Do you not know that in a race all the runners run,
but only one gets the prize? 
Run in such a way as to get the prize.

– 1 Corinthians 9:24

Prologue

In the last post, I touched on strategies for cover calls. Cover-calls can be broken down into two categories; 1) 1-week for necessary portfolio adjustments and 2) 1-month for income. In this week’s post, I want to think about exit strategies for cover-calls.

There are a couple of rules-of-thumb that I found when researching this topic:

1. Consider closing winning cover-calls before expiration. It is better to consistently have smaller wins than the chance of losing big.
2. Take the smaller losses like a man and take them early.

First, let’s take a look at what a winning cover-call looks like. My cover-call is winning if:

My cover call is winning if:

• It is NOT ITM
• The current stock price is below the “Break-Even” price (explained below)
• I have achieved at least 85% of the premium I already received.

Not In-The-Money

At expiration, if the stock’s current price is above the strike price for the cover-call contract that I sold, then this option is ITM. It will be assigned (my stock will be sold at the strike price). Therefore, I will lose any market value for that stock above the strike price. But, is this a loss??? – maybe not.

If the stock’s current price is below the strike price, then this is considered Out-of-the-Money (OTM) and should expire worthlessly. All the premium money I received for selling this cover-call contract I get to keep – plus I can sell another Option contract on this same stock later.

Below Break-Even

The break-even price is the stock’s actual price where I neither make money nor lose money on the trade. The break-even is a function of the cover calls strike price, the premium I collected for selling it, and any fees I paid.

If I sold a 1-week cover-call contract for CRM at a strike price of $150 and received a net premium of $96 for the contract, then my break-even price will be $150 + (($96 – fees) / 100)) = $150.75. Therefore:

• If the price of CRM is less than the $150 strike at expiration, then my net profit will be the original $96 premium I already collected, plus I continue to own the 100 shares of CRM.
• If CRM’s price is above the break-even price of $150.75 at expiration, then I technically lost the dollar difference between $150.75 and the closing CRM price.
• However, if the price of CRM is above the $150 strike price but still below the $150.75 break-even price at expiration, I still made some kind of profit even though the stock gets assigned.

For example:

If at expiration CRM’s closing price was $150.50. It is above the strike price so my 100 shares will be sold at $150/share = $15,000. My loss would be the market value above the $150 ($.50/share = -$50). Add to that loss my assignment fee of $20.95 makes my net loss = -$70.95. But I already received $96 in premiums when I sold the cover-call, so this trade ended up as a profit of $25.05. This trade is actually a win.

85% of Premium

As long as Option Trades are cooking, anything can happen. I will always be at risk to the whims of a psychotic market. But I can end all risks of losing any money by closing ongoing option trades early when I can secure a reasonable profit. The general consciences of what is a fair profit are the 85% rule.

For example, assume I sold one cover-call contract for CRM and received a $96 premium. If before expiration, the CRM stock price had fallen, causing the option to fall to $14.40, then I should buy back the option for $14.40, thus cementing a profit of $81.60 (85% of the original premium). But this begs another question – why would I even want to do this?

There are two reasons why I think the 85% rule is relevant:

1. It takes away the stock skyrocketing risk at the last minute and expires ITM (seen that happen a few times).
2. If I have a max portfolio-risk dollar amount (which I do), closing out of one trade early will allow me to open another trade sooner.

P&L and Performance Status

Net Profit = $1,642.64
Started 79 trades: 38 Vertical Bull Put Spreads, 41 Cover Calls

Profit for Cover Calls $1,233.18

Net Profit: $792.82
Started 15 trades: 6 Vertical Bull Put Spreads, 9 Cover Calls

Max $$$ Available for Spreads (Max Risk): $5,000
Profit from Spreads: $330.27
ROC from Spreads: 6.6%

Net Profit: $128.2
Started 4 trades: 2 Vertical Bull Put Spread, 2 Cover Call

$$$ for Spreads (Max: $5,000): $3,675
Profit from Spreads: $113.10
ROC from Spreads: 6.2%

Profit from Cover Calls: $105.65

Trades Ended 6/28/19

CRM $150cc – 1 contract – Open 6/27 – Expired 6/28 – Net Premium Collected = $95.55
This expired at a closing cost of $151.73 and was assigned. This was a necessary stock sell so the assignment was expected and welcome. – This is a win.

