How to Roll A Covered Call? When and Why?

What Does It Mean to “Roll a Covered Call”?

There are a plethora of reasons why a covered call should be rolled. A covered call that was sold initially will be closed out and a new covered call will be sold in its place. This process is known as “rolling.” There are two common methods for rolling a covered call: rolling up and out, or rolling down and out, depending on the situation. We’ll go through each type in further depth below. We’ll start with the rolling up and out method first.

Why Do You Want to Roll a Covered Call?

Consider the following scenario: You purchased the stock at $50 and sold a 30-day $55 call option on it. The call option’s expiration date is three days away. The stock was trading at $60. In the event that the call is assigned, you run the risk of being forced to sell the stock.

Following a close examination of the preceding example, we can see that the stock price rises above the strike price of the covered call contract. However, if you do not wish to sell the shares, you now face a greater chance of being assigned due to the fact that your covered call is now in-the-money. As a result, you might want to consider buying back that covered call in order to prevent being forced to sell the stock. Additionally, you could sell another call with a higher strike price that has a lower chance of being assigned at the same time as well.

Out of the Money AAPL Covered call

Rolling Up and Out the Covered Call Options

This practice of buying to close an existing covered call and selling another covered call on the same stock, but with a higher strike price, is known as “rolling up and out.”

With reference to the scenario described above, here is an illustration of how rolling up and out might take place. You purchased the stock at $50 and then sold a January monthly $55 call option on it. Days have passed, and the call option’s expiration date is three days away. The stock was trading at $60 per share. You did not want to sell the stock because you were extremely confident about the future of the company. You made the decision to roll up and roll out the monthly $55 call from January to the monthly $70 call in February. However, although there is a net cost associated with rolling up and out the options, the end result is a higher maximum profit potential

Use Case

The following summarizes our initial situation:

  • The stock was purchased for $50.
  • The January $55 call was sold for $0.6.
  • The stock’s cost basis is $49.4 ($50 – $0.6).
  • The maximum profit is $5.6 ($55 – $49.4). (Explanation: When the January $55 call option was sold, $55 was the agreed-upon price to sell the stock at. After receiving the January $55 call option premium, the stock’s cost basis was $49.4.)

The stock is currently trading at $60 per share. We’ve decided to keep the stock but to roll up and out the call options. The action of “rolling up and out” is divided into two parts: purchasing to close the January $55 call and selling to open the February $70 call.

  • We repurchased the January $55 call at a price of $5.6.
  • Simultaneously, we sold the February $70 call for $0.8.
  • The stock’s original cost basis is $49.4 ($50 stock purchase price – $0.6 January $55 call sold).
  • The stock’s new cost basis is $54.2 ($49.4 + $5.6 – $0.8). (Explanation: Calculating the new cost basis is as follows: taking the original cost basis and adding $5.6 to it to cover the cost of buying back the January $55 call, less the $0.8 premium collected from the sale of the February $70 call, yields the new cost basis.)
  • The maximum profit is $15.8 ($70 – $54.2). (Explanation: When the February $70 call option was sold, $70 was the agreed-upon price to sell the stock at. The stock’s new cost basis was $54.2.

Analysis

After the “rolling up and out,” we are no longer obligated to sell the shares at $55, as previously stated. Instead, if the stock price is over $70 a share by the call option expiration date in February, we are obligated to sell at $70 a share. As a result, if the February $70 call option is exercised, we will get a $15.00 per share gain in the market price. Our net cost to acquire the $15 increase was $4.80, so it was a win-win situation. We spent $5.6 to purchase back the January $55 call, less the $0.8 premium we received when the February $70 call was sold, for a total cost of $4.8.

Rolling Down and Out the Covered Call Options

It is also possible that the stock price has fallen. If you were hoping to make money by selling calls, you could end up losing money if the stock price continues to fall.

