Give Your Options Trade a Second Life
Writing (short selling) options is a way to generate additional income. Ideally, the underlying stocks will move in your favor, in which case the options will expire worthless and you can keep writing them to collect premiums.
But inevitably, some of the options you write will be at risk of being exercised.
If an option is exercised against you, depending on whether you sold a call or put, you will have to either sell (call) or buy (put) 100 shares of the underlying stock at the strike price per contract written. Of course, if you don’t want the options to be exercised against you, you can close your short position by buying an offsetting option and move on to the next battle.
However, even if you closed your position on a particular stock, you can keep selling options against it. This is especially true in the case of a covered call, where you hold shares of the stock you sell the call against. After all, you might as well squeeze out cash as much of the stock as you can.
In this case, you can execute a roll.
Keep It Going
When you close your position in either a call or put on a stock, and write another call or put against the same stock, that’s a roll.
Let’s use an example using real market prices to illustrate how you could use this strategy to give new life to a losing trade.
Assume that you own 100 shares of Shopify (NSDQ: SHOP) a high-PE e-commerce stock that has had quite a roller coaster ride in the last few years. You wrote a December 16, 2022 $45 call against the position for $1.20 and collected $120 in premium (I am ignoring the negligible commission cost, which should be very low at a discount broker).
Thanks to Jerome Powell’s statement suggesting that the Fed may slow down its pace of increasing the interest rate, the market rallied, so SHOP has jumped from under $37 on November 25 to over $43 on December 1.
The December $45 call has almost doubled overnight to $2.06, putting your position underwater.
If you are ok with selling SHOP at $45, you can do nothing and let things play out. In this case, if SHOP ends up below $45 in about two weeks, the call will just expire worthless. But if SHOP ends up above $45, the call will be exercised and you will lose your shares at $45. Whether you win or lose on the trade depends on SHOP’s market price at option expiration. Your breakeven point is $46.20 ($45 strike price plus the $1.20 premium).
However, if you feel that the stock is going to much higher and you don’t want to lose your shares, you could close your position by buying another SHOP December $45 call. If you pay $2.06 to close out your position and just stop here, your gain or loss is the difference between $2.06 and $1.20 multiplied by 100.
However, as you close your position, you can sell another longer-dated call against SHOP at a higher strike price. Let’s say you roll over to the March 2023 $60 call for $2.09, you essentially cancel out the cost of closing the original December call. Your new breakeven point is now $61.23 (the strike price of the new call option plus the original $1.20 premium and the $0.03 credit.)
Beware that if SHOP happens to take off in the next three-and-a-half months, then you will face the same decision again, but at the very least, even if this March $60 call is exercised, you get an extra $15, or 33%, gain per share in the stock—you would have lost SHOP at $45 before.
If you are worried about losing SHOP and you also want to squeeze out even more cash out of your shares, you can write a put against SHOP as well. But only do this if you don’t mind buying more shares of SHOP at a lower price.
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