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When Our Covered Call Strike Moves $1000.00 In-The-Money

This really happened. From March to August 2020, many of the large cap technology stocks were on fire. Thor shared with me a covered call trade he executed with Amazon.com, Inc. (NASDAQ: AMZN) where the strike moved $1000.00 in-the-money (ITM) as share price headed to the moon. As you read this article, see if you can find lessons to be learned.

 

Thor’s trades

  • 4/16/2020: Buy AMZN at $2093.00
  • 4/16/2020: STO the 1/15/2021 LEAPS $2100.00 call for $89.00 ($8,900.00 per-contract)
  • 8/28/2020: AMZN trading at $3402.00
  • 8/28/2020: The cost-to-close (CTC) the $2100.00 call is $1,356.80 per -share
  • 8/28/2020: The time-value CTC is 2.6% (use the “Unwind Now” tab of the Elite or Elite-Plus Calculators)

 

AMZN chart from April through August 2020

AMZN Chart Showing Thor’s Trade

 

Trade structuring using the “Multiple Tab” of the Ellman Calculator

 

AMZN Initial Calculations

 

The 9-month 4.3% initial time-value return annualizes to 5.7%.

 

Should we close the trade now?

When a strike moves deep ITM, the time-value component of the option moves closer to 0. In this case, the CTC is 2.6% but in order to close 1 contract, we must invest an additional $135,680.00… yikes! To determine if this an appropriate action for a robust portfolio, we then ask ourselves if we can generate more than 2.6% by contract expiration which is still more than 4 months away. The answer is yes we can. If we cannot take this action, we continue to monitor the trade for potential other exit strategy opportunities.

 

Lessons learned

We all benefit from analyzing our trades… how could I have done better? We never stop learning. From these trades, here are my lessons learned:

  • By using an expiration date months away, we are adding additional risk by trading through multiple earnings reports
  • Longer-term options generate lower annualized returns
  • Shorter-term options allow us to re-evaluate our bullish assumption on a frequent basis

 

Discussion

We all become better investors and traders by analyzing our trades. I do this to this day and will continue as long as I invest. We never stop learning. In this case, Thor learned some valuable lessons while achieving his maximum return as the trade was initially structured. Next time, his returns will be even higher.

 

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,

You have a lot of patience with all of us. You are also a true expert in this type of investment. Truly a person who can be trusted because what you propose and suggest is absolutely logical and real. Let me tell you that you are a “rare bird” in the investment market. It is a pleasure to have found your books and you.

Kind regards from Spain.

Fernando

 

Upcoming events

1. Market Madness Summit: Free webinar

March 23rd

12 PM ET

Using Both Covered Call Writing and Put-Selling to Generate

 Monthly Cash Flow and Buy Stocks at a Discount

The PCP (put-call-put) Strategy (wheel strategy)

Video overview of presentation

Details and register here

 

2. AAII Research Triangle NC: Private webinar

April 10,2021 at 10 AM ET

Zoom webinar- details to follow

 

3. Wealth365 Summit: Free webinar

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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.

29 Responses to “When Our Covered Call Strike Moves $1000.00 In-The-Money”

  1. Todd March 20, 2021 1:05 am #

    Alan,

    I have a hypothetical question that I did not see addressed in either vol 1 or 2 of your “bibles” about rolling out and up.

    The March option for MU I sold was at the 87.50 strike price, which leads to a comparative basis of 8750 for 100 shares.

    Let’s say despite earnings next month, I was high on MU and kept MU and rolled up and out to the 92.50 strike price. And assume on April 16, next monthly expiration, it expires in the money at 95.00. If I were to look at rolling out again for May contracts, would the comparative basis be 9250? I think that is right based on the explanation in the spreadsheet, but I wanted to check.

    Thanks for your help!

    Todd

    • Alan Ellman March 20, 2021 5:44 am #

      Todd,

      2 important points in response to your question:

      1. When rolling an ITM strike out-and-up, the cost-basis is always the previous ITM strike because that is what are shares are worth at the time we are considering the exit strategy. This applies even if we are rolling out-and-up for a second time or more. This cost-basis may be different than the cost-basis from a tax perspective.

