How to Roll a Covered Call: 4 Successful Strategies

Introduction

Are you looking to navigate the intricate landscape of stock market strategies with finesse? Covered call options might just be the beacon guiding you through this dynamic terrain. In this article, we delve into the world of covered calls, a versatile financial instrument that can potentially elevate your investment portfolio. Unveiling the power of rolling covered calls and deciphering optimal strategies, we equip you with the knowledge to make informed choices in this complex yet rewarding realm of investment. So, fasten your seatbelt as we embark on this enlightening journey into the art of strategic investing with covered calls.

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Whether to roll a covered call option depends on your stock expectations.

• It may be preferable to close a position if a call is very much in-the-money and begin a new covered call position in a later month, when you will have more time to react to changes in the market.
• Rolling a covered call is a good strategy to use if you think the stock’s recent rise is likely to be short-lived. If you don’t think the stock will go up much but you want to hold on to it anyhow, rolling covered calls can buy you some time and wait for the stock price to drop.

Rolling a covered call position is a great way to avoid selling your shares in general, but the approach has benefits as well as drawbacks. In general, you should think about rolling a covered call if you think the stock’s rise was only temporary.

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When and Why Roll a Covered Call?

Imagine you’ve sold a covered call, and the stock price surges. You’re at a crossroads. Should you wait and potentially lose your shares, or roll the call and adapt your strategy? Rolling a covered call involves buying back the current call and selling another with a later expiration or a different strike price. It’s a strategic move to prolong your potential gains or reduce potential losses.

Do you know the optimal timing for rolling covered calls? Determining the best time to roll covered calls involves comprehending market dynamics, keeping a close eye on options, establishing reasonable profit expectations, and considering the risk-reward ratio.

Rolling covered calls is a strategy aimed at mitigating stock market risks and enhancing potential returns. Here’s what you need to consider:

1. Begin by selecting a suitable expiration date and strike price.
2. Monitor your stock’s performance and make adjustments strategically.
3. Evaluate the potential rewards and associated risks.

Several scenarios commonly trigger the consideration of rolling covered calls:

• When the option is nearing its expiration.
• When there’s a decline in the implied volatility of the underlying stock or index.
• When you anticipate a price increase but prefer not to prematurely exercise the option and potentially miss out on profits.

Rolling covered calls demands a prudent approach. Let’s delve into the examples below to illustrate this strategy.

1. Deep In-The-Money Play

Our venture began with the acquisition of American Express shares at $150 each on January 19, 2023. Shortly after, we executed a covered call, setting a $165 strike price, expiring on February 17, 2023. Fast forward to February 13, 2023, and American Express stock was commanding a price of $180. With merely four trading days remaining until the call option expires, a crucial decision looms—whether to retain ownership of the stock or seize the profit. Given the call option is already $15 in the money and considering the typically stable nature of American Express stock, the prudent move would be to sell our shares and secure the accrued profit.”

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2. Slightly In-The-Money Play

We initiated this venture by acquiring Tesla shares at a price of $129 each on January 17, 2023. Shortly thereafter, we executed a covered call with a strike price of $190, set to expire on February 17, 2023. Fast forward to February 16, 2023, and Tesla was trading at an impressive $204 per share. With just one trading day left until the call option expires, a pivotal decision looms—whether to retain ownership of the stock or explore an alternative strategy. Notably, a $14 in-the-money call option isn’t substantially deep considering Tesla’s higher-than-average volatility.

There are several strategic pathways we could embark upon:

1. Let the Stock Be Called Away:
   Allow the stock to be called away, providing a clean slate for potential future investments.
2. Opt for a Call Roll Strategy:
   If we anticipate the stock price retracing or consolidating around $190 by March 17th, we could opt to repurchase the expiring February 17, 2023 call and sell a new covered call with a $190 strike price, set to expire on March 17, 2023. This option aligns with the remarkable price surge the stock has experienced, catapulting from below $120 to well beyond $200.”

Understanding the Strategy of Rolling Covered Calls

Rolling a covered call means closing out a previously sold covered call and selling a new one. Depending on the situation, there are two ways to roll a covered call: up-and-out or down-and-out. We’ll go through each type in detail below. We’ll start with the “roll up and out” approach.

Rolling Up and Out: Expanding Covered Call Options

In the realm of covered call strategies, a tactical move involves closing an existing covered call position and simultaneously initiating a new covered call on the same stock. This new call typically has a later expiration date and a higher strike price, a practice often dubbed as ‘rolling up and out.’

To illustrate this strategy with reference to the preceding scenario, consider this hypothetical scenario:

You initially acquired the stock at $50 per share and subsequently sold a $55 call option set to expire in 30 days. As time progressed, the expiration date of the call option drew closer, with only three days left. At this juncture, the stock’s market value had surged to $60 per share. Given your strong confidence in the company’s future, you chose not to sell the stock.

