How to Record & Calculate ITM Covered Call Trades that Become OTM Trades – April 10, 2023
To properly analyze our covered call writing and put-selling trades, we must accurately record each step of the trades such that initial and final results are accurate. In this article, a hypothetical covered call trade which starts out in-the-money (ITM) but ends up out-of-the-money (OTM) at contract expiration will be analyzed. The BCI Trade Management Calculator will be used to demonstrate how to enter and generate final returns for the ITM aspect and how to enter the OTM segment for the ensuing contract cycle.
Hypothetical covered call trade
- Buy 100 x ABC at $100.00
- STO 1 x $95.00 ITM call at $7.00
- Breakeven price point is $93.00 ($100.00 – $7.00)
- At expiration, ABC is trading at $94.00, and the $95.00 (now OTM) call expires worthless
- What price do we enter for the next contract covered call, $100.00, $94.00 or $93.00?
Overview solution
In the 1st contract cycle, there is a $7.00 (7%) realized option gain and a $6.00 (6%) unrealized stock loss (from $100.00 to $94.00) at expiration. This share price decline is accounted for in the current expiration cycle and the price of ABC is entered at current market value ($94.00) in the next expiration cycle. Any change in share price moving forward will be recorded in this 2nd cycle. The BCI Trade Management Calculator will do all the legwork for us.
The Trade Management Calculator
Note the following:
- Blue arrows: Initial trade time-value returns of 2.11%, 29.55% annualized based on a 26-day trade
- Red arrow: Price of ABC at contract expiration
- Green arrow: Final option realized gain in cycle #1
- Purple arrow: Unrealized share loss accounted for in the initial contract cycle
- Brown arrow: Net realized/unrealized combined trade results in the first contract expiration cycle (7% – 6%)
Discussion
Properly entering our option trades in the appropriate expiration cycles will allow us to accurately calculate our investment results. The entries and calculations in this article are not meant for tax purposes.
Author: Alan Ellman