CRM $150cc – 1 contract – Open 6/27 – Closed 6/28 – Net Premium Collected = $23.10
This was a separate contract from the one above and one that I thought I wanted to keep and try again. So, 1 hour before the market close on 6/28, CRM was trading at $150.20. This was above my strike price so I was ITM and anticipating the assignment. But $150.20 was below my breakeven price of $150.75. So I closed this contract by buying it back for a gross debt of $67.00. The end results from this 2-day option trade was a  $23.10 profit, plus I kept the 100 shares of CRM to trade another day…  – This is a win.

Trades Still Cooking

ETF:QQQ $176p/$171p – Open 6/18 – Expires 7/12 – Net Premium Collected = $73.05
Probability of OTM when traded was 84.6%. Now is 91.1%.

ETF:QQQ $176p/$166p – Open 6/25 – Expires 7/19 – Net Premium Collected = $65.05
Probability of OTM when traded was 84.5%. Now is 87.8%

ETF:SPY $280p/$270p – Open 6/28 – Expires 7/26 – Net Premium Collected = $76.05
Probability of OTM when traded was 80.5%.

AMD $36cc – 4 contracts – Open 6/26 – Expires 7/19 – Net Premium Collected = $48.55
The probability of OTM, when traded, was 93.5%. Headroom = 20.5%

New Trades for This Week

Started 4 trades this week

This week’s trading goal:

• 1 vertical bull spread by Tuesday.
• 1 vertical bull spread by Thursday (Thursday = 4th July so this will be Friday).
• 1 1-month cover call by Friday
• 1 1-week cover call (CRM) by Monday (see “Trades Ended 6/28/19”)

CRM $155cc – 1 Contract –  Open 7/1 – Expires 7/5 – Net Premium Collected = $80.55
Probability of OTM when open: 57.8%. Head Room <1%

ETF:QQQ $183p/$173p – Open 7/3 – Expires 7/26 – Net Premium Collected = $54.05
Probability of OTM when opened: 82.0%.

ETF:DIA $257p/247.5p – Open 7/5 – Expires 8/2 – Net Premium Collected = $56.06
Probability of OTM when opened: 81.9%

CRM $155cc – 1 Contract – Open 7/5 – Expires 7/12 – Net Premium Collected = $90.55
Probability of OTM when opened: 67.7 – Head Room 2%

Epilogue

My Exit Strategies for Cover Calls

Consider Closing 1-Week Necessaries:

• If portfolio adjustment is urgent:
  • If the stock price is above the break-even price, let it be assigned. (A loss)
  • If the stock price is between the strike price and break-even price, buy back the contract, then sell the stock outright. By doing this, you are saving trading fees by not letting it be assigned (-$20.95), but instead just paying a trade fee (-$4.95 to buy it back and -$4.95 to sell the stock). (A win)
  • If the stock price is below the strike price, buy it back at a steep discount and immediately sell it. (A win)

• If portfolio adjustment is not so urgent:
  • Follow the same steps as above, except consider selling another 1-Week ATM cover call. Keep doing this until the portfolio adjustment becomes urgent.

Consider Closing 1-Month Income:

• If the premium price to buy back the cover call contract falls below 15% (the 85% rule).
• If the Head-Room falls below 50% of what it was when I sold the contract.
• Last-ditch – if the stock price is above the strike but below the break-even price.

The Two Things I Must Not Be

Premium Greedy:

I need to be psychologically ok with a cover call contract that starts at a $100 profit but ends up at $20. Holding out for every drop of the premium is a sure-fire way of eventually losing big.

Inattentive:

Once I sell a cover call contract, I need to watch every day to see which way the stock price is moving and by how much. If I sell a contract with a 10% Head-Room and halfway through the month, the Head-Room is now below 5%, and then it would be reasonable to think that the stock price is rising faster than I anticipated. Since I want to keep the stock, I need to consider closing the contract while there still is time-value associated with the premium.

Cheers..