      2. If the security has an earnings report in the next contract month and we decide to hold the stock through the report, the best approach is to buy back the near-month short call prior to expiration and write the new call after the report passes.

      Alan

      • Todd March 20, 2021 3:59 pm #

        Thanks Alan, that was helpful. I was able to close out my first trade in the black. Looking to expand to multiple stocks this month as I gain confidence and comfort in what to look for and how to handle various scenarios. This past month definitely was not a slam dunk. In fact, I think as you mentioned, it offered some opportunities to hit a double.

        Todd

  2. Vee March 20, 2021 2:10 am #

    HI Alan,

    I sold 20 put contracts for XLE strike price $50 expiring April 16th, 2021. I got a $2.10 premium per contract for it. Now, I see it is trading below strike price.

    If it falls below $48, should I exit or do nothing since XLE is in uptrend and most likely it will recover by 4/16. BTW, I have set up an alert to notify me if it falls below $48.

    With regards
    Vee

    • Alan Ellman March 20, 2021 5:51 am #

      Vee,

      After we enter a monthly covered call trade, we set a 20% BTC limit order to buy back the option, $0.40 for this trade.

      For those who want to use a maximum stock price loss, 7% – 8% is reasonable but can be adjusted according to personal risk-tolerance and trading style. That would mean setting an alert at about $44.00 if the purchase price was $48.00.

      The short call must be closed first before selling the stock but so far, so good with this trade.

      Alan

      • Alan Ellman March 20, 2021 11:36 am #

        Vee,

        I see you sold a put, not a call. The BCI guideline is to close the short put when the price drops more than 3% below the strike, below $48.50 in this case.

        This applies to the sale of out-of-the-money puts, which is what we use in the BCI methodology. As of market close on Friday, XLE was trading at $49.53 so no action is needed at this time.

        Alan

  3. Ted March 20, 2021 2:55 am #

    Hi Alan,

    Hope you are well. I am curious as to “how far one can go” (following BCI guidelines) regarding transaction amounts.

    EG: if I wanted to increase the amount of contracts I am selling, will that adversely affect the bid/ask because of the significant increase in open interest?

    – Ted

    • Alan Ellman March 21, 2021 7:22 am #

      Ted,

      An increase in open interest will benefit us in that the spread will tend to be tighter. Our concern is when option liquidity is low.

      Alan

  4. Robert G March 20, 2021 3:45 pm #

    Based on your experience, is a dividend capture scheme with bottom/ultra-low strikes not worth the bother? It could provide an opportunity to obtain significantly additional shares for dividend capture, but I suspect that counterparties are both annoyed by and hip to the scheme and will readily call out the shares on ex-div. Can timing such a move provide a generally successful outcome? Do you have a rule-of-thumb for a div capture strike price?
    Thanks again for all that you do!
    Robert

    • Alan Ellman March 21, 2021 7:33 am #

      Robert,

      Early exercise of our options is rare but more likely in the following scenarios:

      1. Strike is in-the-money

      2. Ex-dividend date is close to the contract expiration date

      3. The time-value component of the option is less than the dividend about to be distributed (after the ex-date).

      It is also important to understand that if early exercise does occur, it will usually be the day prior to the ex-date when the stock price will also drop by the dividend amount.

      Alan

  5. Barry B March 20, 2021 10:34 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 03/19/21.

    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 10 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]

  6. Ron March 21, 2021 10:26 am #

    Since an increasing number of ETFs have weekly options, perhaps you might consider also providing the 1-week performance info.

    Thanks for your consistently excellent work!

    • Alan Ellman March 21, 2021 11:03 am #

      Ron,

      This may be a quality enhancement to our ETF reports. I will give your suggestion serious consideration.

      Alan

  7. James Baumann March 21, 2021 12:03 pm #

    Hi Alan,

    I have been a follower of yours for a few years now and am so glad to have come across you and your team on YouTube. The idea of mastering this skill and becoming ‘CEO of your own money’ truly is inspiring. It gives people like myself and many others on this site some real hopes and dreams of becoming financially independent which is tremendous. Thank you so much for that.

