I was short FFIV calls (in a covered call) expiring this Friday at strikes of $97.5 and $100. With FFIV advancing to above $110, I have 2 choices: 1. to buy back to cover those short calls; 2. to buy back to cover those short calls and simultaneously sell another FFIV call with a later expiring date and at the same or higher strike price.
How do I determine which one I should do? Here is my
- For the Jul $100 calls, I rolled up (i.e., bought back the short calls and sold simultaneously another call): bought FFIV Jul $100 call and sold Aug $100 calls for a profit of $2.5/sh. [$2.5 times x number of my contracts x 100 (each contract has 100 shares of underlying stock)] / [maintenance requirement (i.e., the cash I need to have in my trading account for this investment)] x 100% = 8.2%. My return is 8.2% in 1 month (or annualized 98.4%). My strike price is 10% in the money (pretty safe). This is a safe and yet quite profitable investment. So I decided to roll up.
- For the Jul $97.5 calls, I rolled up (bought July $97.5 call and sold to open Oct $100 call) with a profit of $3.1/sh. This trade not only gave me $3.1/sh cash in my account, but also raised my strike from $97.5 to $100. So my net profit is $3.1 + $2.5 = $5.6/sh. My return in 3 months (expiring in Oct) is 18.38% (or annualized return of 73.52%). Again, the $100 strike is 10% in the money, i.e., even if FFIV drops from the current $112/sh to $100/sh in 3 months, I’ll still make a 18.38% return. This is a good deal, so I did it. Please note that I increased the strike price from 97.5 to 100. I did so b/c I anticipate the stock market to enter a post-summer bullish phase until at least the year end. Why did I choose Oct expiration? This is because when you increase your strike, you’ll have to pay more to buy back than to sell open. If FFIV falls below your strike, that becomes your real loss. So one lesson I learned is that I (almost) never pay out of pocket to roll up. I chose Oct expiration because the roll up produced a net premium into my account.
The above case shows how I use the roll up technique to deal with a major problem of covered call that most newbies don’t know how to deal with: capped maximum return. With roll up, there is no capped maximum return on covered calls. You can continue to roll up the expiration date and/or strike price to keep up with the rising stock price.
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I am new and having trouble understanding “rolling up”. I have two questions on this scenario. (1) Why aren’t you being called out on the highly profitable July Calls you sold? (2) By rolling into the Aug Calls don’t you risk greater exposure should the Bullish trend continue? Does this strategy depend on a pullback?
Rolling up simply means trading an option spread, i.e., buying back the expiring call and selling another call of the same strike or a different strike of a later date (the latter has more time value). I use this approach to deal with situation where you don’t want your stocks (the options of which are in the money, hence, you face the stocks being called away). The answer to your first question is yes, your stocks will be called away with an ITM call, if you don’t roll up the options. For 2nd question, my thesis is that stocks spend most times in saw tooth fashion, particularly right now, we are stuck in a trading range. Yes, it may appear that you will miss the profit should the trend continue to go up. But what if the stock comes back? BIDU’s recent action is a good example. I have been holding BIDU for years. Although BIDU went from ~$100 to as high as ~$160 in the last 9 months or so, I always trailed behind with my options (strike ~105 and 110). Now BIDU’s price is back where it was 9 months ago, but I have already pocketed multiple months time value by selling calls.