CRM reported good earnings. My covered call (short May 21 $125 call) is due today. CRM is a good stock with good time value and I want to keep it. So I bought back the call (strike 125) and sold Aug. 20 call (strike 130). This spread has a different expiration date and different strike prices. It is called diagonal spread. The price difference of this diagonal spread is $0.3/sh. So I made $0.3 x 100 = $30 for each pair of contract (1 contract = 100 shares). But my new strike price is $5 higher (at $130) than the previous strike at $125. This means that when the option is exercised (when the call buyer buys my CRM stock), the buyer now has to pay me $130/share, instead of $125/share before. Or in other words, I am making $5/sh more in the stock. The total profit = $0.3/sh (option spread) + $5/sh (strike price difference) = $5.3/sh. ($5.3 x the # of shares I own)/$ of margin requirement (the money that I have to have in my margin account) = 16% (in 3 months), or 54.3% annualized. My option strike price is now 12% in the money (ITM). This 12% ITM means that CRM has to drop >12% of its value (down to below $130/sh) for me to start making less money.
Take home lesson:
- CRM has gone up a lot. We are still in a bull market. I expect CRM to stay at this price level or go higher. Therefore, my previous strike price at 125 is a bit too deep in the money. Although safer, it’s not as profitable. So I wanted to gradually go up on the strike price, but not too fast to put myself in harm’s way. That why I rolled up from 125 to 130. Why did I choose Aug expiration at 130? Because Aug 130 options were selling at slightly higher than the prices of May $125 options. When I rolled up my spread, I didn’t have to pay any money. Instead, I received $0.3 per share. This way, in case CRM prices come down, my value in CRM stock per se will come down. (But if I hold CRM long enough, I expect CRM price to bounce back. ) But I won’t lose any money on the options, since today’s roll up I made money ($0.3/sh). Should the options expire worthless by Aug 20, I won’t lose any money. Consider another scenario: rolling up from 125 to 135. If I bought back my May $125 options and sold Aug $135 options, instead of receiving $0.3/sh, I’d have to cough up $3.2/sh. This is higher risk with higher potential gain. If CRM stays above 135 by Aug expiration, the extra profit would be $1.8/sh (5 – 3.2). But if CRM drops below 135, particularly if it drops below 130, my potential would even higher. Should this happens to me, not only I’d lose money on CRM stocks, but also on options. So one lesson I learned: Do not pay extra out of pocket when you roll up (with exceptions). Better be safe than sorry.
