SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Covered Calls –Does Rolling Forward Mean Higher Risk?


Do you roll forward to avoid exercise? It seems like an obviously advantageous move. You avoid exercise and generate a net credit. What can go wrong? Actually, rolling incurs more risk, and every covered call writer needs to study the potential roll and compare the advantages of rolling versus closing and taking a loss or allowing exercise.

The forward roll works because a later-expiring contract at the same strike is always worth more, due to higher time value. So you can always change out the short position profitably.You can roll forward to a later option with a strike higher, in which case it is more difficult to create a net credit. However, if you are exchanging the current strike for one five points higher and you lose $200 on the deal, what happens if the later strike is exercised? You make a profit:

 

Extra profit on exercise, five points $500
Less: loss on the forward roll -200
Net profit $300

 

The system of replacing calls is quite simple. However, there are four major pitfalls possible with the forward roll of a short call. These are:

 

  1. It doesn't always avoid exercise. If the ultimate goal is to avoid exercise, the forward roll is not always successful. For example, if an ex-dividend date occurs before the later call's expiration, the short call might be exercised right before ex-date, a strategy used to get the dividend in addition to a little profit in the 100 shares. Be aware of ex-dates when you roll forward and remember that exercise can happen at any time.
     
  2. It might not be worth the delay. If your roll produces less than a net of $50 or so, you have to question whether it is worth it to tie up your position for another week, or more. In some cases, letting exercise happen and getting your 100 shares called away is the most sensible outcome. Compare likely outcomes and remember to compare profitability and the time required to keep your call covered.
     
  3. If you don't run the numbers, you could lose on increasing the strike. Make sure you create a profitable situation when you move up one strike as part of your forward roll. For example, if your strike goes up 2 1/2 points but you lose $275 on the net change in value on the deal, you lose money.
     
  4. You could create an unqualified covered call. The forward roll can unintentionally set you up with an unqualified covered call. If you are close to getting to long-term capital gains status on your shares of stock, but your roll creates a new position with a strike more than an increment below current market value, the period counting toward favorable long-term treatment stops dead. Investigate the rules for qualified and unqualified covered calls and make sure you don't lose the better tax rate in the deal.

A final note: In tracking open covered calls after a roll, be sure to adjust your basis to reflect the exchange of one position for another. When you roll forward, you set up a credit, but it consists of a loss on the current position, versus a net credit  created on the new position. Your basis in the new covered call has to be reduced to account for the net loss.


Example: You opened a covered call for 5 ($500), but it now is in the money and the premium is 6.25 ($625). You roll forward to a later-expiring option with the same strike, and receive $700. The net credit is $75 ($700-$625). But the loss on the original call was $125 ($500-$625). So your true basis in the net call is 5.75 ($700-$125, or $575). So in order to get a net profit, you have to be able to buy to close below that price.


Covered call forward rolling is a sensible strategy, but you have to make sure you know all of the rules, and that you have a realistic grasp of what can happen. You want to make sure you know what to expect. Remember, experience is what you get when you were expecting something else.


Michael C. Thomsett is a widely published author with over 80 business and investing books, including the best-selling Getting Started in Options, coming out in its 10th edition later this year. He also wrote the recently released The Mathematics of Options. Thomsett is a frequent speaker at trade shows and blogs on his website at Thomsett Guide as well as on Seeking Alpha, LinkedIn, Twitter and Facebook.

Related Articles:

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • What’s Wrong With Your 401(k)? (If anything)

    There currently are over sixty million Americans that are active 401(k) participants, and well over 500,000 total active 401(k) plans offered by employers in the United States.  Despite these high numbers, usages could be higher, as the US Census Bureau estimates that only 41% of all employees with access to a 401(k) plan utilize it, with even less funding it fully.

    By cwelsh,

    • 0 comments
    • 90 views
  • Upcoming Decay of Options

    I am on the hunt for a short volatility position for three main reasons. First, the market’s wild swings have, for the time being at least, diminished. Second, option activity has dried up as my options barometer continues to be stuck in the 4 – 6 range as traders are not making big bets in either direction.

    By Jacob Mintz,

    • 0 comments
    • 150 views
  • The Scientific Process of Increasing Expected Returns

    For many US investors, the "base case" for equity investing is US large cap stocks, most commonly benchmarked as the S&P 500. You could absolutely do far worse than owning these 500 great US companies, and the weight of the evidence suggests that most actively managed mutual funds that benchmark themselves against the S&P 500 index have in fact done worse.

    By Jesse,

    • 0 comments
    • 290 views
  • Those Golden and Death Crosses

    The use of moving average (MA) for predicting future price behavior must be undertaken cautiously. MA is a lagging indicator, so the question must be: Can a lagging indicator provide guidance for the future? Yes. The use of two MA lines and how they interact is a reliable form of reversal indicator.

    By Michael C. Thomsett,

    • 0 comments
    • 265 views
  • Trading Reverse Iron Condors When IV Is Elevated

    Our members know that pre earnings straddles and calendars have been our bread and butter strategies in the recent years. We enter those trades when the prices are cheap compared to previous cycles. However, in the last few months of 2018, Implied Volatility exploded, making most of those trades too expensive.

    By Kim,

    • 0 comments
    • 304 views
  • How To Short Volatility The Right Way

    Shorting volatility in 2017 was easy money. In fact, it was easy money every year since 2010 when iPath S&P 500 VIX Short Term Futures TM ETN (NYSEARCA:VXX) has been created. Just go short VXX, buy puts or put debit spreads, and you would make money every year since 2010.

    By Kim,

    • 12 comments
    • 885 views
  • Leveraged Anchor Implementation

    This week Steady Options implemented the newest iteration of the Anchor trades – the Leveraged Anchor. This will now officially be tracked. We will also continue to track the Traditional Anchor as well. It is our belief that the Leveraged Anchor will perform better, on a risk adjusted basis than Anchor has, particularly on the upside of the trade.

    By cwelsh,

    • 0 comments
    • 778 views
  • 2018: A Year To Remember

    Making money in the stock market in 2017 was easy. Pick almost any stock or index. Buy calls. Sell put credit spreads. Almost any bullish or slightly bullish strategy would work. Everyone was a genius trader. Then came 2018. US stocks posted its worst year in a decade. Volatility exploded. 

    By Kim,

    • 0 comments
    • 527 views
  • SteadyOptions 2018 - Year In Review

    2018 marks our seventh year as a public service. It was an excellent and exciting year. We closed 124 winners out of 161 trades. Our model portfolio produced 129.5% compounded gain on the whole account based on 10% allocation per trade. The winning ratio was 77.0%. We had only one losing month in 2018. 

    By Kim,

    • 0 comments
    • 1,215 views
  • Systematic vs. Discretionary Trading

    Much of the discussion in finance is about "active" vs. "passive". Active management typically uses security selection and/or market timing to make portfolio management decisions. Passive management typically does not, instead, focusing on market risk premiums as the source of expected return. So which is better?

    By Jesse,

    • 0 comments
    • 611 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs