Exit strategy execution for covered-call writing and put-selling is the third required skill needed to achieve the highest returns (stock and option selection are the other two), explains Alan Ellman of The Blue Collar Investor.
Knowing how and when to implement these position-management trades will have a major impact on our ultimate success. In July 2020, Clark sent me a series of trades he executed with MGM Resorts International (MGM) where several exit-strategy maneuvers were utilized. This article will analyze this series of trades.
Clark’s MGM Trades from 6/8/2020 Through 6/21/2020
- 6/8/2020: Buy 100 x MGM at $23.18
- 6/8/2020: Sell 1 x July 17, 2020 $26.00 call for $1.54
- 6/12/2020: Buy-to-close (BTC) the $26.00 call for $0.54
- 6/12/2020: Sell-to-open (STO) the July 17,2020 $19.00 call for $2.38 (rolling-down)
- 6/21/2020: MGM trading at $17.17
Let’s break down these trades into four categories:
- Initial structuring
- BTC trade
- STO trade
- Exit strategy execution after the STO rolling-down exit strategy
MGM Initial Calculations
Using the multiple tab of the Ellman Calculator, we see that the initial trade structuring resulted in an initial time-value return of 6.6% with an additional 12.2% upside potential, a possible 18.8% five-week return. This reflects a tempting, but highly risky trade. We should only enter trades that align with our personal-risk tolerance. My initial time-value return goal range is 2%-4%, which usually results in a similar upside potential for OTM strikes. No right or wrong here but we must define our goals and risk tolerance prior to entering our trades.
The BTC price point was at 35% of the original premium. In our BCI methodology, we prefer closer to 20% in the first half of a monthly contract. On 6/21/2020, the $26.00 call could have been closed at $0.10.
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The STO of the $19.00 call locked in a trade loss of $80.00 per contract (calculating share loss and option credit) if MGM closes at or above $19.00. We are still early in the contract, so after closing the short call, we can wait another week to see if share price recovers and perhaps create an opportunity to hit a double.
Exit Strategy Execution After the STO Rolling-Down Trade
At this point, we set a BTC limit order at $0.45 for the $19.00 short call and manage moving forward. What’s done is done and we must focus on the positives moving forward.
There are two positives here, as I see it:
1. Clark was focused on managing the trades, which gives us a huge advantage over those who do not.
2. We have experienced a trade that is instructive on many levels and the lessons learned will put cash in our pocket in the future. This is precisely how I learned more than 20 years ago.
Learn more about Alan Ellman on the Blue Collar Investor Website.