Covered calls in roller coaster markets

Investment Analysis Clubs Macro Economic Trends and Risks
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Covered calls for income are the least risky of option trades, the biggest risk is opportunity loss if the stock moves above the strike price. If it’s not a buy & hold position it’s not a major issue. But with a buy & hold position you might have a capital loss (and tax consequences). The conundrum is that while ‘anchoring is not a good idea’ the capital loss is real.

With stocks that don’t pay dividends, getting called is highly unlikely which gives the option seller the opportunity to roll the calls roll up & out right up to expiration.

One situation I have not heard talked about is closing a covered call position early because it has already earned most of the premium. Say you sell a call 30 days out for $300, or $10 per day. If the premium drops to $100 in 10 days you have made $200 or $20 per day and the remaining value is $100 in 20 days, $5 per day. At some point you might want to close the position. I tend to put a Good 'Til Canceled (GTC) Buy to Close (BTC) order at 10% of the original premium. Maybe I should raise it to 20% right after selling the call.

The reverse situation is the stock going up above the strike price. To keep the stock you have to roll the call up, out, or up & out. They call this, “Trading like a pro.” What I have not yet seen is a tool to find the best options available in option chains with hundreds or thousands of calls and leaps. My Call Option Selector can do it but I have yet to find the best way to implement it. The solution seems to be to maximize both premium and capital gains in the least amount of time. As I discovered yesterday rolling up and out PLTR calls, the strike price does not need to be at or above the stock price, just above the current strike price which gives the stock the opportunity to drop in price and gives you the opportunity to roll the option once again later. This trade seems not to be considered, “Trading like a pro.”

Thinking by writing is better than thinking aloud. Back to programming the Selector. :wink:

The Captain

PLTR per contract
Strike $110 → $120,
Net premium $376
$1,376 in 90 days
$15.29 per day

This seems to be a good way to walk back up buy&hold positions.

Note, $$$ per day is a good way to compare trading various stocks and options. Instead of comparing Apples to Aardvarks, compare $$$ to $$$.

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I think this approach will point you toward short-term options (weeklies) where the time decay curve is steepest. Unfortunately, it also increases transaction costs.

DB2

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I use weeklies when the Covered Call Selector picks them as the best choice. The transaction costs are well worth it, just over $4.50 for most trades, less than 1% for a $500 premium.

The Captain

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Captain

I have pure admiration for your studious empirically solid algorithmic approach in this thread.

To what degree do you have to deal with competition from large scale investment pools? Do they cut into your profits margins on these trades or?

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How does your selector control for the second by second potential price movement of the premium? Are your inputs on a 20 minute delay or are they real time?

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It’s what puts food on the table so it’s worth the time and effort as well as being most entertaining. Since very young I loved to solve puzzles and Martin Gardner’s “Mathematical Games” in Scientific American was one of my favorite columns.

This was reinforced by computer programing. You either get it right or you create a bug. On multiple occasions I had to look up the math to solve client problems. In my first job at IBM Service Bureau the National Observatory asked for a ten decimal digit log table. My boss asked me to calculate the estimate. I had no idea of the math involved so I looked it up. Coming up with the algorithm I had no idea how long the computer would take. Solution? Write the code, time the job, present accurate estimate. I loved the job at IBM, they let me get away with just about anything.

Both. I don’t use the actual last price for options but the bid-ask average. The Selector output is just a guide but close enough to real time because the buy and sell options tend to move in lockstep:

  • On weekends, when researching trades, it’s real time, the last bid-ask average for options and last price for stocks on market close.
  • During trading hours the Covered Call Selector uses delayed prices (free from CBOE).
  • Actual trades, realtime from my broker.
  • It’s helpful to watch the daily price chart to make the two trades. It’s important to execute the second trade (sell the new call) quickly.

The Captain

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Captain, this is an excellent trade. Regards

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Martin Gardner’s columns were also among my favorites. This book (photos below) was one of my favorite books when I was younger. In fact, I still have it, it’s one of the few that I haven’t allowed to be discarded over the decades. Just snapped these photos now.

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““the biggest risk is opportunity loss if the stock moves above the strike price.”” It should read if the stock moves above the strike price PLUS the premium you got for the option.

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Right! :+1:

The Captain

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The covered call is similar to naked put, both in premium and risk. Except that, you have an ability to convert your stock holding to a long-term gain.

Remember the covered call, has only limited upside but a significant downside, like some event causing the stock go down 20%. So you need to have the level at which you will close the trade.

Also, this is something most option traders and I do all the time. When you calculate the premium as annualized yield, sometime it drop because of time decay, or because the stock has moved up, or some catalyst has passed and the premium compresses. So you roll it to a different calendar and strike to get higher annualized yield.

