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A covered call investor's most painful experience is watching a company's share price soar far beyond the strike price of a call that the investor has sold short.

The investor stands by helplessly, as every penny of share price appreciation falls off the table and into the grubby paws of the option buyer (I realize that's a harsh assessment; rest assured that we option sellers are much more charitable towards longs when they are on the wrong side of a trade.) A kind of death watch sets in, as the investor morbidly counts the days until option expiration, praying for early assignment to put you out of your misery.

It is the investing equivalent of root canal, but without the anesthesia: You just can't wait till it's over.

But cheer up - here's a technique you can deploy to transform your root canal-like agony to Shiatsu-like bliss:

1. Determine the cost to close the call.

2. Determine the 'lost upside' you will recoup if you sell the shares, by subtracting the strike price from the current market price.

3. Subtract 1. from 2. to determine your net cost for two trades.

4. Determine the trading costs you will incur by executing the two trades.

5. Subtract 3. and 4. from the cumulative income you will earn (from share appreciation and option premium) if you hold the shares until option expiration.

6. Calculate the new annualized yield on the covered call, taking into consideration your additional costs (items 3. and 4.) and the accelerated expiration date (i.e. the day on which you close the position).

Depending on the degree of time decay, and the delta between strike price and market price, you might actually increase your annualized yield, even though the two trades will result in a net debit. You will liberate your money for reinvestment into another opportunity.

Two Examples

Here are two real-life examples that illustrate this technique. One is from my portfolio, and the other from my brother-in-law Ian's. (From the examples you'll be able to infer which of us is the retired physician, and which majored in humanities.)

On January 20,2013, Ian purchased 500 shares of the electric car maker Apple (AAPL) for a split-adjusted price of $69 per share. Over the next year and a half, he sold or rolled calls on those shares seven times. The seventh call was a $95 option expiring April 17, 2015, which he sold in July 2014.

As AAPL's share price headed north of $95, Ian's demeanor drifted south. By nature sunny and free-spirited, he grew morose and sullen, directly in proportion to AAPL's price appreciation. He loved those AAPL shares, and could feel them slipping away. As AAPL moved inexorably upward -- past $100, $110, and $120 -- his despair deepened. When he traded in his iPhone for a Samsung Galaxy, he knew he had hit rock bottom.

On February 19, with AAPL trading over $128, Ian pulled himself together and made his move. He:

- Closed his call for $33.90, and

- Immediately sold his shares for $128.74.

The net cost of these two trades was $.16 per share: $33.90 minus $33.74 in recouped "lost upside" (i.e. the difference between $128.74 and the $95 strike price, money that otherwise would have been forfeited).
By accelerating option expiration (from April 17 to February 19), he increased his cumulative annualized yield from 20.28% to 21.68%.

Moreover, he freed up about $47,400 for immediate reinvestment!

The example from my portfolio involves 100 shares of Valero (VLO), which I purchased in June 2014 for $51.27 per share. I sold or rolled calls on those shares three times, with the last call expiring March 20, 2015 with a $52.50 strike price.

With VLO selling at over $60 on February 19 I decided to exit this position.

I closed the call for $8.15 and immediately sold the shares for $60.40, or $7.90 above my strike price, thus costing me $.25 per share ($8.15 - $7.90). By accelerating option expiration from March 20 to February 19, I increased my cumulative annualized yield from 15.5% to 16.19% (even with the additional $.25 per share cost) and freed up $5,200 for immediate reinvestment.

Assessing the Impact

The ultimate impact of this maneuver on your portfolio depends on how you deploy the proceeds of closing a position. There are three possible scenarios:

1. Don't reinvest. If you choose to keep the money on the sidelines rather than reinvest, you will be the same position that you would have been in had you let the option expire, less what you paid to close the position. You'll take a very small loss, but will have invalidated the reason for closing the position in the first place.

2. Reinvest profitably - good job.

3. Reinvest at a loss - you'll wish you had let the position expire.
It's treacherous out there - be careful!
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Thanks. I needed that. I'm in this position right now, and trying to decide what to do.

I own 100 shares of NXPI, bought at 83, and covered it with a $90 March call. An unexpected merger shot the stock price to nearly 100 overnight (now 98.58).

The call expires next week, and I've been trying to figure out the best course of action. I still want to own the stock. My calculation, in which I have little confidence, had me making out a little better buying back the call once the time value is all gone, rather than letting it be assigned (and then buying back the stock).

But I'm going to apply your thanks!

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D -

So glad I could help! Would love to know how you make out. Good luck!

David J
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The thing I'm having trouble getting my head around is the unrealized gain I get from buying back the option. It looks like I'm going to have to pay something like $800 to close that position, but then I own all of the stock appreciation from my $83 purchase price. - which is about an additional $800 dollars (90 strike on the option).

I can also, sell another call to defray the cost, and put myself right back into this position! (hopefully not ;-),
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A covered call investor's most painful experience is watching a company's share price soar far beyond the strike price of a call that the investor has sold short.

I experience regret, but not pain. Any time the stock price ends up above the strike price of my covered call, I've achieved my maximum gain. My original goal was met.

Pain is when the price of the stock DROPS far beyond the strike price of the call less the extrinsic value you earned on the call.

This is the same regret you feel when selling the stock before a big jump, and the same pain you feel while holding a stock during a big drop.

Just a variation on the theme.
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Can you let me know the following:

Share price paid
Date you purchased the shares
Option strike
Option premium earned
Option expiration

One contract, right?

Have you closed the position yet?

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Well said.

You're right, loss is absolutely more painful than lost upside.
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I'll take that pain any day. I tend to do LEAPS and if it blows through the strike in a few months all the better.

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The timing could not have been worse. By the time of expiration, the stock had climbed to 107 and it was just too pricey to buy back the option. Plus, I had the suspicion that the price would ease off after a fast climb. So I just let the contract assign and the shares were called away at 90, giving me a profit of just under $1000 (and a "lost profit" of about $1700). Which is painful, but as pointed out, not as painful as an actual loss.

My hunch has played out - as the stock has now dropped to $100. If it had been at 100 4 days earlier, I might have employed your strategy. But now I have the money in my account and I want to get back in.

I'm thinking not buy the stock this time, but rather set up a diagonal or maybe a synthetic long. Any thoughts?
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Nice haul on the $1k (and regarding the lost $1,700.... my philosophy with this trades has always been, and will always be: Think forward & don't look back. Otherwise you can make yourself nuts with regret.)

Timing is everything with the 'cure for root canal' maneuver. It must be done far in enough in advance of expiration to move the dial on annualized yield (which is the main criterion I use to assess trades). The approx. sweet spot parameters are: Minimum 3 weeks prior to expiration, when stock is trading 10%+ over strike.

I don't buy calls, and the only spreads I'll do (very infrequently) are bull call spreads, so I'm not able to advise on the trades you are contemplating. Just not for me.
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