Consider the following scenario: You bought the stock at $50 and then sold a January $55 call option on it. After barely two weeks, the stock had fallen to $40 per share. As a result, you would want to consider buying back the January $55 covered call, whose value has decreased, and selling another call with a lower strike price, such as a February $45 call, which would bring in more option premium and increase the probability of making a net profit on the trade overall. If you do not manage to attain profitability or breakeven, you will at the very least be able to reduce the cost basis of the stock and lessen your loss.

Use Case

Our initial scenario remained the same as in the preceding case.

  • The stock was purchased for $50.
  • The January $55 call was sold for $0.6.
  • The stock’s cost basis is $49.4 ($50 – $0.6).
  • The maximum profit is $5.6 ($55 – $49.4). (Explanation: When the January $55 call option was sold, $55 was the agreed-upon price to sell the stock at. After receiving the January $55 call option premium, the stock’s cost basis was $49.4.)

The stock is currently trading at $40 per share. We’ve decided to keep the stock but to roll down and out the call options. The action of “rolling down and out” is divided into two parts: purchasing to close the January $55 call and selling to open the February $45 call.

  • We repurchased the January $55 call at a price of $0.10.
  • Simultaneously, we sold the February $45 call for $1.
  • The stock’s original cost basis is $49.4 ($50 stock purchase price – $0.6 January $55 call sold).
  • The stock’s new cost basis is $48.5 ($49.4 + $0.10 – $1.00). (Explanation: Calculating the new cost basis is as follows: taking the original cost basis and adding $0.10 to it to cover the cost of buying back the January $55 call, less the $1.00 premium collected from the sale of the February $45 call, yields the new cost basis.)
  • The maximum loss is $3.5 ($45 – $48.50). (Explanation: When the February $45 call option was sold, $45 was the agreed-upon price to sell the stock at. The stock’s new cost basis was $48.50.

Analysis

After the “rolling down and out,” we are no longer obligated to sell the shares at $55, as previously stated. Instead, if the stock price is over $45 a share by the call option expiration date in February, we are obligated to sell at $45 a share. As a result, if the February $45 call option is exercised, we would suffer a loss in the market price since the cost basis stays greater than the $45 strike price. However, by decreasing the strike price from $55 to $45, we were able to earn a credit of $0.90. We spent $0.10 to buy back the January $55 call, minus the $1.00 premium we received when the February $45 call was sold, for a total credit of $0.90.

Despite the fact that the outcome of our rolling down and out approach was less than ideal in our preceding example, the process may be repeated every month. The repeating of the process has the potential to lower the cost basis of the stock even more. We may be able to turn losses into profits or break even in the end.

Use Case

Let’s take our last hypothetical case one step further. We continue to own the stock and have sold a February $45 call option on it. The stock is presently trading at $44 a share, one week before the expiration of the February option contracts. We’ve opted to retain the stock but only roll out the call options. The process of “rolling out” is simply the act of purchasing to close the February $45 call and selling to open the March $45 call. In other words, we are gaining additional time while maintaining the same strike price.

  • We repurchased the February $45 call at a price of $0.10.
  • Simultaneously, we sold the March $45 call for $1.
  • The stock’s last cost basis is $48.5.
  • The stock’s new cost basis is $47.6 ($48.5 + $0.10 – $1.00). (Explanation: In order to calculate the new cost basis, start with the original cost basis and add $0.10 to it to cover the expense of buying back the February $45 call. Then subtract the $1.00 premium received from the selling of the March $45 call to get the new cost basis.)
  • The maximum loss is $2.6 ($45 – $47.6). (Explanation: When the March $45 call option was sold, $45 was the agreed-upon price to sell the stock at. The stock’s new cost basis was $47.60.

Analysis

Despite the fact that the outcome of our rolling out technique was less than ideal in our preceding example, we were able to reduce the cost basis by an additional $0.90 per share. The repetition of the process has the potential to cut the cost basis of the stock even more in the future. After all is said and done, we may be able to transform losses into profits or break even. When we are trapped in a downtrending market or a market with no discernible direction, patience is essential.

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