Calculating 2-Month Returns When Rolling Out and Up

07/15/2014 8:00 am EST

Focus: OPTIONS

Alan Ellman

President, The Blue Collar Investor Corp.

Using the recent successful covered call writing trade of one of his members as an example, Alan Ellman of TheBlueCollarInvestor.com demonstrates how options calculations can give an accurate assessment of profits.

Options calculations will give us an accurate assessment of our covered call writing profits. It's more meaningful to use percentages rather than dollar amounts when executing these calculations. For example, a $1000.00 profit on a $10,000 investment (10%) is much more significant than a $1000 return on a $100,000 investment (1%). That's why percentages form the foundation for both versions of the Ellman Calculator (Basic and Elite).

A few months ago, one of our members, Jonathan, shared with me one of his successful covered call writing trades and inquired about percentage returns month-to-month. In this article, I will breakdown that trade and use the Ellman Calculator to demonstrate the second leg of the trade where Jon rolled out and up:

The trade in 100 share format

  • 2/10/14: Buy 100 x AGN @ $120.36
  • 2/10/14: Sell 1 x Feb. $120 call @ $2.52
  • 2/21/14: Share value = $125.59
  • 2/21/14: Buy back Feb $120 call @ $6.20
  • 2/21/14: Roll out and up to the March $125 call @ $4.10
  • 3/21/14: Option expires in-the-money and shares are sold for $125

The calculations

You will note that the trade was established mid-February contract. Here are the final returns from the first 12 days of the trade as shown in the multiple tab of the Ellman calculator:

chart
Click to Enlarge

Jon achieved a very nice short-term return (1.8% in 12 days) and then decided to roll out (next month) and up (higher strike price). For this computation we use the what now tab of the Ellman Calculator and, first, fill in the blue cells on the left:

chart
Click to Enlarge

The option was bought back @ $6.20 and the next month's higher strike was sold for $4.10. The key point here is that our cost basis is now $120, not $120.36 or $125.59. The reason is that we are deciding whether to roll the option or allow assignment we must compare apples-to-apples. If we permit assignment we will receive $120/share as per our initial option obligation. If we roll the option, our cost basis must be the same so we can decide which approach is in our best interest. Once the blue cells on the left side of this tab are filled in as shown above, the white cells on the right side become populated with results:

chart
Click to Enlarge

Once the shares were sold as a result of option exercise on March 21, 2014, a 2.42%, 1-month return was realized and Jon had $12,500/contract in cash to use the following week for the April contracts.

2-month final returns

In reality, this is a six-week return because the trade was initiated mid-contract in February:
1.8% + 2.42% = 4.22% = 36.6% annualized.

Summary

Although calculations can be challenging for many of us, using percentages and the Ellman Calculator will make our covered call writing decisions more meaningful and help elevate our returns to the highest possible levels.

By Alan Ellman of TheBlueCollarInvestor.com

Related Articles on OPTIONS