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Rolling Up and Out on Covered Calls

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One of the most popular options strategies for conservative equity investors is selling covered calls. Selling calls on a one to one ratio with shares you already own is a great way to earn extra income on a stock that seems to be trading in a predictable range, and if the stock rallies through the strike of the calls that you’ve sold before they expire and the stock is called away, not only have you sold it at a profit, you also collected the premium on the calls, adding to your profits.

But what if you didn’t really want to sell the shares?

You can do what professional traders do and roll the calls “up and out.”

Here’s an example:

In May of 2018, you recognized that Apple (AAPL - Free Report) was trading in a tight range between $190 and $200/share. You, as the owner of 500 shares, decided to make a little bit of extra income on that holding during what was looking to be a relatively uneventful summer season, so you sold 5 calls that expire on September 21st with a strike of 225 and you collect $3/each in premium for a total credit of $1500.

For most of the summer, this looked like an extremely sensible trade as AAPL stayed in that tight range and traded at extremely low volatility, bouncing back and forth between $185/share and $195/share, without ever threatening a serious breakout in either direction.

Here is the risk profile for the trade back in May:

The calls you sold were decaying in value every day and it looked like you would collect the entire premium.

Then, on August 1st, APPL did break out to the upside, rallying more than $10/share in a single day and becoming the first U.S. stock with a trillion-dollar market capitalization. The rally has continued ever since and AAPL shares closed at $222.98 on Wednesday.

The calls you sold still have 22 days until expiration and $225/share certainly seems within reach, in which case you’d be selling the 500 shares at $225. Considering the stock was trading at $190 in May when you executed the option sale, this will still have been a very successful trade. You will have made $35 – or 18% in four months - on the stock, plus an additional $1500 in option premium.

Not too bad, right?

Except it’s possible that the recent rally has shown you that AAPL shares still have the legs to run. After all, it’s a Zacks Rank #2 (BUY), they’ve been consistently growing earnings at a double-digit rate, there have been 10 upward earnings estimate revisions in the last 30 days and the 2018/2019 iPhone upgrade cycle looks much more promising than last year’s, with several new features promised at a variety of price-points lower than the eye-popping $1000 level of last year's iPhone X.

Maybe you’re not ready to give up on AAPL yet, even though you’ve had an impressive recent gain.

Roll the September calls up and out.

In a single spread trade, you’ll buy back the SEP 225 calls and simultaneously sell the January 250 calls.

The closing prices on Wednesday were:

 

                                           Bid                          Offer

SEP18 225 Call                  $3.15                     $3.20

JAN19 250 Call                   $3.15                     $3.25

Because you’d be entering the order as a spread, you can most likely execute the trade inside the bid/ask spread for “even” – meaning no credit or debit.

Here is the risk profile of the updated position today:

You'll notice it's basically the same as the previous risk profile, except shifted to the right (a higher underling price).

You’d then have basically the same position as you had when you started, you’d still own the shares and you’d be short 5 calls against it with a little over 4 months left until expiration – which is before the expected earnings announcement which will be at the end of January or the beginning of February.

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