US stocks fell for the second straight day after the Federal Reserve’s minutes revealed that officials are ready for a higher interest rate hike and a greater balance sheet reduction to aggressively fight inflation.
I have initiated (sell) covered call positions in Tesla and Nvidia in March 2022, with SP USD1,200 and USD280 respectively. As their premium value has dropped from the amount that I received when I initiated those contracts, I closed the call option contracts (buy them back) and locked in the profits (which is the difference between the premium I received and the premium that I paid).
For Tesla, I received USD2k on 24 March 22 when I open the contract and paid USD1.6k on 6 April 22 to close the contract. Thus, my profit is USD400
For Nvidia, I received USD708 on 18 March 22 (open) and paid USD141 on 6 April 22 (close) and the profit is USD567.
I then opened a new contract for Tesla at the same strike price of USD1,200 but expiring at a later date of 13 May 22, which 2 weeks later than the contract that I closed on 6 April 22. I collected a premium of USD2.6k.
So, let’s see if this method of rolling a covered call contract makes sense or it is better to just let the original contract expire on its own, assuming the share price of Tesla does not rise above USD1,200 on the expiration date.
Method 1: Selling 1 Option Contract Without Rolling
Start date: 24 March 22
End date: 29 April 22
Total duration: 36 days
Premium collected: USD2,000
Average Premium Earned Per Month (30-day period): USD1,667 (2000/ 36 x 30)
Method 2: Selling Covered Call Contract As Share Price Dips
Start date: 24 March 22
End date: 13 May 22
Total duration: 50 days
Premium collected: USD3,000 (2,600 + 400)
Average Premium Earned Per Month (30-day period): USD1,800 (3000/ 50 x 30)
As illustrated in the above example, Method 2 produces a higher average monthly yield as compared to Method 1. This is because the maximum gain earned in an option contract is capped by the premium collected from the contract. When the contract expires worthless, the total gain will still be the same whether it is a dollar less than the strike price or a hundred dollars less than the strike price. As the share price continues to dip, the rate of decline in premium becomes disproportional and thus the rate of profit gains drops as well. Thus, rolling makes sense to readjust the call option contract to a lower strike price or a later expiration date to earn more premium on the time value of the contract.
Read more about this strategy in this article:
Why I Choose To Roll My CALL Option Contract When Share Price Falls
Concluding Thoughts
Selling OTM CALL options may yield lower returns as compared to ATM or ITM CALL options. However, it gives the option contract seller more margin for error, especially when the trend reverses and share price starts rising. If share price continues to drop, seller can choose to roll the CALL option contract to a later date or lower strike price to earn more premium.
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