In light of this, you made the strategic decision to execute a ‘roll up and out.’ Specifically, you opted to replace the expiring $55 call with a new $70 call, extending the expiration date. Importantly, this maneuver may involve a ‘net cost’; however, the ultimate outcome is an augmented maximum profit potential.”

Example – Roll a Covered Call Up and Out

Summary of Strategic Moves: Rolling Up and Out Covered Calls

1. Initial Situation:
   • Stock purchased at $50 per share.
   • Sold a $55 call expiring in 30 days for $0.6 premium.
   • Stock’s cost basis: $49.4 ($50 – $0.6).
   • Maximum profit: $5.6 ($55 – $49.4).
2. Current Stock Situation:
   • Stock now trading at $60 per share.
   • Decision: Keeping the stock and executing a ‘roll up and out’ strategy.
3. Rolling Up and Out Actions:
   • Bought back expiring $55 call for $5.6.
   • Sold new $70 call with a later expiration for $0.8.
4. Resultant Cost Basis:
   • Original cost basis: $49.4.
   • New cost basis: $54.2 ($49.4 + $5.6 – $0.8).
5. Updated Maximum Profit:
   • Maximum potential profit: $15.8 ($70 – $54.2).

Explanation for New Cost Basis: Adjusted cost basis calculated by adding the cost of buying back the January $55 call ($5.6) and subtracting the premium from selling the February $70 call ($0.8) from the original cost basis. The resulting $54.2 is the new cost basis after the ‘roll up and out’ strategy.

Rolling Down and Out: Adjusting Covered Call Options When Stock Prices Fall

When the stock price declines, a strategy to mitigate potential losses from a covered call position involves adapting the call options. Here’s an example to illustrate this scenario:

1. Initial Scenario:
   • Purchased the stock at $50 per share.
   • Sold a $55 call option.
2. Stock Price Drops:
   • Stock price falls to $40 per share within two weeks.
3. Adjusting the Strategy:
   • Consider buying back the $55 covered call.
   • Sell a new call with a lower strike price, like a $45 call, with a later expiration date.
4. Objective:
   • This strategy aims to increase option premium and enhance the possibility of a net profit on the overall trade.
5. Outcome:
   • Even if immediate profitability or breakeven isn’t achieved, this approach helps reduce the cost basis of the stock and minimize losses.

This strategy allows flexibility in managing a covered call position during market downturns, optimizing the potential for a better outcome.

Example – Rolling a Covered Call Down and Out

In this example, we maintain the initial scenario, emphasizing the strategy of rolling down and out the covered call:

1. Initial Scenario Recap:
   • Stock purchase at $50 per share.
   • Sold a $55 call for $0.6.
   • Stock’s cost basis: $49.4 ($50 – $0.6).
   • Maximum profit potential: $5.6 ($55 – $49.4).
2. Stock Price Declines:
   • Stock price drops to $40 per share.
3. Adapting the Strategy:
   • Decision: Keep the stock and implement a ‘roll down and out’ strategy.
   • Actions:
4. Bought back the $55 call for $0.10.
   • Sold a new $45 call with a later expiration for $1.
5. Resultant Cost Basis:
   • Original cost basis: $49.4.
   • New cost basis: $48.5 ($49.4 + $0.10 – $1.00).
6. Potential Loss:
   • Maximum potential loss: $3.5 ($45 – $48.50).

Explanation for New Cost Basis: Adjusted cost basis calculated by adding the cost of buying back the January $55 call ($0.10) and subtracting the premium from selling the February $45 call ($1.00) from the original cost basis. The resulting $48.5 is the new cost basis after the ‘roll down and out’ strategy.

This approach aims to minimize losses and adapt to changing market conditions by adjusting the covered call accordingly.

Rolling ITM (In-The-Money) Covered Calls

Rolling in-the-money (ITM) covered calls is a strategy that requires careful evaluation based on the specific circumstances. Let’s consider an example to better understand this approach:

1. Initial Scenario:
   • Sold a $170 call option.
   • Bought Apple shares at $160 per share.
   • Option has three days until expiration.
   • Apple’s current price: $183.
2. Evaluation for Rolling:
   • With a $13 ITM call option, it’s likely to be assigned in the next three days.
   • Decision point: Should you roll the covered call to retain ownership of the stock?
3. Rolling Options:
   • Current $170 call option (3 days left) can be repurchased for $14.15.
   • Alternative: Roll to a $170 call with 37 days until expiration, currently selling for $15.40.
   • Rolling gains: $1.25 credit per call ($15.40 – $14.15).
4. Financial Implication:
   • After collecting a $2.00 premium from the call sale, net cost for buying Apple shares would be $158 ($160 – $2.00).
   • The $1.25 credit results in a 0.8% gain ($1.25 / $158) over the next 37 days, equivalent to 7.89% annually.
5. Consideration and Flexibility:
   • Whether this gain is satisfactory depends on individual preferences and financial goals.
   • Depending on future stock movements, future rolling opportunities may arise, adjusting the strategy accordingly.

This strategy allows for flexibility and potential gain, but its effectiveness and alignment with your objectives should be carefully assessed.

