Saving a Broken Covered Call by Rolling Up and Out

2023-05-13

I just recently discovered the magic of rolling losing options positions to handle unexpected market movements.  Prior, when I sold a covered call, I felt at the mercy of the underlying’s price to decide whether I’d get assigned on a losing position.  Rolling positions allows me to seemingly have my cake and eat it too.  This is particularly useful when trading securities that can trade multiple times a week.

Specifically, imagine you have a SPY covered call with a strike price of $410, expiring on May 15, 2023.  SPY is currently trading at $411.59.  There’s a good chance you will have your shares assigned at the end of May 15…  If this is your intention, that’s great.  You keep your premium, you get some cash for your shares, and you lose out on a little bit of capital gains from SPY’s upward movement (assuming you sold the covered call below $410).

But there exist other options where you can keep your shares and make money keeping them:

  • Roll out - If you want to keep your shares and make some money to boot, then roll this option into the future.  In the example below, the May 16 410 strike call option is trading at about $2.53.  So, you can buy out your May 15 position for about $2.02 and sell the May 16 option for $2.53, making about $0.51 in the process.  You have a chance of keeping your options and pocketing some more premium if SPY goes below $410.

  • Roll up and out - If you are willing to take less premium and increase the probability of keeping your shares, you can look for a call that has a higher premium and a higher strike price.  This generally requires looking at prices further in the future.  In the example below, on May 17, there is a call option that costs about $2.30 that has a strike of $411, but the net premium will be only $2.30 - $2.02 = $0.28.  For the lower premium and the longer time to expiration, we get the following two benefits:
    • Lower probability of losing our underlying shares.  While the delta is still 0.5087 on this option, SPY does not, on average, increase by $1 in share price per two days (otherwise, S&P’s annual lift would be 40%).  Being able to increase the strike by $1 every 2 days will eventually make the option OTM.
    • In the event of assignment, we yield $1 more per share due to the higher strike.

Finally, rolling calls as opposed to letting them get assigned, allows you to make more trades.  An assignment would require the typical two day waiting period for the transaction to close, reducing the number of opportunities to make money.

Note that it only works reasonably well if your option is not too far ITM.  Options that are very ITM will require longer trading expiration dates to find substitute options to roll to for positive premium.  Imagine if you had a $407 strike expiring on May 15.  In this case, you could buy to close at $4.31 and then sell to open on May 17 at a $408 strike , but for only a $2 net premium ($4.33 - $4.31).

This approach will allow you to make more aggressive options trading decisions at the cost of a possibly slow rolling up and out process to get back OTM.  SPY’s multiple trading days per week allows quick moves to recover broken options positions.

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