Rolling Up In The Same Contract Month: Evaluating A Real-Life Trade
Dr. Alan Ellman | Jul 26, 2015 02:33AM ET
Mastering exit strategies is one of the three required skills for covered call writing as well as selling cash-secured puts. In this article I will review and evaluate a real-life trade executed by one of our members. The trade involves rolling up in the same contract month with BWLD when share price accelerates significantly
The initial trade
- 11/12/2014: Buy Buffalo Wild Wings Inc (NASDAQ:BWLD) at $144.53
- 11/12/2014: Sell-to-open (STO) the December $145.00 call at $4.70
One week after initial trade
- 11/19/2014: BWLD trading at $150.00
- 11/19/2014: Buy-to-close (BTC) the $145.00 call at $7.40
Two weeks after initial trade
- 11/26/2014: BWLD still trading at $150.00
- 11/26/2014: STO the $150.00 call at $3.00
The question we are evaluating is whether the best path to take was to roll the option up from the $145.00 strike to the $150.00 strike. Here is the Ellman Calculator showing results if no action was taken:
Calculations if Option is not Rolled Up
If no action was taken and share price did not decline below $145.00, a 3.6%, one-month return would be realized. This profit is protected by $5.00 (down to the $145.00 strike) or 3.3%. This is a great position and return for conservative investors.
Calculations after rolling up
- Option credits: $4.70 + $3.00 = $7.70
- Option debit: $7.40
- Net option credit: $0.30
- Share appreciation: $5.47 ($150.00 – $144.53)
- Net credit: $5.77 = 4%
- Downside protection of this credit: $0
Discussion
By taking no action we generate a 3.6%, one-month return with 3.3% protection of that profit. By rolling up we generate a slightly higher 4.0%, one-month return with no protection of that profit on a stock that has accelerated significantly in a short time frame. For most conservative retail investors taking no action is the prudent approach.
Other exit strategy possibilities
Should share price rise causing the $145.00 strike to trade near parity (all intrinsic value), the mid-contract unwind exit strategy may come into play (see pages 264 – 271 of the ). Also, should the strike remain in-the-money as expiration approaches we may still consider rolling out or rolling out and up.
Get The News You Want
Market tone
Stocks declined reacting (over-reacting?) to weak corporate earnings for Apple (NASDAQ:AAPL), IBM (NYSE:IBM), Caterpillar (NYSE:CAT) and Microsoft (NASDAQ:MSFT). However, Morgan Stanley (NYSE:MS) and Amazon (NASDAQ:AMZN) beat expectations. The big picture shows that more than 75% of companies have exceeded earnings forecasts, while 52% have surpassed revenue expectations. This week’s economic reports:
- In June, US home resales hit their highest point since February 2007. Existing home sales rose 3.2% to an annual rate of 5.49 million units. Sales were 9.6% higher year-over-year
- However, new single-family home sales fell 6.8% in June to a seasonally adjusted annual rate of 482,000, a seven-month low. However, sales were 18.1% higher than in June 2014
- The median price of US existing homes sold in June reached a record $236,400. The median June sales price was 6.5% higher than a year earlier
- Initial jobless claims declined by 26,000 to 255,000 for the week ended 18 July, the lowest level since November 1973
- Continuing claims dropped 9,000 to 2.21 million for the week ended 11 July
For the week, the S&P 500 fell by 2.21% for a year-to-date return of 1.01%.
Summary
IBD: Uptrend under pressure
: 6/6- Buy signal since market close of July 14, 2015
BCI: Cautiously bullish using an equal number of in-the-money and out-of-the-money strikes. Although there have been more positive surprises than negative ones this earnings season, some of the disappointments have been major players (AAPL, MSFT, IBM). Keep in mind that these reports weren’t egregious ones but rather didn’t meet market consensus. We also have the possibility of an interest rate hike of 25 basis points in September if our economy continues to improve.
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.