Utilizing “Poor Man’s Covered Call” for Covered Call Rolling

The “Poor Man’s Covered Call” strategy involves purchasing long-term call options while simultaneously selling short-term call options on the same asset. This approach requires less initial investment, giving rise to its name. Let’s explore its potential for covered call rolling:

Example Scenario:

• Apple (AAPL) shares currently priced at $165 per share.
• Implementing a simulated “poor man’s covered call” with an October $195 call purchase at $2.82 and selling a May $175 call at $1.36, resulting in a net debit of $177.

Scenario Evolution:

1. Scenario on May 15:
   • Apple stock priced at $178, four days before the May $175 short call expires.
   • If no action is taken, the loss from the May $175 short call needs to be covered.
2. Rolling Strategy:
   • Alternatively, choose to roll the covered calls:
     • Buy back the May $175 short call.
     • Simultaneously sell a June $175 call.
3. This results in a net credit of $130.

Outcome:

• By executing this rolling technique, the cost of the “poor man’s covered call” is reduced from $177 to $47 ($177 – $130).

This showcases the adaptability of the “Poor Man’s Covered Call” strategy, enabling cost reduction and potential profit enhancement through strategic rolling. The same principles of informed decision-making for rolling covered calls apply to this strategy as well.

Identifying Optimal Stocks for Covered Calls

Choosing the right stocks for a covered call strategy involves selecting those with specific characteristics. Stocks with low beta and within a trading range are considered ideal, aligning with a neutral to mildly bullish or bearish outlook on the stock’s future. Beta, indicating a stock’s volatility compared to the market, plays a significant role. A beta between 0 and 1 is preferred, implying less volatility within a narrow price range.

Using Filters for Stock Selection:

To efficiently identify such stocks, a stock screener can be employed with the following criteria:

1. Beta: Between 0 and 1 (lower volatility preferred).
2. Dividends: The stock pays dividends, indicating potential additional returns.
3. Average Daily Volume: Over the last 90 days, the stock should have a daily trading volume of over one million shares, ensuring liquidity and active trading.
4. Forward Looking EPS (Earnings Per Share): Greater than 0, showcasing positive future earnings expectations.
5. Forward Looking P/E (Price-to-Earnings) Ratio: Less than 20, indicating a reasonable valuation.

Outcome:

Applying these criteria to a stock screener, the list was narrowed down to 78 stocks that align with the trading strategy, meeting the specified characteristics.

This approach enables strategic stock selection for implementing a covered call strategy, maximizing the potential for successful outcomes.

Symbol	Beta (10 Yr Ann)	Dividend Yield	Fwd EPS LTG (3-5 Yrs)
PGR	0.54	0.29%	27.65%
HDB	0.81	0.98%	19.30%
NEM	0.3	3.36%	16.80%
CB	0.73	1.65%	14.19%
GEN	0.91	2.83%	13.40%
UNH	0.7	1.36%	13.04%
MTB	0.84	4.19%	13.03%
AZN	0.54	3.22%	13.00%
HIG	0.89	2.44%	12.72%
ITUB	0.83	5.02%	12.40%
CAH	0.81	2.48%	11.85%
ATVI	0.57	0.55%	11.77%
AU	0.29	1.76%	11.71%
WEN	0.88	4.41%	11.68%
CI	0.64	1.95%	11.27%
TJX	0.85	1.70%	11.20%
LMT	0.69	2.49%	10.89%
MRK	0.44	2.53%	10.47%

Exploring Ideal Stocks and Strategy for Passive Income with Covered Calls

Several stocks like COLGATE-PALMOLIVE CO. (CL), COCA-COLA CO. (KO), and CAMPBELL SOUP CO. (CPB) have exhibited consistent price ranges over the past five years. These price ranges provide a solid foundation for implementing the covered call strategy effectively.

When employing the covered call strategy, if the stock price surpasses the short call strike price, one can opt to roll the covered options to the same or a higher strike price with a later expiration month. This strategic move ensures the potential for continued income generation and benefits from dividends, presenting an attractive proposition for passive income.

Altria (MO) stands out as an excellent choice for the covered call strategy due to its strong dividend offerings. Investing in Altria and similar dividend-yielding stocks can be a key component in constructing a portfolio that delivers a reliable and consistent passive income stream on a monthly basis.

By selecting stocks that demonstrate stable price ranges and integrating the covered call strategy, investors can establish a sustainable income stream, reinforcing financial stability and growth over time.

Conclusion

Although the market might be a roller coaster at times, it doesn’t have to be! More stable returns, reduced exposure to risk, high income potential, and capital gains are all benefits of covered call writing. Options traders use covered call rolling as a strategy to increase profits while minimizing losses. Rolling covered calls allows traders to prolong contracts, modify strike prices, and earn additional premium. In this way, investors may hedge against potential losses without sacrificing potential gains. Covered call rolling is a reliable investment technique that may be used in any market. In sum, rolling your covered calls is a great way to reduce your exposure and increase your returns.