Position management or exit strategies for covered call writing and selling puts is the third required skill to achieve the highest possible return levels (stock and option selection are the first two). First, we must determine if an exit strategy opportunity actually exists and then, if so, which one to execute. On May 3rd 2019, Rob N wrote to me regarding a successful trade he was involved with and was considering a rolling strategy in the same contract month. This article will dissect the pros and cons of rolling up in the same contract month and evaluate if this is the best course to take.
Rob’s trade with CarMax, Inc. (NYSE: KMX)
- 4/25/2019: Buy 100 x KMX at $75.89
- 4/25/2019: Sell 1 x $78.00 call (May 17 expiration) at $1.42
- 5/3/2019: KMX trading at $78.50
- 5/3/2019: Cost-to-close the $78.00 call is $1.15
Initial structuring of the trade using The Ellman Calculator
KMX: Initial Calculations with the Multiple Tab of The Ellman Calculator
Rob received an initial 23-day return of the option (ROO) of 1.9% with an additional upside potential share growth of 2.8% resulting in a 23-day potential return of 4.7%. This is where the trade is positioned as of Rob’s email on 5/3/2019. For a free version of The Basic Ellman Calculator click here.
Evaluating rolling up in the same contract month
Rob was considering 3 paths to take:
- Rolling up to the $79.00 strike for an option net debit of $0.55 ($1.70 – $1.15)
- Rolling up to the $80.00 strike for an option net debit of $0.95 ($1.70 – $0.75)
- Taking no action and possibly getting assigned after expiration
Now, why would we roll up to then lose money on the options? Frequently, moving the strike up will create an unrealized stock gain to the strike or current market value of the stock, whichever is lower. In this case, share value would move up $0.50 from the original $78.00 strike to current market value of $78.50. In both cases, we would be rolling up to a losing scenario. Should share price move up to the new strikes, we would now have net credits in both rolling scenarios:
- $79.00 strike: (-$0.55 + $0.50 + $0.50) = +$0.45 = 0.6%
- $80.00 strike: (-$0.95 +$0.50 + $1.50) = +$1.05 = 1.3%
To achieve these relatively small additional credits and avoid losses on the option side, we would be dependent on continued share appreciation of a stock that has recently enjoyed significant price acceleration. In a way, we are taking a (currently) very successful trade and putting the results at risk.
Best strategy when share value increases significantly mid-contract
The mid-contract unwind exit strategy can be employed when the time value component of the premium approaches zero or such that closing the entire position and using the now available cash will allow us to generate at least 1% more than the time-value cost-to-close. For this calculation, we use the “Unwind Now” tab of the Elite version of the Ellman Calculator:
Time-Value Cost-To-Close Using the Elite Version of The Ellman Calculator
The calculator shows a cost-to-close of $120.00 per contract or 1.54% of current market value. The original return was 1.9% so closing the entire position is way too expensive and not appropriate at this. It may become viable should share price continue to accelerate in the next few days.
Discussion
There are many times when the best action is no action at all. In this case, Rob has maximized his initial trade as long as share value remains at or above $78.00. We must remain focused and prepared to act should a viable exit strategy opportunity arise. If the strike remains in-the-money as expiration approaches, there is also the opportunity to roll the option out or roll-out-and-up to the next contract month.
***For more information on position management for covered call writing, see the exit strategy chapters and sections in these educational products:
BOOKS
DVDs
https://thebluecollarinvestor.com/minimembership/complete-dvd-bundle-package/
Recent Philadelphia Money Show Interview
https://www.moneyshow.com/video/11655/selecting-the-right-strike-price/
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:
Amazon testimonial for The Complete Encyclopedia August 19,2019 titled Feel the burn:
… the BCI books were the “trainer” at the gym that I needed. They make my neurons burn with learning. The concrete examples put flesh on the bones of the abstractions and the questions at the end of each chapter coerce me to read and re-read until the fog goes.
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BOOTH 314
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