Covered call writing involves a minimum of 2 legs: we are long the stock (own the stock) and short the option (sold the option). There are many times when we employ the position management skill and options are bought back and new options sold or our underlyings are sold. This adds additional legs to the trade and calculations can become challenging to compute and interpret. On June 4, 2018, Kaveh sent me a series of trades he executed that I thought would serve as a great example as to how to decipher the trade results.

 

Kaveh’s trades through the middle of the June 2018 contracts using Viper Energy Partners LP (NASDAQ: VNOM)

  • 5/21/2018: Buy VNOM at $33.30
  • 5/21/2018: Sell June $33.00 in-the-money call at $0.90
  • 6/1/2018: Buy-to-close the June $33.00 call at $0.15
  • 6/1/2018: VNOM trading at $30.41
  • 6/1/2018: Sell-to-open the June $29.00 call at $1.75 (rolling down from the $33.00 call to the $29.00 call)

As of June 1, 2018, we have 4 legs to these trades:

  • Buy stock
  • Sell $33.00 option
  • Buy back $33.00 call
  • Sell $29.00 call

We also have the current share price significantly lower than when initially purchased. So where do we stand at this point in time and could we have improved our situation? The best way to simplify a situation like this one is to break up the stats into the “stock side” and the “option side”.

 

Stock side of these trades (commissions not factored in)

As of June 1, 2018, we have a loss of $2.89 per-share ($33.30 – $30.41)

 

Option side of trade (commissions not factored in)

As of June 1, 2018, we have a net credit of $2.50 per-share ($0.90 – $0.15 + $1.75)

 

But wait, what are our shares really worth on June 1st?

$29.00…as a result of selling the in-the-money $29.00 call. Therefore, our share loss is really $4.30 per-share.

 

Current status as of June 1st

We now have a net debit of $1.80 per-share ($4.30 – $2.50) + trading commissions. This represents a loss of 5.4% on a cost basis of $33.30 per-share.

 

Possible ways to have improved these results

When we close out short calls in the first half of a contract, we consider waiting to “hit a double” in expectations of share recovery or selling the underlying if that stock was significantly under-performing the S&P 500. In this case, share value declined by 8.7%, while the market benchmark moved slightly higher. Strict adherence to the BCI exit strategy guidelines would lead us to selling the stock and using the cash in a completely new position to mitigate the initial losses. 

 

Chart confirmation

 

technical analysis for covered call writing

VNOM PRICE DECLINE IN LATE MAY 2018

 This price chart confirms the dramatic price decline in late May 2018 after a superb run-up from August 2017 (yellow field). This was true for the entire energy sector. 

 

Comparison chart with S&P 500

When we have price decline in our underlying, leading to exit strategy opportunities, we view stock performance relative to the overall market to guide us to decisions between rolling down or closing the entire position (short call and long stock). The screenshot below may guide us to closing the entire position in an effort to mitigate losses:

covered call writing exit strategies

VNOM UNDERPERFORMING the S&P 500 DURING the JUNE 2018 CONTRACTS

 

Discussion

When using multi-leg trades when instituting exit strategies, a way to clarify calculations and positions is to break down the stock and option results separately. Following the BCI exit strategy guidelines will result in mitigating losses and enhancing gains.

 

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Upcoming event

February 7th – 10th, 2019

Orlando Money Show

Omni Orlando Resort @ Champions Gate

February 7th – 10th 2019

Speaking schedule:

1. Getting Started with Stock Options: Creating Monthly Cash Flow with Covered Call Writing 
February 8, 2019, 3:10 pm – 3:40 pm

2. Getting Started with Stock Options: How to Select the Best Options in Bull and Bear markets
February 9, 2019, 2:00 pm – 2:45 pm 

 

Market tone

This week’s economic news of importance:

  • Home builders’ index Nov. 60 (68 last)
  • Housing starts Oct. 1.23 million (1.232 million expected)
  • Building permits Oct. 1.26 million (1.27 million last)
  • Weekly jobless claims 11/17 224,000 (215,000 expected)
  • Durable goods orders Oct. -4.4% (-3.4% expected)
  • Existing home sales Oct. 5.22 million (5.18 million expected)
  • Consumer sentiment Nov. 97.5 (98.3 expected)
  • Leading economic indicators Oct. 0.1% (0.6% last)

 

THE WEEK AHEAD

Mon Nov. 26th

  • Chicago Fed national activity index Oct.

Tue Nov. 27th

  • Case-Shiller house prices Sept.
  • Consumer confidence index Nov.

Wed Nov. 28th

  • GDP Q3
  • New home sales Oct.

Thu November 29th

  • Weekly jobless claims 11/24
  • Personal income Oct.
  • Consumer spending Oct.
  • Pending home sales Oct.

Fri November 30th

 

For the week, the S&P 500 moved down by 3.79%% for a year-to-date return of (-)1.54%

Summary

IBD: Market in correction

GMI: 1/6- Bearish signal since market close of November 11th, 2018

BCI: Selling only in-the-money strikes. The fundamentals are still in place for a market turnaround. The December Fed announcement will play a major role in end-of-year price movement.

 

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The 6-month charts point to a bearish tone. In the past six months, the S&P 500 was down 4% while the VIX (21.52) moved up by 71%.

Wishing you much success,

Alan and the BCI team

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