On 2/21/2022, Bob wrote a 3/17/2022 $29.00 call on SBLK. On 2/26/2022, SBLK was trading at $31.76 and the cost-to-close the short call was $2.78. On 3/1/2022, SBLK was going ex-dividend for an eventual $2.00 per-share distribution. Will Bob’s shares be sold the day prior to the ex-date?
Case for early exercise
- Ex-dividend dates are the main reason for early exercise
- On 2/26/2022, the $2.78 cost-to-close premium consisted of only $0.02 in time-value with the possibility of a $2.00 per-share dividend on the horizon, if exercised
Case against early exercise
- Very rare, even when ex-dividend dates occur prior to contract expiration
- Contract expiration (3/18/2022) is far from the ex-dividend date (3/1/2022)
- Option buyers want to be option sellers, not share owners
- On the ex-date, SBLK will decline in value by $2.00 due to the future distribution. This is 1 of the factors in determining the stock price that day
Price chart of SBLK
SBLK Price Chart Before & After the Ex-Date
- 2/21/2022: Covered call written on an accelerating price chart (red arrow)
- 2/26/2022: SBLK appreciated to $31.76 (blue arrow)
- 3/1/2022: SBLK declines in value on the ex-date (green arrow)
Discussion
Early exercise is possible, but unlikely. If it does occur, the final returns will be maximized, and the cash freed up from the sales of SBLK can be used to initiate another option-selling income stream in the same contract cycle. Unless we absolutely want to retain the underlying shares (Tax issues, for example), a case can be made that early exercise should be embraced rather than avoided.
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Alan,
At the end of a contract, if the covered call expires otm and we still hold the stock, how do we calculate final returns.
Thanks,
Art
Art,
The final results at contract expiration will be a combination of realized & unrealized returns. Let’s give an example:
BCI trading at $155.90
STO a 1-month $160.00 call at $3.50
The initial option return is 2.25% ($3.50/$155.90)
At expiration, BCI is trading at $158.25, and the $160.00 call expires worthless
The unrealized share gain is $2.35 per-share or 1.51%
The net combined % return is 3.76% (2.25% + 1.51%)
The net combined $ return is $$585.00 ($235.00 + $350.00)
The BCI Trade Management Calculator will provide all these calculations for us.
Alan
Alan,
With the recent market improvement, would you advise selling more calls than puts? I’ve read that you prefer calls in bull markets and puts in bear markets.
Thanks,
Elliot
Elliot,
Let me start with this. Both strategies can be impressively productive in both bear and bull market environments once we have mastered the 3 required skills.
I do lean slightly to put-selling in bear and volatile market conditions, which allows us to avoid purchasing the shares if they decline after entering the put sales. This is especially true if share decline does not move below the deep OTM put strike. We also have our exit strategy arsenal to avoid exercise.
I lean to covered calls in normal to bull market environments which allows us to use OTM calls and create 2 income stream trades (3, if dividends are involved).
I have no issue whatsoever with members who prefer puts in all market conditions. Once again, both are wonderful strategies when managed properly.
Alan
Premium Members,
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Hi Alan,
I’m a premium member and have been following your strategies in your books and video courses for portfolio overwriting on 4 underlyings in a non-sheltered account. For the August contracts, I sold calls at strike prices about 6-8% OTM. With this recent rally, they are now all pretty far ITM, at about 11-13% above where they were at the start of the contract.
I would like to keep my shares to maintain my lower cost basis and to avoid a taxable event, but if they don’t pull back, it will cost a lot to roll them out and up. What do you typically do in this type of situation?
Thanks so much! I really appreciate it.
Angela
Angela,
The strategy you are employing is “portfolio overwriting” where income generation and security retention are our 2 major goals.
Let’s start with the current situation and then move on to future considerations.
To avoid exercise, the short calls must be bought back (closed). As we approach expiration of the August contracts, the cost-to-close may look hefty, but the reality is that most of it is intrinsic-value which is mitigated by the unrealized increase in share value when removing the original strike. This applies to rolling-out-and-up. We can also just roll-out, and the intrinsic-value will be negated when the next month option is sold. Use the “What Now” worksheet tab of the Trade Management Calculator to run the numbers. Bottom line: roll-out or out-and-up are the 2 choices in this scenario.
For future considerations:
Use deeper out-of-the-money strikes and settle for lower initial time-value returns to decrease the necessity of exit strategy intervention. We can use 3 approaches here:
1. Use an initial time-value return goal range of 5% – 6% annualized.
2. Use implied volatility to establish 84% success probability trades:
https://www.thebluecollarinvestor.com/using-implied-volatility-to-determine-safe-strikes-for-portfolio-overwriting-a-real-life-example-with-paypal-holdings-inc-nasdaq-pypl/
3. Use Delta to establish high success probability trades: Here’s an example with puts that can be applied to calls:
https://www.thebluecollarinvestor.com/using-delta-to-create-low-risk-high-return-put-selling-trades-a-real-life-example-with-etsy-inc-nasdaq-etsy/
Alan
Premium members,
The latest Blue Chip Report for the top-performing Dow 30 stocks for the September 2022 contracts has been uploaded to your member site. Look on the right side of the member site in the “Resources/Downloads” section for the report dated September 2022.
Alan & the BCI team
Hi Alan,
I’m not a member yet, but I’ve started reading your first book. I believe it was written before Weekly options were very popular. Do you still use Monthly options for Covered Calls. If so, why?
I look forward to a trial on your site.
Thanks!
Kim
Kim,
A lot has happened since my 1st book, including 7 more books.
You are correct that Weeklys have become more popular as have all option products since 2007.
I have multiple portfolios dedicated to option-selling, both calls and puts. Some with Weeklys, most with Monthlys. There are pros & cons to each (see screenshot below).
Here are links to 3 of the dozens of articles I have published related to weekly options:
https://www.thebluecollarinvestor.com/portfolio-overwriting-with-weekly-options/
https://www.thebluecollarinvestor.com/how-to-use-weekly-options-to-avoid-earnings-reports/
https://www.thebluecollarinvestor.com/creating-a-portfolio-of-weekly-cash-secured-puts/
Bottom line: Both work, both are great approaches to generate cash flow, and both have pros & cons.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Premium members:
This week’s 4-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options, mid-week market tone as well as the implied volatility of all eligible candidates.
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