    I have a question regarding the AMZN trade mentioned above. I am having a little trouble understanding how the cost to close the $2,100 strike call could only be $1,256 when the stock is trading at $3,402 or $1,302 in the money. This would seem like a no brainer to close if the option was worth less than the intrinsic value. Is there something I’ve missed? Thanks again.

    • Alan Ellman March 21, 2021 12:26 pm #

      James,

      Excellent catch. There was a typo in the article (now corrected). The cost-to-close was $1356.80, not $1256.80, making the time-value cost-to-close slightly over 2%. We will almost never see an option priced below parity (intrinsic-value).

      Thanks for pointing this out and for your generous comments.

      Alan

  8. Herbie March 21, 2021 12:28 pm #

    Alan,

    As a long time fan and frequent listener to your presentations I have a question that comes up regularly. When you have an ITM short call position on a stock that is about to go ex-dividend do you roll up/out or take the risk of the stock is called?

    Thank you,
    Herbie

    • Alan Ellman March 22, 2021 5:52 am #

      Herbie,

      If it is critical to retain the shares and capture the dividend then we must remove the short call obligation (buy back the option) prior to the ex-date. We can write a new call the day of or after that ex-date.

      It depends on the trade strategy and goals. For me, if my shares are assigned, I have maximized my trade (without dividend capture) and have the cash back to immediately re-invest. Dividend capture will pale in comparison to option premium in the long run.

      That said, there is nothing wrong with also generating dividends in addition to option premium and share appreciation potential. We must decide on how we will structure our trading strategy and then trade accordingly.

      Bottom line: To ensure dividend capture, a short call should not be in place after the ex-date. Early exercise is rare, but possible if the short call is in place.

      Alan

  9. Eric March 21, 2021 10:07 pm #

    Hi Alan ,
    I am to BCI and new to the options trading universe as well, so as I learn new things everyday, I find myself more curious in the above example (Thor’s interesting covered call so long winded).

    I am surprised why the option buyer did not exercise that deep in the money call yet without regard to expiration date? Some brokerages do automatically exercise once deep ITM ..

    The other obvious question is what would you do UN Thor’s situation? What visible options he has .. You concluded the story above by asking “can we do better than generating 2.6% at expiration. ?” And your answer was” Yes we can” But didn’t expand what other solutions for this trade if you were Thor other than shelling out the $135,680 buying to close the short call contract, which clearly was not agreeable to you?

    What would you do?

    Best regards

    • Alan Ellman March 22, 2021 6:16 am #

      Eric,

      Happy to explain.

      There are many reasons why early exercise of our options is so rare. Option buyers control the shares (maybe ours, maybe other shares) until contract expiration. The cash required to purchase the shares upon exercise can be kept in an interest-bearing account until contract expiration, 4 1/2 months away in this case.

      The option buyer will also be exposed to less capital risk by not exercising early and final decisions can be made months later.

      Also, most option-buyers want to be option-sellers, not share owners. Their hope is to be directionally correct and generate significant returns by leveraging the power of options.

      Another reason early is so rare in trades like this one is that it doesn’t make financial sense for an option buyer to exercise as long as there is a time-value component to the option premium and no dividend about to be distributed. Let’s break down the math:

      With AMZN trading at $3402, the cost-to-close is $1356.80. The $2100.00 strike is $1302.00 in-the-money. This is the intrinsic-value component of the CTC premium. If the option is exercised that would be the exercise benefit to the option buyer… $1302.00. This means the time-value component of that CTC premium is lost, in this case $54.80 per-share ($1356.80 – $1302.00).

      If the option buyer wanted to own AMZN at that point in time a better approach would be to sell the option and then buy the shares at market price thereby benefitting by $56.80 per-share.

      When early exercise does occur in these circumstances, it is extremely rare and usually due to investor error.

      Addressing your second inquiry, what would I do? Let’s assume an investor had the cash required to close the trade… We ask ourselves if we can generate more than the time-value cost-to-close (in this case 2.6%) by contract expiration (4 1/2 months away). That’s about 1/2% per-month, quite attainable for most option sellers. We close the trade and use the cash for a new covered call trade with a different security to generate > 1/2% per-month, usually a lot more than 1/2% per month.

