In a previous article, I shared that I was in a catch-22 situation with Nvidia shares and options contract, which resulted in a lose-lose situation whether Nvidia’s share price rose or fell.
This situation happened because I sold Covered CALL contracts on my Nvidia shares when they were trading at a very low price. To make matters worse, I sold at a very low strike price to earn more premium, which got me trapped as Nvidia’s share has more than 4x since the start of the year.
I had 300 Nvidia shares and 3 Covered CALL Contracts. The premium of each contract is worth more than 10x the premium I received when I first sold the contract at the start of the year.
Read more about the article here:
How A Wrong Move In Options Trading Stopped Me From Taking $66k Profit | Disadvantages (Risks) Of Selling Covered CALL Options
Proposed Strategy
I thought of a way out that would involve some level of risk and I want to share what I have done. Hopefully, it can give some food for thought for people who are trapped in a similar situation.
As Nvidia was trading at an all-time high, thanks to the hype surrounding the AI bandwagon, I thought that the quarterly result released on Aug 23 would be a game-changer. A less-than-stellar result would crash the stock given so much hype to push up the price to all-time high. On the other hand, a good earnings report may propel the stock further. I am more inclined toward Nvidia missing expectations and analysts’ estimates so I decided to adopt the following 4-step strategy.
- Sell some of my current Nvidia shares to realize my profits on them
- Let my Nvidia Covered CALL (CC) contracts become naked CC (with no underlying shares to cover if assigned)
- Avoid early assignment by extending the expiration date to the furthest possible expiration date
- Keep 100 shares of Nvidia as a safety net in case of an early assignment/ exercise of Covered CALL contract
For step 1, I started selling Nvidia shares in batches when the share price was fluctuating in the 400+ range. I sold on days when it rose and on days when it fell. On some days, I panic sold more when the share price dropped drastically, in fear of a greater crash even before the earning result was released. Therefore, I managed to sell away 200 of my 300 shares before Nvidia’s quarterly earning result was released on 23 Aug 23.
For step 2, the biggest risk of selling a naked Covered CALL was the possibility of an early assignment. If that happens, I do not have the shares to sell to the Covered CALL buyer and my brokerage will need to buy from the open market to cover to honor the contract. The market buy price is likely to be higher than the price when I sold the shares. That would also put me in a margin loan if I do not have enough cash in my account to buy the shares, i.e. my brokerage lends me money to buy those shares and charges me interest for that.
To mitigate Step 2, I would execute Steps 3 and 4.
For step 3, I have explained in another article why it is less likely for long-dated options contracts to be assigned early due to the extrinsic (time) value in the contract. The options contract buyer would earn more by selling off the options contract as he is redeeming the time value when closing the contract, i.e. he is selling the remaining time value of his contract to the new buyer. Thus, by extending the contract to the furthest, I am lowering the risk of early assignment and because of that, I am able to hold onto my (naked) SELL CALL positions while waiting for a good opportunity to close the contracts.
Further Read:
What Is Early Assignment Risk In Options Trading? Who Is Affected & How To Mitigate It?
In the worst-case scenario whereby the buyer of the options decides to forgo a bigger profit and exercises the contract, I have 100 shares as standby to sell him at the strike price agreed in the contract, which is my Step 4. Of course, beyond that, if the 3 options contracts are exercised together, I would go into margins loan and buy 200 Nvidia shares from the open market to sell to the respective buyers.
[Afternote] Nvidia reported great earnings on 23 August and the share price rose to USD500. However, it did not manage to stay there or go higher as investors sold the news and started taking profits on their incredible gains. As such, there is still a possibility that this strategy can work, as long as Nvidia’s price actions continue to weaken and with every passing day, the time value is slowly being eaten away. By then, I will be able to close the contract at a lower premium, which would mean a lower loss (less than 10x) or break even if Nvidia’s share price collapsed.
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