When you don’t find a good alternative, close early because that lets you to deploy the cash elsewhere or to reduce the risk.

Generally I prefer bit boring name (or with less volatility) and downside protection if I am doing a covered call. With high volatility names like $PLTR, I prefer to do spreads. With spreads you have defined risk and return. More important is limit your downside. For ex: $PLTR can easily drop to $100, $80 and still be wildly overvalued. The premium you earn will not be enough to mitigate that kind of stock decline.

Even if you want to do wheel strategy with weeklies, my recommendation is, buy 2 or 3 months out call and then sell weeklies against it.

When you are trading options, or for that matter in trading, managing the risk is most important. If you ignore risk, all your profits can be easily wiped out in a single trade.

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Not at all. You are getting the risk completely upside down. The biggest risk is not the stock moving above your strike price, because that is your best case scenario.

The biggest risk is the stock declining suddenly because of some company/ industry specific event for ex UNH has dropped 50% and it is going to take many, many quarters before it gets back to that price. Don’t assume the stock will immediately bounce back.

Your biggest risk is not stock moving up, but stock declining.

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I don’t understand these numbers exactly. I think you are saying that you rolled from the 110s to the 120s, and 90 days is probably the Aug 15, 2025 ones. In other words, you bought back the 110s that you sold previously, and you sold the 120s instead. Correct? If that is the case, I don’t see where the “Net premium” number comes from. Buying the 110s back now would cost about $28.15, and selling the 120s now would get you about $21.80. The net premium paid per contract would be about $635 in that case. Where did the $376 number come from? Also, where did the $1376 in 90 days number come from?

I suppose it depends on which opportunity you are discussing. If it’s the opportunity loss of future gains in the stock, then when it sells at the strike price (plus the premium), you then “lose” all gains above that level.

However, if you look at it as the opportunity to sell calls against that stock repeatedly for the purposes of earning a regular income, then perhaps not. In that case, any close above strike price causes the stock to be lost and then you can’t sell covered calls on it anymore. That is, unless you buy back the stock, of course, but buying back the stock at that point kind of “reverses” the gain on the previous trade (because you will be paying more for the stock because it had gone up past the premium). And that action negates the earning of regular income (because much of what you earned last month had to be plowed back into the stock to buy it back).

I don’t usually trade options that way. In my case, when I sell an option, I almost always intend for that option to be exercised. I use options as a tool to buy and sell stock at slightly better than prevailing prices (I learned this from Apple about a decade ago when they contracted with a large wall street firm to effect some buybacks for them via selling lots of put options).

I’ll give an example of a recent trade I did (which still hasn’t completed, but will complete in about 2 weeks from now). Over the last few years, Disney stock has languished, but every year or so, they come up with some news item that causes the stock to pop, and then slowly come back down to earth. I held some Disney stock at one point, but dumped it on the pop when Iger came back to the rescue a few years ago. Then the stock came back down to a price at which I was willing to buy it (80s, 90s), so I sold some puts (Aug '24) and they were exercised and assigned and I owned some DIS at about $90. Then in November when the stock rose to about 100, I sold some 102 calls (Nov '24) and they were exercised and assigned so I sold those shares at about $105. Most recently, when I saw DIS dropping to the 90 area again, I sold some 90 puts (Apr '25) and I got lucky (barely!) and they were exercised and assigned, so I now owned DIS again at $88 or so. Then there was the most recent pop last month so I sold 105 calls (Jun '25) figuring I am willing to take a quick gain from $88 to $108 in a scant 2 months. In my mind those shares are as good as sold (at 105) already, and the trade is done. Even though the stock is now $113+, I see no reason to roll those options up and out. Instead I will allow those trade to end, and then next time Disney drops to around $90 (maybe even $95 if no recession and the business is doing well), I’ll consider buying the shares (mostly via selling puts to get a slightly better price).

I’ve owned UNH for decades and I won’t sell calls (though I probably should have when it was $500-600 recently LOL) because I don’t want to incur such a large capital gain (it’s almost all gain as the basis is tiny) if those calls are exercised and assigned and I have to sell the shares. If my UNH were in a tax-protected account, I would have been selling calls at prices about $550. But I do sometimes sell puts at low-ish prices where I would be willing to buy. Most recently I sold some UNH puts at the peak of the recent panic, I think the stock was in the 270s that day!

So far, over the years, all my UNH puts have expired worthless, and the current batch of UNH puts will likely also expire worthless in about 2 weeks from now.

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Many IT companies were doing that during that time to plan for ESOP. I don’t see them doing anymore with RSU, not sure what exactly has changed but that practice has gone away mostly.

