Establishing Our Cost-Basis in a Multi-Step Managed Trade – February 1, 2021
Covered call writing calculations are meaningful only when the correct stats are entered into our formulas (calculators). The cost-basis of a managed trade can be confusing as stock and option values are changing with each step of the trade series. In July 2020, Steve shared with me a series of trades he executed with KraneShares CSI China Internet (NYSE: KWEB). The sequence of trades involved opening a covered call position, rolling out-and-up and finally the mid-contract unwind exit strategy where both legs of the trade were closed. This article will explain the cost-basis that should be used to make the calculations most useful to our trade decisions and evaluations.
Steve’s trades with KWEB
- 6/08/2020: Buy 200 shares of KWEB on at $56.50
- 6/8/2020: Sell-to-open (STO) $56.00 strike at $1.65 for the 06/19/20 expiration
- 6/19/2020: KWEB went up to $61.00 on expiration Friday
- 6/19/2020: Rolled-out-and-up
- 6/19/2020: Buy-to-close (BTC) the $56.00 strike at $5.90
- 6/19/2020: STO the $61.00 7/19/20 expiration at $2.90
- 7/06/2020: BTC the $61.00 strike at $6.95 as the stock was at $67.64
- 7/6/2020: Sell the stock @ $67.64
KWEB: Initial covered call writing calculations (6/8/2020)
The trade was established with a 2.1% initial time-value return with 0.9% downside protection of that time-value profit. The cost-basis for this leg of the trade series was $56.00 after deducting the intrinsic-value component of the $1.65 premium from share purchase price.
KWEB: Rolling-out-and-up calculations (6/19/2020)
Factoring in the bought-up value of KWEB (shares worth $56.00 with the $56.00 strike in place, are now worth $61.00), the initial 1-month return is 3.57%. The cost basis for this leg of the trade remains at $56.00 because that is what our shares are practically worth as the rolling-out-and-up exit strategy was initiated.
KWEB: Mid-contract unwind exit strategy (closing both legs of the trade on 7/6/2020): Total return from 6/8/2020 to 7/6/2020
Stock position: +$11.14 ($67.64 – $56.50)
Option position: -$8.30 (+$1.65 – $5.90 +$2.90 – $6.95)
Net position: +$2.84 ($11.14 – $8.30)
1-month total trade return: $2.84/$56.50 = +5.03%
After calculations credits and debits, we divide by our initial investment of $56.50 per share to determine our overall return result. When calculating taxes, if trading in non-sheltered accounts, different stats are used. The ones utilized in the BCI methodology are based on allowing us to make the best trade decisions at any given point in time.
Authort: Alan Ellman