What is a good price to "Roll" a Covered Call?

Question

For an already initiated Covered Call, I wanted to ask if there is an optimal price to roll? For instance, if I buy/write a stock worth $10 with a strike price of $12, I can be faced with 3 scenarios as time progresses:

1. The price of X will be less than $10
2. The price of X will be equal to $10
3. The price of X will be greater than $10

For the example, we'll assume X remains fairly stable around the $10 mark, i.e. price fluctuations are not greater than 10% either way, and we will roll to the same strike price of $12.

I understand the concept of bid and ask for options pricing...just wanted to check if there is, statistically, computationally, or otherwise, a better underlying price to roll the call to a subsequent time period.

Answer 1

There is no reason to roll an option if the current market value is lower than the strike sold. Out-of-the-money strikes (as is the $12 strike) are all time value which is decaying constantly and that is to our advantage. If share price remains below the strike, the option will expire worthless, you will still have your shares and free to sell another option the Monday after expiration Friday. If share price is > $12 on expiration Friday and you want to keep those shares, you can roll out or out-and-up depending on your outlook for the stock.

Good luck, Alan

Answer 2

An expiration 2 years out will have Sqr(2) (yes the square root of 2!) times the premium of the 1 year expiration. So if the option a year out sell for $1.00, two is only $1.41.

And if the stock trades for $10, but the strike is $12, why aren't you just waiting for expiration to write the next one?

Answer 3

If the call is in the money and you believe the reason for the price jump was an overreaction with a pullback on the horizon or you anticipate downward movement for other reasons, I will roll (sometimes for a strike closer to at the money) as long as the trade results in a net credit!

You already have the statistical edge trading covered calls over everyone who purchased stock at the same point in time. This is because covered calls reduce your cost basis and increase your probability of profit. For people reading this who are not interested in the math behind probability of profit(POP) for covered calls, you should be aware of why POP is higher for covered calls (CC). With CCs you win when the stock price stays the same, you win when it goes down slightly, you win when the stock goes up. You have two more ways to win than someone who just buys stock, therefore a higher probability of making a buck!

Another option:

If your stock is going to be called at a loss, or the strike you want to roll to results in a net debit, or your cash funds are short of owning 100x shares and you are familiar with the stock, try writing a naked put for the price you want to buy at. At experation, if the naked put is exercised, your basis is reduced by the premium of the put you sold, and you can write a covered call against the stock you now own. If it expires worthless you keep the premium. This is also another way to increase your POP.

Answer 4

Yes, there is an optimal price when you should roll. However that optimal point in time is only known in hindsight because (hypothetically) today could be the ideal time whereas perhaps today is the best day so far but 3 days from now could be a better day to do so.

However, there is something that you can do computationally to determine if it's a good idea to roll a short call to a subsequent time period.

Calculate the average premium per day that you will be receiving from your short call from now until it expires. Compare that to the average premium per day that you will receive from options of the same strike for later expirations. If any of them are significantly higher, it's usually a good idea to roll.

It's not such a straightforward comparison if you are looking at rolling to a different strike price. Then, you have to account for the higher (or lower) amount that you will receive if assigned. Per your example, if the stock rose toward $12 and you would like to keep it, rolling the short $12 call up and out to $13 for even money might be desirable.

Understand that premiums are related to the square root of time so you usually get more premium per day for shorter expirations. For example, an ATM one month call might be $1 whereas the same ATM call for 9 months might be $3. Therefore, the ROI is much higher for one month writes though there's no guarantee that you'll be able to do it 9 times. In fact, it's unlikely.

The short answer? Evaluate what you can get for rolling an option and if it improves the sitation, do it. Otherwise, sit tight and let time decay work its magic.