Have Multiple Exit Strategies

03/26/2013 8:00 am EST

Focus: OPTIONS

Alan Ellman

President, The Blue Collar Investor Corp.

Using your arsenal of exit strategies will elevate your profits from decent to fabulous returns, writes Alan Ellman of TheBlueCollarInvestor.com.

Covered call writers can be good at what they do or great at it. They can generate decent returns or the highest possible returns. One of the mission statements of The Blue Collar Investor is to assist each other in achieving the greatest levels of success. The implementation of exit strategies when indicated is critical to this end.

Most covered call writers buy the stock, sell the option, and then hope for the best. Not us! I once wrote an article highlighting the “mid-contract unwind” exit strategy where a covered call position is closed when the stock price rises and the time value of the option premium approaches zero (trades near “parity”). I referenced a trade I executed in one of my covered call portfolios (commissions not included):

February 21:
Buy 300 x TPX @ $73.73 = $22,119

Sell 3 x March $70 calls @ $5.82

ROO (time value or profit) = $5.82 – $3.73 = $2.09 = 3% = $627

Intrinsic value of premium ($3.73) is used to “buy down” the cost basis from $73.73 to $70 (strike price) = $21,000

February 24:
With TPX trading @ $78.05 and the March $70 call trading near parity @ $8.40, I executed the mid-contract unwind exit strategy:

Buy-to-close 3 x March $70 calls @ $8.40 = $2520

Additional value of shares by closing option = $78.05 – $70 = $8.05 x 300 = 2415

Cost to close = $0.35 ($8.40 – $8.05) x 300 = (-) $105

Sell 300 x TPX @ $78.05 = $23,415

Cash generated from stock sale: $23,415

Next, I will show you the steps I took after unwinding the original TPX trade.

February 24th:
I checked the stocks on my premium watch list

Buy 400 x RAX @ $53.42 = $21,368 (slightly less than my original investment of $22,119; slightly higher than the “bought down” cost basis of $21,000)

Sell 4 x March $55 calls @ $1.10 = 2% = $440

Deducting the $105 from the $440 my additional income for utilizing this exit strategy is $335.

Thus far I executed the mid-contract unwind exit strategy generating an additional $335 or 1.6% into my account. I also generated unrealized profit from the share appreciation of RAX from $53.42 to the strike sold ($55) = $1.58 x 400 = $632. Here is the one-month realized and unrealized profit to date (see bold figures):

$627 + $335 + $632 = $1594

1-month return = $1594/$22,119 = 7.2%

Let’s now move forward to the day I wrote this article, the day prior to expiration Friday.

March 15: Rolling out exit strategy:
RAX trading @ $56.55

Buy-to-close 4 x March $55 calls @ $1.70

Sell-to-open 4 x April $55 calls @ $3.45

Initial profit = $3.45 – $1.70 = $1.75 x 400 = $700

This represents a 3.2%, one-month return with 2.7% downside protection of that profit

Once I executed this rolling out exit strategy, I went from attack mode (aka generating cash!) to management mode where I look for exit strategy opportunities.

Conclusion:
Using our arsenal of exit strategies will elevate our profits from decent to fabulous returns. It’s one of the critical factors that make Blue Collar Investors different from all the others. Not all trades work to perfection like the ones above, but many do. In either case, being prepared to implement exit strategies will absolutely increase our bottom line results even if it is simply mitigating losses. There will always be some losses but our objective is to have many more winning trades than losing ones. In this article, I demonstrated the use of the “mid-contract unwind” and “rolling out” exit strategies that resulted in a two-month return of 10.4% as long as RAX did not decline below $55. If it did, I was prepared to act.

By Alan Ellman of TheBlueCollarInvestor.com

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