Portfolio Tactics: Analyzing Risk When Rolling Your Covered Calls

Question(s) of The Day

One of our members struggled with the following question(s):

Expiration Friday is looming and I'm not sure what strike prices to choose for rolling out and up. Can you give some guidance on what would make sense to moderate risk tolerance? Also, I want to lower my risk by selling an in-the-money covered call. What underlying should I utilize?

These are very relevant questions, so let me break them down into 3 sub-questions: #1 what covered-call positions should we pay attention to? #2 how do we decide what strikes we're going to utilize for the new expiration cycle? #3 how we can lower our risk by selling 1-year in-the-money covered calls.

#1 Are We Utilizing Portfolio Overwriting or In-The-Money Covered-Call Writing?

Rolling out (and up) on/near expiration Friday only applies to short-term covered-call writing. However, it's possible that for a 1-year in-the-money covered call you can get assigned prior to expiration when there's an ex-dividend involved. As for Sam's question, we should focus on the short-term expiration cycle (July 17).

#2 How Do We Decide What Strikes To Utilize?

Initial Trades

When rolling out to a new expiration cycle, I'd like to discuss 2 of Sam's positions he currently has on.

  • Danaher: bought on June 19, 2020 at $174.90; sold the $180 July 17 call for $4.85

  • Veeva: bought on June 19, 2020 at $223.81; sold the $230 July 17 call for $10.13

Both stocks have since risen above the short call strike, but the difference between the two is huge: VEEVA is trading at $254.16, while Danaher is trading at $183.67.

Rolling Out Danaher Covered Calls

Evaluating the expected return for Danaher, the following screenshot of the elite calculator shows up.

(Source: Option Generator Calculator)

Excluding the upside potential, the return on our covered-call would stands at 2.77%. Our total breakeven, as can be seen from the image above, amounts to $170.05.

Now, let's evaluate the next one-month returns for $180 and $185 strikes in the AUG expiration cycle.

(Source: Option Generator's Calculators)

The current cost-to-close is $4.85 of which $3.67 is intrinsic value, leaving 29.42% of the option in time value. That component is going to disappear, so it pays for Sam to wait until next week to roll out to AUG. But let's say that we were to roll out right now. What would the AUG return be for the $180 (current strike) and the $185 strike? Time to figure that out.

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