Evaluating Returns When Rolling Out And Up
Dr. Alan Ellman | Mar 29, 2015 02:17AM ET
Covered call writing and put-selling calculations must be accurate and preferably understood by option-sellers. I created the Ellman Calculators to facilitate the authentic computations we depend on. In this article, I will review a successful trade executed by one of our members, David L, who used UTHR from our Premium Running list as the underlying security.
Initial trade for the March contract
- Buy UTHR @ $155.90
- Sell March $150 in-the-money call for $9.25
- Intrinsic value = $5.90
- Time value (Dave’s initial profit) = $3.35/share
- ROO = $3.35/$150 = 2.2%
- Downside protection of ROO = 3.8%
Initial returns for UTHR
This represented an excellent conservative position to take on one of our outstanding performers.
Trade status one week prior to expiration
- Share price = $163.22
- Cost to close = $15.50
- Considering rolling out and up
- April $160 call generates $9.50
Using the “What Now” tab of the Ellman Calculator to calculate rolling out and up 1 week prior to expiration
Rolling out and up with UTHR
The computations show a 5-week return of 2.57% with 2% downside protection of that profit (not breakeven).
Return if we opened the position today
David astutely pointed out that if the position were entered 1-week prior to expiration that the initial return would be 3.9% as shown in the screenshot below:
Get The News You Want
United Therapeutics Corporation (NASDAQ:UTHR) calculations 1-week prior to expiration
What is our real return, 2.57% or 3.9%?
It’s 2.57%. To own the shares at $163.22 (current market value) we would have to buy back the option at $15.50. That would raise the real-life value of the shares from $150 (the option obligation) to $163.22 or + $13.22, leaving a net debit of $2.28 or 1.5%. This must be factored into our real-life returns. Rolling the option will also result in one less commission than closing the entire original position and re-opening at $163.22.
When should the option be rolled?
Next week. Dave had huge downside protection of his initial option profit and was fairly safe to max the returns from his original trade. Time value erosion of the option premium is logarithmic in nature, not linear, so the near term option time value will deteriorate faster than the next month option. It will be advantageous to us to wait closer to expiration to begin the rolling process.
Congratulations to David on an outstanding trade.
Market tone
We had a mixed week of economic data along with global concerns, both economic and political, leading to a volatile and down week for our markets:
- According to the Commerce Department, the 3rd estimate of 4th quarter GDP remained at 2.2% on an annualized basis, below the 2.4% expected by analysts
- New orders for durable goods declined by 1.4% in February. Experts anticipated a 0.3% increase
- Sales of existing homes increased by 1.2% in February after reaching a 9-month low in January. However, sales were up 4.7% year-over-year
- The median price of existing homes rose by 7.5% year-over-year
- Sales of new homes had its 3rd month of impressive gains, increasing by 7.8% in February. Experts were expecting a decline
- New-home inventory declined from 5.1 to 4.7 months
- Year-over-year, sales of new homes rose by 24.8%
- The median price of new homes rose by 2.6% year-over-year
- The Consumer Price index (CPI) rose by 0.2% in February after falling the 3 previous months. Compared to February, 2014, the CPI was unchanged
- Initial jobless claims for the week ending March 21st came in at 282,000, below the 290,00 projected by experts
For the week, the S&P 500 fell by 2.2% for a year to date return of 0.6%, including dividends.
Summary
IBD: Uptrend under pressure
: 2/6- Buy signal since market close of January 23, 2015
BCI: Cautiously bullish using an equal number of in-the-money and out-of-the-money strikes. I am inclined to be more conservative until we can view the market reaction to the first interest rate increase and market volatility levels off.
Original post
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.