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I write calls against some of my long held positions when I consider them to be slightly overvalued. Of course I write them at significantly higher price, for ex: I own $CRWD, my cost basis is $49 and if I sell it then I will incur significant tax. However, I have recently wrote $600 Jan call. First of all I am not expecting it to be called, if it is probably I am going to be okay. Let us assume, I don’t want to, I can most likely roll that option. This is actually preferred because when I buyback the calls I sold I incur short-term loss, which will be used to offset other short-term gains, and the stock appreciation is on long-term, assuming I rotate.

If I don’t rotate, then the premium is added to the net price and becomes long-term gain.

This is where the covered call is preferable over put selling. Because Put selling premium when earned is always short-term gain.

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I’m afraid I screwed up the numbers a bit (I did some of the arith in my head). Here are the trades:

Trade Date Premium Strike Expiration Days $$$/Day
Sell 03/12/25 495 110 06/20/25 100 $4.95
Buy 06/04/25 -2040 110 06/20/25 84 $5.89
Sell 06/04/25 2425 120 09/19/25 191
Net second call 385 + 1,000 107 $12.94

It’s 191 days from the first option to the expiration of the second option, split into 84 day for the first and 107 for the second.

The Captain

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The $12.94 per day suddenly gets to < $4, if the stock is below $120. You are overthinking and doing unreliable measurement. I would encourage you to look at annualized yield. You have to consider the cost of buying the underlying shares. If the common shares are < $10, the per day $$$ is very different from for a stock that is $100 or $400…

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In the stock market there are real numbers (cash), aspirational numbers, comparison numbers (per day $$$), and other numbers.

If the stock is below $120 the option expires worthless and I still have the stock to sell covered calls. It’s not as if it just went to zero. Today PLTR dropped to $119.91, a lovely number as my cost basis is $107.54.

The Covered Call Selector does it for me, it calculates the CAGR of the whole trade if called. If not called then it only calculates the premium.

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The light column is about the premium, the blue column is if the option gets exercised. Clicking on the column titles sorts the table

The Covered Call Selector can operate in two modes, by dollar amount or by number of contracts. By dollar amount solves the problem of comparing under $10 dollar stocks against $100 or $400 stocks. Say I have $45,000 available, it will compare 45 contracts of the $10 stock against 4 contracts of the $100 stock, and 1 contract of the $400 stock. When I’m rolling calls I’m not interested in comparing to other stocks so I use $$$ per day to weed out the less productive calls in this particular option chain.

The Covered Call Selector is not quite as simple minded as you think it is. As a web app it has been in development for over 8 years, before that it was spreadsheets for well over a decade. As the features were developed and improved the option returns improved radically. The philosophy is quite simple, option chains can have hundreds or thousands of calls. Without a tool to pick the best ones, one is leaving a lot of money on the table. This is as true for the initial selling of calls as it is for rolling them up and out. The craziness of the market these past six months convinced me to improve the Covered Call Selector with screens to manage rolling options, this is still work in progress but it has already improved my trading.

The Captain

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Puts, similarly to calls, when exercised can also become long-term gains (because the premium is calculated into the basis). Almost all my puts that are exercised eventually become long-term gains because I only sell puts on stocks that I am willing to own at that price (strike minus premium) and hold for a reasonable period. It’s pretty rare that I end that kind of trade immediately like the Disney trade I described above. But that’s only because the catalyst that caused the stock to pop happened very quickly and it became time to close the trade.

I’m trying to figure out why this would make you happy. Yesterday you had stock worth $131, now worth $119 ($121 in AH). And yesterday you bought a Jun 110 call, and sold the Sep 120 call. The June call has a delta of 0.79 while the Sep call has a delta of 0.6, so those two trades net come to a loss as well. As you mentioned, ideally on Sep 19th the stock should be $119.99 so you can keep it, have the Sep options expire worthless, and then be able to sell new calls against that stock. But now isn’t the opportune time for it to be under $120, because you still need some time decay on the trade. Obviously, you won’t wait until Sep 19th, if there is a good opportunity to close the trade and take 80-90% of the gains early. Then you can sell new calls even earlier. I used to use that technique when I used spreads, as soon as the spread reached 90-95% of maximum return, I closed the trade and sometimes created a new one further out.

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A fair question! When I finally understood options I decided to use covered calls to generate income. In this scenario the underlying is not the center of attention, the options are. Capital gains are not the center of attention, option premiums are. As you point out:

That is not to say that capital gains are ignored, rolling options is a way to manage them.

True in isolation but not in the big picture of managing covered calls for income. The trade generated cash and increased the strike price (capital gains) by 10%. How to measure the worth of this trade compared to other trades? $$$/Day. This is not an absolute indicator but compared to the dollar value of the underlying stock it ranks the trade vs. other potential trades. This is not built into the Covered Call Selector, it’s a mental calculation.

The Captain

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