Should I Roll-Out When My Option is DITM Mid-Contract? – April 12, 2021
Exit strategy opportunities for covered call writing must be recognized and acted upon when indicated. It is important to understand when and how to react to these situations and determine the best exit strategy, if any. In October 2020, Patrick shared with me a covered call trade he had executed and was considering closing the option and selling a new one the following contract month. He was deciding if the cost-to-close justified the rolling-out exit strategy. This article will analyze the trade with JD.com, Inc. (NASDAQ: JD).
Patrick’s trade
- 10/6/2020: Buy 100 x JD at $76.94
- 10/6/2020: STO $75.00 call at $5.12
- 10/13/2020: JD trading at $83.36
- 10/13/2020: Cost-to-close (ask price) the $75.00 strike is $9.35
Initial structuring of the trade
The multiple tab of the Ellman calculator shows an 1-month initial time-value return of 4.2% with a 2.5% downside protection of that time-value profit.
What is the time-value cost-to-close (Unwind Now tab of the Elite and Elite-Plus Calculators)
The Unwind Now tab of the calculator shows a time-value cost-to-close of 1.32%. This action will reduce the original initial 4.2% time-value return to 2.88% while only 1-week into the 4-week contract.
Strategy considerations
Rolling-out or out-and-up are generally reserved for in-the-money strikes as contract expiration approaches. We use the What Now tab of the calculators for these calculation decisions. Since we are early in the contract and the strike did move deep ITM as share price accelerated, we do use the Unwind Now tab but not for rolling considerations. Instead, we consider the mid-contract unwind exit strategy.
Based on Patrick’s calculations, we ask ourselves the following question: Can we generate more than 2.32% in option time-value premium by the current contract expiration (11/6/2020) if close the entire covered call trade and enter a new one with a different stock? Our goal with this MCU exit strategy is to generate at least 1% more than the time-value cost-to-close. In this case, it’s a close call. I would lean towards taking no action and continue to monitor the trade. If the strike is still ITM as expiration approaches, we use the What Now tab to evaluate the benefit of rolling the option (assuming no earnings report in the upcoming contract period).
Discussion
Exit strategies are critical to the overall success of our option-selling strategies. We must identify when these opportunities arise, and which exit strategy to employ and when. Position management is the third of the 3-required skills for mastering option-selling.
Author: Alan Ellman