Exit Strategy Considerations When a Strike Moves Deep ITM Early in a Contract – May 2, 2022
When our covered call writing and put-selling trades start out much better than anticipated, Blue Collar Investors immediately evaluate our exit strategy arsenal to see if we can achieve even higher returns. On 11/12/2021, one of our premium members shared with me a trade he had initiated with Big 5 Sporting Goods Corp. (Nasdaq: BGFV) where an in-the-money strike quickly moved deep, deep ITM. Let’s evaluate the exit strategy choices.
Exit strategy opportunities
- Rolling-up in the same contract cycle
- Rolling-out or out-and-up
- Mid-contract unwind exit strategy (MCU)
- Take no action
Rolling-up: The risk with this approach is that profit-taking after a quick and substantial rise in price may take a maximum trade and turn it into a lower return or even a losing trade.
Rolling-out or out-and-up: This strategy is usually reserved for late in a contract where the time-value component of the option premium is eroding due to Theta. Selling the next contract expiration will result in a net time-value credit for rolling-out or a net debit or credit for rolling-out-and-up.
Mid-contract unwind exit strategy: We consider this exit strategy when share value accelerates significantly leaving the strike deep ITM and the time-value component of the premium approaching zero. When this the case, both legs of the covered call trade are closed and the cash is used to enter a new trade with a new underlying security.
Take no action: We take this path when there are no exit strategy opportunities.
5-day chart of BGFV incorporating 11/8/2021 – 11/12/2021
Exit strategy evaluations
It’s too early in the contract (expiration more than 1-month away) to consider rolling-out or out-and-up so we will consider the mid-contract unwind strategy or taking no action.
BGFV Unwind Now Calculations (Elite and Elite-Plus Calculators) versus “Take no action”
The time-value cost-to-close is $178.00 per-contract or 5.93%. We ask ourselves if we can generate at least 1% more than 5.93% by contract expiration which is 1-month away. It would take another highly volatile stock to do so. Using the MCU strategy at this time may be appropriate for some aggressive investors but most conservative retail investors will take no action and continue to monitor this trade which has a favorable outlook at this point in time.
Discussion
Position management or exit strategies is the 3rd required skill for successful option-trading. After selecting the underlying security and associated option to sell, we must have a plan in place to react, non-emotionally, to every possible outcome. That said, not every change in circumstance will represent an exit strategy opportunity. In the case of BGFV, the outlook is favorable but there are no exit strategy opportunities at this point in time that will enhance the trade. We continue to monitor the trade as such circumstances may come up later in the contract.
Author: Alan Ellman