When Rolling Up and Out Can Go Wrong

*** August 29, 2023 Update ***

Looking over SPY prices over the last month...  the price of SPY bottomed out on August 17-18 to close under 437 both days!  And these were the lowest prices over the last 30 days!  So, if I would have held onto my June 14 covered calls, I would have been OTM for the exact expiration date!  Ugh!



Introduction

So, my MO in options trading has been to sell covered calls and roll them up and out if there’s a risk they will be assigned.  (I don’t want to lose the shares and do “the wheel” because I don’t want to wait until the transaction closes to keep trading.)


This has generally worked well.  However, recently, I was stuck having to pay over $10 / share of SPY to keep from being assigned…


What happened?  I’ve been generally selling one and two days until expiration covered calls on SPY to take advantage of the huge thetas near expiration.  I usually have a delta of no more than 20% and when I do roll, I try to


  1. Make net positive premium on the transaction and

  2. Increase the strike price


Well, in the two weeks from May 26 to June 9, SPY’s price increased from 415 to 437:  5% in 2 weeks!  (I don’t remember why, but it almost certainly was due to inflation numbers.)


In the plot below, I was pretty deep in the money during my June 2 trade (424 strike with a 428.08 underlying price, 7 days to expiration, delta = 77%).  The premium was $5.39, which paid off my prior options with a net $0.10 profit.



Unfortunately, SPY’s price kept increasing and I got deeper into the money with this position.


  • On June 6, SPY was at 428.16, so I rolled up and out for a 10 DTE

  • On June 9, SPY was at 430.71, so I rolled up and out for a 50 DTE

  • On June 14, SPY was at 437.97, so I rolled up and out for a 66 DTE


On June 22, I surrendered when SPY was at 436 and my strike was at 438.  I figured

  • I made enough capital gains
  • That this level of SPY would persist and would go beyond 438 by the August 18 expiration
  • I wanted to get back into generating cash flow
  • I didn’t want to stress about options trading and realized that capital gains are good, too.

In summary, from May 25 - June 22:


  • I lost 6.98 per share in premium

  • SPY went up about $21


So my net gain was about $14 per share for the month…  Today, SPY is trading at about $445 (and peaked at about $460 at one point), so there would have been no reversion to the mean 6 weeks later…


Lessons Learned

What could I have done to stop the bleeding?


  • Buy a call a little beyond the covered call?  In other words create a credit spread [1]?

  • Have a stop-loss policy?  Like the 20%/10% rule from [2]? Equivalently, I can say no to rolling up and out too far into the future...

  • Not trade around the time of major announcements? But I may also miss high volatility opportunities...


I’ll have to look into these and see how often they would trigger given my current and future approach to trading.

References

  1. https://www.investopedia.com/terms/c/creditspread.asp
  1. https://www.thebluecollarinvestor.com/setting-stop-loss-orders-for-covered-call-writing/

Comments

  1. xAugust 14, 2023 at 11:39 AM

    Good write up. This is an interesting challenge and a good illustration of the downsides of rolling the call up and out. I'd be interested in seeing a table showing more detail on your trades during this time. What were the strikes, premiums, DTE, and dates of Trades?

    ReplyDelete
  2. xAugust 14, 2023 at 11:42 AM

    It would also be interesting to back test this strategy and see the breakdown of premium and capital gains for this strategy, versus the capital gains of a Buy and Hold strategy on SPY

    ReplyDelete

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