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Should I Unwind My Covered Call?

01/15/2020 9:24 am EST

Focus: OPTIONS

Alan Ellman

President, The Blue Collar Investor Corp.

Alan Ellman breaks down a subscriber’s trade to determine the when is the best time to unwind covered calls.

Covered call writing exit strategies are critical to our overall success. There are times, however, when the best action is no action at all. On July 25, 2019, a subscriber, Rob, shared with me a successful trade he executed and was considering closing one week prior to the Aug. 2, 2019 expiration.

The question of when to exit these trades are critical to our overall trading success. Here is a real-life Example with Alibaba Group (BABA) stock.

For an answer, we need to turn to the “Unwind Now” tab of the Elite version of the Ellman Calculator.
Rob’s trade as of July 25, 2019

  • June 17, 2019: Buy Alibaba (BABA) at $173.54 and sells the Aug. 2 $175.00 call for $2.35
  • On July 25, 2019: BABA is trading at $178, the price of $170.00 call is $4.78

Initial trade setup

covered call writing calculations

BABA: Initial Calculations

Calculation entries to unwind the entire position

covered call writing exit strategies

Calculation results to unwind the entire position

unwind

Discussion

The initial trade structuring shows a potential five-week return of 2.2% (yellow cells). If the trade is closed on July 25, the time-value cost-to-close is 1.02%, almost cutting in half the maximum results Rob is currently enjoying.

The question we ask is can we generate more than 1% more than the time-value cost-to-close by contract expiration. In this case, can we generate more than 2.02% in one week? The answer is probably not, so unwinding does not appear to be in our best interest. Another (better) approach would be to take no action but continue to monitor the trade.

Use the multiple tab of the Ellman Calculator to calculate initial option returns (ROO), upside potential (for out-of-the-money strikes) and downside protection (for in-the-money strikes). The breakeven price point is also calculated. For more information on the PCP strategy and put-selling trade management click here and here.

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