Rolling our covered call trades involves multiple months of trading statistics. The calculations may be deceiving initially but on deeper analysis, rolling our options can represent an invaluable trading tool which enhances our overall returns. Some of our members have expressed concern when rolling out-and-up because the cost-to-close our near-month in-the-money call deducts the intrinsic value of the closing option and calculates only time value as the cost-to-close. However, when share value declines after the rolling trades, it appears that we are losing from the rolling decision. In this article, a typical hypothetical rolling example will be established and then we will rely of the math to help understand the pros and cons of rolling out-and-up. 

Hypothetical rolling out-and-up trade

• 1/22/18: Buy XYZ at $48.00
• 1/22/18: Sell Feb $50.00 call at $1.50
• 2/16/18: XYZ trading at $54.00
• 2/16/18: Buy-to-close (BTC) the Feb $50.00 call at $4.10 ($0.10 of time value + $4.00 of intrinsic value)
• 2/16/18: Sell-to-open March $55.00 call at $2.00
• 3/5/18: XYZ is trading at $48.00

When we roll out-and-up, as opposed to simply rolling-out or allowing exercise of the near-month in-the-money strike, we are taking a bullish stance on the overall market and underlying security. Once the new positions are established, we now move to “position-management” mode.

Initial trade calculations using the “Multiple” tab of the Ellman Calculator

Calculations for Initial Covered Call Trade

The calculations show an initial time value return (ROO) of 3.1% and a possibility of another 4.2% from share appreciation up to the $50.00 strike price. At expiration of the near-month option, this total 7.3%, 1-month return has been realized in this hypothetical.

Rolling out-and-up calculations using the “What Now” tab of the Ellman Calculator

Rolling Out-And-Up Calculations

The option side of the rolling trade shows a net debit of $2.10 per share ($4.10 – $2.00) as we roll out from the February to the March contract and up from the $50.00 strike to the $55.00 strike. However, the share value which originally was limited by the $50.00 strike, now has an unrealized gain up to the current market value of $54.00 (+ $4.00 per share). This results in a net credit of $1.90 per share or 3.80% on a cost basis of $50.00. Now, if share value moves up to the new $55.00 strike, we generate an additional 2% for a total potential 1-month return of 5.80%.

What is the cost-to-close the near month $50.00 strike?

Initially, it appears that the cost-to-close is $4.10 but that does not factor in the increase in share value from the $50.00 strike to current market value of $54.00. That $4.00 intrinsic value is factored into the $4.10 premium to buy back the initial call, so we must calculate in the form of “buying up” share value. So, our net debit to roll out and up is $4.10 – $4.00 = $0.10 per-share. Let’s view this from a different perspective: Let’s say we didn’t hold a position with XYZ in the near-month but wanted to use it in the upcoming month. We would pay $54.00 per-share and write the $55.00 call. Let’s calculate:

Calculations for Month 2

The results are virtually the same as when we roll options out-and-up, rounding decimal differences aside. If we allow assignment and enter the covered call trade the next week, we will also be incurring one additional commission compared to rolling the option.

Discussion

Rolling out-and-up is similar to entering a trade at the start of the new option contract with a small time value cost-to-close debit ($0.10 in this example). As long as we have our position management arsenal ready to go, we should have many more successful outcomes compared to the number of break-evens or losses. 

Upcoming event 

AAII National Investor Conference: Las Vegas Nevada

October 26 @ 8:00 am – October 28 @ 1:00 pm

Market tone

This week’s economic news of importance:

• Advance trade in goods July -$72.2 billion (-$69.6 billion expected)
• Case-Shiller home price index June 6.2% (6.4% last)
• Consumer confidence index August 133.4 (127.2 expected)
• GDP revision Q2 4.2% (4.1% expected)
• Pending home sales July -0.7% (1.0% last)
• Weekly jobless claims 8/25 213,000 (212,000 expected)
• Personal income July 0.3% (as expected)
• Consumer spending July 0.4% (as expected)
• Core inflation July 0.2% (0.1% expected)
• Consumer sentiment index August 96.2 (95.4 expected)

THE WEEK AHEAD

Mon September 3rd

• None: Labor Day

Tue September 4th

• Markit manufacturing PMI August
• ISM manufacturing index August
• Construction spending July

Wed September 5th

• Trade deficit July 

Thu September 6th

• Weekly jobless claims 9/1
• ADP employment August
• Productivity Q2
• Markit services PMI August
• ISM nonmanufacturing index August
• Factory orders July

Fri September 7th

• Nonfarm payrolls August
• Unemployment rate August
• Average hourly earnings August

For the week, the S&P 500 moved up by 0.93% for a year-to-date return of 8.52%

Summary

IBD: Market in confirmed uptrend

GMI: 6/6- Bullish signal since market close of July 9, 2018

BCI: Selling 3 out-of-the-money calls for every 2 in-the-money for new positions.

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The 6-month charts point to a bullish tone. In the past six months, the S&P 500 was up 8% while the VIX (12.86) down by 30%.

Wishing you much success,

Alan and the BCI team