      Alan

  10. Marcus March 22, 2021 1:41 am #

    Alan,

    Say, is the safest and most profitable way to make money in the market selling puts to collect premium and if assigned, to turn around and sell a call on that position, only to repeat this cycle thereafter?

    Marcus

    • Alan Ellman March 22, 2021 6:19 am #

      Marcus,

      We refer to this as the PCP (put-call-put) Strategy in my books and online courses and it is a great strategy approach especially in bear and volatile market conditions.

      In normal and bull market conditions, using out-of-the-money covered calls is my strategy preference but both approaches offer tremendous opportunities to consistently beat the market and many years substantially.

      Alan

      • Marcus March 22, 2021 10:34 am #

        I’m totally with you, Alan! I,too, love covered calls. Thing is, I’m always afraid my position will be taken away from me and feel like if I do write a call, no matter how far out of the money it is, I have to sit in front of my computer all day just in case I need to buy the call back should it creep too close to my strike price. How do you avoid this?

        Thanks,
        Marcus

        • Alan Ellman March 22, 2021 11:21 am #

          Marcus,

          Early exercise is extremely rare especially if not associated with dividend distributions. Even if a strike moves in-the-money, exercise is highly unlikely prior to contract expiration.

          As a result, the main time we need to be concerned is when the strike is in-the-money on the day of expiration where we can roll the option to avoid exercise.

          We should also clarify why early exercise would be problem. It would relate to tax issues if trading in a non-sheltered account in a few circumstances. Otherwise, it actually be a positive.

          Alan

          • Marcus March 22, 2021 11:43 am
            #

            I’m not sure what you mean by “dividend distributions”. Are you implying that one shouldn’t write covered calls on dividend paying stocks?

            Thanks, Alan!

          • Alan Ellman March 23, 2021 6:00 am
            #

            Marcus,

            Not at all. I always have dividend generating stocks in my portfolios. My point is that the main reason for early exercise is ex-dividend dates. If it is critical to our trading strategy to avoid early exercise (let’s say due to tax consequences for low cost-basis shares), we must learn to circumnavigate around these dates.

            We accomplish this by not having a short call in place after the ex-date especially when the ex-date is close to the expiration date and the strike is in-the-money. Also, it is more likely when the dividend distribution will be greater than the time-value remaining in the option premium. Despite all that, early exercise is extremely rare.

            Alan

  11. Alan Ellman March 23, 2021 8:51 am #

    Fellow Blue Collar Investors,

    Quick reminder that my 3rd and final live webinar in March is today, Tuesday the 23rd. I’m excited to join Market Madness Traders Summit to bring you this free educational event.

    Market Madness Traders Summit

    Presented by TradeThirsty and Westmark Trading

    March 23rd 2021

    Click here to register:

    https://tradethirsty.info/market-madness-alan-ellman?cookieUUID=5060b7d5-14ba-4c74-b859-dfd0aed2241c&cookieUUID=837ccc45-7bff-4bfe-9385-9f890999fc5e&affiliate=289

    BCI Event Date:

    TODAY March 23, 2021 | 12:00 p.m. ET US (Tues)

    My Topic:

    The PCP (Put-Call-Put) Strategy: Selling Cash-Secured Puts to Enter Covered Call Trades

    As always, BCI’s own Barry Bergman will join as chat area monitor and expert, available to answer your questions and assist as needed.

    See you later!

    Alan Ellman, President
    The Blue Collar Investor

  12. Alan Ellman March 24, 2021 3:36 pm #

    Unusual market movement:

    For the April contracts, I favored OTM strikes 2-to-1 over ITM strikes and I’m fully invested. 20% BTC limit orders are in place. None of these thresholds have been reached.

    There has been quite a bit of movement in and out of stocks so I will be favoring ITM strikes for all new positions as I take more defensive positions.

    Alan

  13. Alan Ellman March 24, 2021 5:15 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

  14. Alan Ellman March 25, 2021 5:56 am #

    Premium members,

    The High Dividend Yield Report for the 2nd Quarter 2021 has been uploaded to your member site. Scroll down on the left side of the site.

    Alan

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