How to Manage a 5.3% Mid-Contract Unrealized Gain: A Real-Life Example with BHP Group Limited (NYSE: BHP) + Alan’s Wealth365 Webinar Registration Link – September 19, 2022
When we have a maximum mid-contract unrealized gain on a trade, there are opportunities when we can generate additional income streams and, thereby, enjoy higher than initial maximum returns. There are also scenarios when we should take no action and continue to monitor these trades. On 1/19/2022, Patrick shared with me such a trade he was managing.
Patrick’s trade
- 1/11/2022: Buy 100 x BHP at $63.08
- 1/11/2022: STO 1 x 2/28/2022 $65.00 call at $1.46
- 1/19/2022: BHP trading at $67.99
- 1/19/2022: 2/18/2022 $65.00 call at $4.40
Exit strategy opportunity to evaluate
When share price accelerates substantially, we evaluate the mid-contract unwind (MCU) exit strategy. If we can generate at least 1% more than the time-value cost-to-close the original covered call trade by contract expiration, we take action. Let’s run the numbers on this BHP trade.
BHP initial trade calculations with the BCI Trade Management Calculator (TMC)
The red arrows show an initial time-value return (ROO) of 2.31%, 17.24% annualized based on a 49-day trade, and the blue arrow shows upside potential of 3.04%, for a total net maximum return of 5.35%.
Entering the data into the Unwind Now tab of the TMC Calculator and BCI spreadsheets
BHP Unwind Now calculations
The brown cells (red arrow) reflect a time-value cost-to-close of 2.17% or $141.00 per-contract. This will initially reduce our 5.3% unrealized return to a current 3.13% unrealized return. We ask ourselves if we can generate at least 3.17% by 2/18/2022 with a different security after closing this trade.
Discussion
When we decide to close an unrealized 5.3% 1-month return, we must have a high degree of confidence that we can generate at least 1% more than the time-value cost-to-close. In the case of BHP, the return we would seek is 3.17% by contract expiration. Possible? Yes. High degree of confidence? Not so much. There are times when the best action to take is no action at all.
Author: Alan Ellman