Portfolio Tactics: Analyzing Risk When Rolling Your Covered Calls

As can be noticed from the image below, we pay $5.20 (mid-price of the July 17 options) to buy back the current short call. If we roll out to AUG, we're set to generate $10.6 for the $180 call and $6.90 for the $185 call. Without factoring in upside potential, rolling out would yield 3.00%, whereas rolling out and up would produce an additional one-month return of 2.98%. Moreover, since the $185 is slightly out-of-the-money we can generate an extra 0.72% in upside potential (from $183.67 to $185).


(Source: Option Generator's Calculators)

I've marked the word the net credit, meaning we're collecting additional cash in the rolling transactions. The following phrase should always be kept in mind: As long as we collect credits in rolling transactions, we continue to reduce our breakeven level.

In case of the $180 AUG call, our breakeven point will be reduced by another $5.40. Remember that our initial breakeven for the July expiration was standing at $170.05. Now it's $164.65. In case of holding the stock outright 100% (so without selling a covered call), we'd start losing money if DHR drops below $174.90... However, by choosing the $180 call, our shares are still theoretically worth $180 versus $183.70.

Talking about the $185 call, our shares will be worth $185 at the very maximum at expiration Friday in AUG. However, let me remind you that we also collect a net credit for rolling out and up! As such, our adjusted cost-basis is now $170.05 (initial situation) - $1.70 (net credit received when rolling out and up from $180 to $185) = $168.35 or roughly 2.7% higher than for rolling out.

Based on our overall portfolio delta (directional exposure to the underlings) and technical analysis, we make our final non-emotional rolling decision. As for DHR, the technical picture looks bright with an impressive streak of showing a positive directional movement index (DMI).


(Source: Pro Realtime)

Preliminary conclusion for DHR

Rolling out and up is a more bullish tactic, but in case of DHR, it still results in breakeven reduction. If we can achieve this every single month, our probability of profit will continue to march higher, thereby reducing the odds of facing a substantial and permanent capital loss. As highlighted in the article about Salesforce, covered-call writing on a monthly basis does not only lead to a higher win rate because of lowering the break-even point, it also reduces the standard deviation. Based on the chart technicals for DHR, I would favor rolling out to the $185 covered call if it fits within our risk tolerance boundaries. As there's still plenty of time value left in the current short call, waiting until expiration Friday makes sense.

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