluecollarinvestor.com/hitting-a-double-on-the-last-day-of-a-contract/

      Alan

      • Roger June 14, 2021 9:11 am #

        Thank you, Alan. Have a great week!

  5. joanna June 14, 2021 8:36 am #

    I guess the bottom line here as far as absolute numbers is concerned: 1. Either be impatient and unwind at a loss of $230.00 or be patient and allow assignment at a profit of $141.00…..presuming that the stock price doesn’t absolutely crater in 10 days.

    • Roni June 16, 2021 3:49 pm #

      Joanna,

      in hindsight (which is the best sight) it seems that the best alternative was # 1, unwind at a loss of $230.00 since CCS has cratered and is now trading at 62.33. There are 2 more days left, so who knows?

      Roger’s question is a great question. I focus on monthly CC trades, and it happens to me almost every cycle.

      This week I have had 5 buybacks filled at 10%, and I am sitting here asking myself what to do, and wishing for a market rebound after the FED meeting and the Biden press conference.

      Alan’s post is very helpful.

      Roni

  6. Nathan June 14, 2021 2:43 pm #

    Hi Alan,

    If $INDU were to close below the 20 D EMA two consecutive day, would you think that would be enough technical evidence to merit an investment in DOG?

    Due to the possible brevity of the short term down trend in $INDU, I was think about selling a call option for 1% as opposed to 2% to provide more room for profit. How do you know when to buy back the short call in trades like this and sell DOG?

    Thank you for all your help!

    -Nathan

    • Alan Ellman June 15, 2021 6:08 am #

      Nathan,

      Inverse ETFs have application in confirmed bear markets. I last used these securities briefly at the beginning of the market collapse in March 2020. Since the market generally moves up, with a myriad of whipsaws along the way, we must proceed with caution as it relates to inverse ETFs.

      The 2021 market is up 12% year-to-date so we cannot categorize current conditions as a bear market. Even if we feel that the market is about to decline (not my current position), we should wait for a confirmation before using DOG or any of the other inverse ETFs.

      Alan

      • Nathan June 15, 2021 9:40 am #

        Thank you, Alan!

  7. Mansumeet June 16, 2021 1:06 am #

    Good evening Alan

    A few months ago I came across your books and videos and I have been implementing them, particularly doing covered call trades and earning decent interest.

    However, significant part of my portfolio is into SPY ETF as I was taking an invest and forget approach over long term. Since I came across your material, I like your approach better as it shows significant potential of beating the market or spy returns. My question is – should I sell some or majorityof my spy ETF and get more stocks that you recommend in your BCI premium weekly list or just leave majority chunk in spy and do the little bit of premium stock CC trading on the side. What would you do in this situation?

    Downside of leaving it all in spy is that I miss out potentially on significantly larger returns via premium stocks and their cc trades. On the other hand selling of spy to buy premium stocks you listed will have tax implications for me as this is all in taxable account and there are significant unrealized capital gains I am sitting on at this moment. I am also in the highest tax bracket if that makes a difference in decision making.

    Thank you

    Mansumeet

    • Alan Ellman June 16, 2021 8:23 am #

      Mansumeet,

      Welcome to our BCI community.

      I would defer to a tax expert for that aspect of your inquiry. This way, the totality of your financial situation can be properly evaluated.

      Regarding a scenario where the bulk of a portfolio is dominated by 1 security, we first examine diversification. SPY is certainly diversified from a stock perspective. However, returns are limited.

      We can write covered calls against SPY to enhance returns. Expect premium returns for slightly out-of-the-money strikes of about 1/2% per-month. We can structure the strategy such that exercise is unlikely (but possible).

      If we are seeking greater returns with elite-performing growth companies found in our premium reports, then I would take a small percentage of SPY to convert to higher-volatility securities and then proceed to write calls against those shares. After a short time-frame we will be able to evaluate the tax loss/ premium gain ratio.

      Alan

  8. Alan Ellman June 16, 2021 3:47 pm #

    Premium members:

    The Blue Chip (Dow 30) for the July contracts has been uploaded to your member site. Look on the right side of the premium page in the “resources/downloads” section.

    Alan

  9. Alan Ellman June 16, 2021 5:06 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.

    New members check out our ongoing and never-ending training videos (“Ask Alan” and Blue Hour webinars). We add at least one new video each month. Only premium members have access to the entire library of these training tools.

    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

  10. Tri June 17, 2021 1:44 am #

    Hi Alan,

    It’s confusing for me when you said to target around 2-4% profit per month, max is 6% if it’s super bullish. However, in the premium report, you also said since it’s bullist, you have OTM-ITM ratio 2-1. 2 OTM – 1 ITM.

    When I choose the strike OTM, the upside potential + premium usually are more than 4%, such as

    rvlv $ 56.99 $2.67 $60.00 07/16/21 $ – $ 3.01 (upside) $ 54.32 (BE) 4.7% (ROO) 5.3% 0.0% (DP)

    Above is the example with OTM.

    So what should I follow ?

    Thanks,

    Tri

    • Alan Ellman June 17, 2021 6:22 am #

      Tri,

      Time-value return goal ranges may differ from investor-to-investor. In my case, as you stated, it’s 2% – 4% per-month for near-the-money strikes whether in-the-money or out-of-the-money. I will go up to 6% in a bull market environment. These are guidelines.

      This range does not include upside potential (OTM) or downside protection (ITM).

      In the example you provided, the ROO is 4.7% which is at the upper end of the guidelines and would be in consideration for my portfolio.

      Alan

  11. Alan Ellman June 18, 2021 1:00 pm #

    Rolling weekly puts:

    For our members using my 10-Delta weekly put strategy:

    This weekend I am traveling to visit family and won’t return to my office until Monday afternoon. I have one portfolio dedicated to this strategy with all positions about to expire OTM today.

    I rolled all positions to next Friday generating an initial annualized return of 9.9%.

    The key to strategy success is to make sure initial time-value returns meet our stated goals and using 10 Delta (or less) put strikes which will approximate a 90+% chance of the option expiring out-of-the-money.

    Alan

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