Q & A. Rolling a Covered Call


I received this Comment:


Scottrade will not allow selling puts
so I did a covered call on FSYS back about a month ago with an Oct expiration
on the 50 strike which is now well over the $5.70 I received…about 11.20 bid 11.90 ask.

 My calculations are that if FSYS is
above the 50 at expiration I will get 1739 for the shares and 570 for the
premium. If I buy back the calls and sell now, the profit is 1300 per 100
shares. Or should I buy back the calls and roll to the 70 strike with a current
premium of about $370…what is your opinion Thanks, I read the book

 Dave

 ***

 Hello Dave,

 

1)    Scottrade doesn’t seem to understand
that writing a covered call entails the same risk as writing a cash-secured
naked put.  They are not alone and short
of changing brokers, there’s not much you can do about that.

 

2)    If
the stock is above the strike at expiration, you receive $5,000 for each 100
shares.  You also keep the premium.  That makes your sale price $55.70 per share
(and that’s the price to report to the IRS). 
I don’t understand where your ‘1739’ comes from.

 

3)    It’s
often a good idea to buy back the calls early and to sell the stock (I do NOT
mean simply buy back the calls and hold the stock) before expiration.  You sacrifice a small amount of potential
profit, but your money is free for reinvesting and all risk is eliminated.  The question is:  just how much potential profit are you
willing to sacrifice?  That’s up to you.  I note that there is still a considerable
amount of time premium remaining in the calls ($4) and that buying back now would
sacrifice a substantial portion of your maximum profit on this position.  This is obviously a volatile stock with high
option premium, and that always increases risk. 
But because you are considering rolling to the 70 strike, you are
obviously not too concerned with the possibility that the stock will drop below
50 anytime soon.  I don’t know why you
chose this specific covered call, but if it was to generate a small profit, you
have already earned that profit.  If it was to collect
all, or nearly all, of the time premium in the call option, you are far from
meeting that goal.  That’s why I cannot offer
advice on whether you should close the position now.  That has to be your decision based on your
profit objectives and tolerance for risk.

 

4)    As
far as rolling to the Oct 70 calls, that requires the investment of a
substantial chunk of cash (to buy the Oct 50s and sell the Oct 70s).  Are you that bullish on the stock? Do you
want to move from a reasonably conservative play of owning a position that is
equivalent to being short a put that is 9 points out of the money to being short a put that is 11 points in the money?  I cannot decide that for you, but sellers of
naked puts traditionally sell options that are out of the money. 

 

5)    I want to take this opportunity to
point out something that’s easy to miss. 
Your initial idea was to sell the Oct 50 put.  At some point your plan was to buy back that
put, earning a profit.  Did something
change?  If you had sold that put, would
you be thinking of rolling it to the Oct 70 put instead?  I seriously doubt that you would.  My point is: 
If you wanted to write the naked put, then stay with that plan.  The fact that your broker forced you to adopt
a position (covered call) that is equivalent to the position you wanted (naked put)
does NOT mean you should revamp your methodology to accommodate your
broker.  I believe you are considering this roll – not because you like that new position better – but because you own stock and want to sell out of the money call options.  I suggest you think of your position
as being short the naked put and trade the position as if you were short that naked
put.  If you would buy back that Oct 50
put and roll to the Oct 70 put – a very bullish trade, then it may be okay (but
risky) to roll to the Oct 70 put. 
Instead, if you would be happy to see the stock rally and the value of
your naked ‘put’ decline, then do nothing and your only decision is when (if
ever) to repurchase that put.  I’d hate
to see you change strategies because your broker does not allow you to own the
exact position you want to own.  The two
positions are equivalent and you should think of them that way.  Let me know if that makes sense to you.

 

Mark

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2 Responses to Q & A. Rolling a Covered Call

  1. Dave 08/13/2008 at 2:51 PM #

    Mark
    The 1739 was my profit per 100 shares I have 300. I actually have owned FSYS for a few years and trade it back and forth with a long term price potential of $100 (IMO).
    I like to keep at least 100 shares and work off those by buying dips selling calls etc but never expected a one day advance of $12 like they had a week or so ago, and the shares have continued to go up beyond what reasonable people would expect. Certainly its very difficult to gauge momentum.
    My actual thought process: when at 37 I did not expect it to increase beyond 49 by the October expiration. Analysts had a target price of $44 so I thought sell out of that range ie 50, keep the premium, and the shares and repeat the process all over again. Never really thought of selling the Oct put at 50. Actually I would have sold the 30 put and bought the 25 put as a bullish put spread.
    In any event I appreciate your rapid response.
    Dave
    Dave
    It’s never easy to know where a stock is headed, or how far it will go. You made a good trade. It appears it will give you a good return, although October expiration is a long five weeks away and who knows where the stock will be?
    I like the idea of selling put spreads. It’s safer than selling naked puts. You are facing one of the risks of being a covered call writer – and that’s selling your stock at the price you agreed to sell it, but now you are disappointed with that decision.
    Consider a compromise. This is not a recommendation – merely a way to keep your stock without having to commit so much cash. You can roll the Oct 50 to the Jan 60, instead of the Oct 70. That won’t cost too much cash. That’s important in case the stock turns around and dives.
    Or, you can allow the stock to go away at expiration and (at that time) sell some put spreads. Eventually the stock may decline in price, allowing you to repurchase the shares. If not, you keep earning income from the put spreads.
    Mark

  2. Dave 08/16/2008 at 12:31 PM #

    thanks I will give that some thought