How to Enter Our Rolling-Out-And-Up Trades into Our Monthly Trading Logs – September 12, 2022
In our last blog article, we discussed how to enter our rolling-out trades into our covered call writing trading logs. This article will highlight the additional considerations when rolling our covered call trades out-and-up.
Trade log challenges when rolling-out-and-up
- We are combining 2 months of option premiums: how do we break this down?
- What cost-basis do we use for the next contract month?
- When we roll-out, we are almost always rolling-out to an in-the-money (ITM) strike but when we roll-out-and-up, we can be rolling to an in-the-money, at-the-money or out-of-the-money strike. How does this impact our trade entries?
Hypothetical trade
- 12/27/2021: Buy 100 x BCI at $48.00
- 12/27/2021: STO 1 x 1/21/2022 $50.00 call at $1.50
- 1/21/2022: BCI trading at $52.00
- 1/21/2022: BTC the 1/21/2022 $50.00 call at $2.05
- 1/21/2022: STO the 2/18/2022 $51.00 ITM call at $2.50
- 1/21/2022: STO the 2/18/2022 $52.00 (ATM) call at $4.00
- 1/21/2022: STO the 2/18/2022 $55.00 (OTM) call at $1.00
BCI guidelines for rolling trade entries: current contract month
The current month concludes with the final stock price at the in-the-money strike (we generally roll strikes that are ITM), our contract obligation. This means we have maximized our trade as initially structured as shown in this screenshot:
In these hypothetical trades, a 1-month 7.29% (brown cells) return were realized.
BCI guidelines for rolling trade entries out-and-up: next contract month
At the time we roll the option, shares can be worth no more than our contract obligation to sell at $50.00, so we enter $50.00 as the price per-share. Since we are rolling-out-and-up, the strike can be ITM, ATM or OTM and we enter the new contract expiration date, 2/18/2022, in this case. We then use the net BTC and STO net option credit or debit our option $/Share entry.
Important note: The net premium will be a negative number when the cost-to-close the current month strike is greater than the next month premium. This deficit is largely negated by the unrealized share appreciation created when the lower strike is removed.
Rolling-out-and-up to an ITM, ATM and OTM strikes: Next month trade log entries
The net option premiums based on the next-month and current month premiums are as follows:
- $51.00 ITM strike: $2.50 – $2.05 = +$0.45
- $52.00 ATM strike: $4.00 – $2.05 = =$1.95
- $55.00 OTM strike: $1.00 – $2.05 = (-) $1.05
The trade entries and calculations are shown in the screenshot of the BCI Trade Management Calculator:
- The $51.00 ITM strike has a potential 1-month return of 2.9% (0.9% + 2.0%)
- The $52.00 ATM strike has an initial time-value return of 3.9%. The 4.0% upside potential will be realized if share value remains at or above the current price of $52.00
- The $55.00 OTM strike has a potential 1-month return of 7.9% (-2.1% + 10.00%). Notice the negative time-value return which is mitigated by the unrealized share appreciation when the current month strike was elevated
- As with rolling-out, there is the (minor) flaw in this approach for ITM strikes (red circled area). In the brown cell, we see downside protection of 0%, when, in fact, it is 1.9% ($1.00/$52.00) because the shares are, in fact, trading at $52.00 at the time of the roll
Discussion
When rolling-out our covered call trades out-and-up, we must break up our trade entries over the 2 contract cycles. This includes having rules and guidelines for:
- Stock price entry
- Final stock price
- Dividing option credits and debits over 2 contract cycles
- Rolling out-and-up to ITM, ATM and OTM strikes
These trade entry rules and guidelines are not perfect, but they are practical and represent the best way to reflect our current trade status.
Author: Alan Ellman