Setting Our 20%/10% Guidelines After Rolling an Option Out or Out-And-Up – October 17, 2022
Rolling-out is a covered call writing exit strategy we frequently use when a strike is expiring in-the-money (ITM) and we want to retain the underlying shares for the next contract cycle. After closing the short call in the current month prior to rolling, a new trade with the same security is set up in our trading log for the next contract. This article will demonstrate how to set up our 20%/10% guidelines for the rolled-out trade. Since the concept is a bit complex, I will create a hypothetical example with nice even numbers.
Proposed BCI trade
- 3/21/2022: Buy 100 x BCI at $48.00
- 3/21/2022: STO 1 x 4/15/2022 $50.00 call at $1.50
- 4/15/2022: BCI trading at $52.00 on expiration Friday
- 4/15/2022: BTC the 4/15/2022 $50.00 call at $2.10
- 4/15/2022: STO 1 x 5/20/2022 $55.00 call at $1.75
Results of the 4/15/2022 contract before rolling
- Option profit: $1.50 per-share
- Stock unrealized profit: $2.00 per-share ($50.00 – $48.00)
- Total profit %: $3.50/$48.00 = 7.29%
Rolling entries into the next contract cycle
- Value of stock at rolling (ITM strike): $50.00
- Net option credit or debit (debit in this hypothetical): -$2.10 + $1.75 = -$0.35
- Investment per-contract: $5000.00 (value of stock x 100)
BCI pre-rolling final results
The final result for the current contract cycle is a cash (partially unrealized) profit of $350.00 or 7.29%. This result is partially unrealized because the shares have not been sold.
BCI rolled-out-and-up trade as a standalone trade (if there was no trade the previous contract cycle)
The $1.75 premium resulted in a 20% guideline of $0.35 and a 10% guideline of $0.18. This does not factor in the value of our shares pre-rolling ($50.00, the ITM strike) and the cost-to-close the current month contract ($2.10).
BCI combined roll-out-and-up trade
Notice that when factoring in the cost-to-close the previous contract short call, the net option premium is actually a negative number, rendering the 20%/10% guidelines not applicable.
Discussion
Establishing our 20%/10% guidelines after rolling an option requires 2 sets of calculations. The first has to do with initial time-value returns which factors in practical value of the underlying at the time of the roll ($50.00 in this hypothetical) and the net option credit or debit (-$0.35, in this hypothetical). The second data set reflects the actual time-value premium received for the rolled-out trade without factoring in the time-value cost-to-close. The post-rolling 20%/10% guidelines are based on the latter contract data, not the combined data ($1.75, in this hypothetical). In this hypothetical, the 20%/10% guidelines are $$0.35 and $0.18.
Author: Alan Ellman