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Rolling Covered Calls - Options Mastery Series Lesson 40

Filed Under Options Mastery Series 

Rolling Covered Calls
 
Writing covered calls has become a popular way for more conservative investors to make use of stock options. As a matter of fact, even retail brokerages like the strategy. This says volumes because most brokerages usually try to keep the average investor away from stock options. This is due to the fact that stock options are more complex than stocks and most brokers don’t have the training in options. 
 
As you already know, a covered call is long stock and short call. You sell the options, collect premiums and if the stock doesn’t move much and the option stays out-of-the- money, you keep the collected premiums from selling the calls at expiration. If the stock stays stagnant, you can repeat this process over and over again. But what happens if the stock moves into-the-money?
 
If the short call goes into the money, the chance increases that the call option will be exercised. Moreover, it becomes more expensive to buy out of the position (buying back the short call). As a result, you consider “rolling” the position if it appears that the stock isn’t making a second or third standard deviation type move. “Rolling up” involves buying back this month’s option and selling the call for the next strike up in the next month.
 
Keep in mind that the stock you hold as part of the covered call position has also appreciated in value and this will usually more than offset the costs of closing out the short option position. Of course, when you roll up and sell the new call, you collect the premiums again. If the stock keeps moving up, you can also keep rolling up. So, even though premium collection is mainly for range bound, stagnant stocks, you can also roll up as the stock moves up. OK, but what happens if the stock starts trading down?
 
When the stock moves down, we don’t roll the position. Why is that? In a covered call strategy, you get out of the call. The covered call strategy no longer applies. If the stock looks like it’s breaking down, you could then buy puts if you intend on keeping the long stock.
 
As a matter of fact, you can close out the short call by purchasing the corresponding put. (The corresponding put is the put opposite the call-same strike and month). However, if you plan on keeping the stock, just buy two corresponding puts and you will end up with long a put. Of course, you are in a one-to-one ratio with the stock and options. So, if you were long 500 stocks you would have 5 long puts. When you “morph” a position it is also called a continuation strategy.
 
As Ron Ianieri, stock option guru and founder of the Options University states: “I might roll up strikes as the stock is going in my direction but when the stock stops going in my direction and heads the other way, it’s time to close out unless I have the wits about me to say that the reason I’m closing this position is the stock broke its up trend. It can’t be that it’s just trading down just a bit. It has to be a technical break like when that stock moves below the 50 day moving average and then follow through the next day down further.
 
I can close out my buy write with the purchase of the first corresponding put, but I can actually get short by buying a second corresponding put and then play the downward movement; that’s called a morph and completely changes the position with just one little trade. I went from being in the wrong covered call position with a stock that’s broken its up trend and has now broken its up trend and is breaking down.
 

For information, online classes, mentoring and all things stock option, contact the Options University at www.optionsuniversity.com

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