Should I Allow Exercise & Repurchase the Stock or Roll the Option?: A Real-Life Example with Tesla, Inc. (Nasdaq: TSLA) – June 26, 2023
The crafting and managing of our covered call writing trades are directly dependent on our pre-defined goals. In this article, we will analyze a TSLA covered call trade where the strike was about to expire in-the-money (ITM) and exercise was inevitable if no action is taken. This trade was shared with me by a BCI member.
Trade information
- TSLA is viewed as a long-term buy-and-hold with a bullish assumption moving forward
- TSLA was purchased at the end of September 2021 at a basis of $270.00 per-share (#1 in chart below)
- 1/9/2023: TSLA trading a $119.77 (#2)
- 1/9/2023: Sell 1 x 1/27/2023 $160.00 call (#2)
- 1/25/2023: TSLA reports favorable earnings (#3)
- 1/27/2023: TSLA moves up to $177.90, leaving the $160.00 strike deep ITM (#4)
- Should the option be rolled or allow exercise and re-purchase on Monday?
TSLA 6-month price chart
Trade analysis
When writing covered calls on shares we intend to hold for the long term, the strategy approach is known as portfolio overwriting, where we use only deep out-of-the-money strikes to avoid exercise. That was properly structured in this case, with shares trading at $119.77 and the strike of $160.00 with a 2-week expiration.
However, the BCI earnings report rule was breached, with contract expiration occurring after the ER date. The favorable report caused share price to accelerate well past the $160.00 strike. Now what? Do we roll or allow exercise and re-purchase the shares on the Monday after expiration Friday?
To roll or not to roll
It is true, that if we roll the option, we are paying a miniscule time-value price (pennies) to buy-to-close the near-term option. However, if we allow assignment, we are exposing ourselves to weekend risk. If share price moves much higher by Monday, we lose. Of course, the opposite also holds true, but do we want to take the chance?
The elephant in the room
This dilemma was caused by writing a covered call through an earnings report. As an alternative, a 1/20/2023 weekly call could have been written with no covered call in place for the 1/27/2023 expiration date. After the week of the ER, calls could have been written at the new basis ($180.00 range).
Discussion
Before entering and managing our trades, we must identify our goals. We always avoid earnings reports. If we are portfolio overwriting, we only use deep OTM strikes and, if faced with exercise of ITM strikes at expiration, rolling the options will avoid weekend risk.
Author Allen Ellman