The Covered Calls Expire this Week


For those following my covered call writing saga, we’re coming down to the wire.  The calls I wrote on BJ’s Restaurants expire next Friday.  Since this is the last week and they are “in the money,” meaning that they are above the price the person who bought the calls can purchase them for, chances are good that they will be purchased this week.  It would probably happen at the last minute, but because they are American style calls, it could happen at any time.

As I always seem to find when I deal with options, there was one point where I could have jumped out if I’d been very deft and done well.  A few days after I sold the calls the share price of the stock dropped down into the low $33 range and the calls went from $1.40 each to $0.25 each.  I could have made maybe $0.90 per call after brokerage fees in only a few days – not bad.  The question at that point, however, was whether the stock would stay down, or go down further, in which case they would expire worthless and I could save the brokerage costs by staying put.

Of course, the stock instead rallied over the next few days, pushing the price of the calls back up somewhat — although not as high as they were — and making it likely that the stock will be purchased.  This isn’t a terrible thing.  I purchased the shares around $31 per share, so I’d make a nice profit and get to keep the proceeds from the calls.  I’m just not sure I want to sell at this point, so I’m looking at my options (pun not intended).

At Friday’s close, the stock was at $36.53 per share.  The May 35 calls I wrote were at $1.66 per call.  Note that their price is getting pretty close to the difference between the stock price, $36.53, and the strike price, $35.  Because there is not a lot of time left before they expire, the time value of the options is decreasing towards zero. (Time value is the value of the options beyond the difference between the current price and the strike price due to the fact that the speculator may be able to make money by purchasing the options and using the leverage they provide to make bigger percentage gains than they would by simply buying the stock.  The closer you get to expiration, the less likely that is to happen.  Another way to think about this is as the premium you pay for insurance that you will be able to buy the shares for the strike price.  Like any insurance policy, the less time the policy covers, the less valuable it will be.)  With only a week to go, the stock will probably close above the strike price on Friday, although this stock does move quite a bit so there is a chance it will not, especially if the rally we’ve been having falters.

Here are my options:

1) Hold pat and let the shares be purchased for $35.  I would make a profit of about $4 per share plus the $1.40 premium on the options.  I confess I would kick myself if the stock then proceeded up to $40 per share or something, although I do have additional shares.  I would be happy though if they fell back into the low $30 range where they had been trading and I could buy them back for less than for what I sold them.

2) Buy the options back, take a loss on the options, and hold the stock.   I could buy a set of May calls to offset the calls I wrote and close the position.  At $1.65 each I would take a loss of $0.25 per option plus a couple of hundred dollars in commissions, but this would be less expensive than selling the shares and then buying them back again.

3) Roll the options into June or July.  The June $35 calls are currently selling for $2.05 each and the July calls are selling for $2.55.  I could buy back the May calls and then write the June or July calls.  This would net an additional $0.40 per call for the June calls or $0.90 for the July calls, before commissions.  After commissions it would probably be $0.20 and $0.70 per call for the June and July calls, respectively.  This would be a good move if the stock stagnated and especially if it fell since the premiums I would receive would offset part of the loss from the drop in share price.  Given the big gains stocks have made this year, that might be a good move since they may be due for a breather.  Then again, if the stock continued up, I’d have an additional month or two to  wait while my short position grew ever bigger.

4) Roll both out in calender date and up in price.  I would write July $40 calls and buy back the May $35 calls.  The July $40 calls are selling for $0.40 per call, so this premium, combined with the $1.25 per call I received when I wrote the May $35 calls would just cover the cost of buying back the May $35 calls.  If the stock continued upwards, I’d be able to make an additional profit until the stock crossed the $40 mark.  If the shares fell, however, I really wouldn’t have any additional protection.

Right now I think I’ll go ahead and let the stock get sold.  As I’ve said, I have additional shares beyond those on which I wrote the calls, so if the stock keeps climbing I will make a nice additional profit, so things wouldn’t be so bad.  If the stock falls back down, I can use the cash I got from the sale to buy more shares at a lower price and maybe write some additional calls.

I can’t help thinking though that I’d have been better off just holding the stock.  If the shares sell at $35, I will make a profit of about $400 per 100 shares from the appreciation on the stock plus $125 per hundred shares from the options, for a total of $525 per hundred shares.  If I had just held the shares, I could sell them for $36.53 per share right now and make about $553 per hundred shares.  I would probably be feeling differently if the shares had stayed below $35 per share since I’d be getting some income despite the fact that the shares were going nowhere, but it seems like I can usually do better just holding the shares.

My father used to say that if your broker sends you a Christmas card, you’re trading too much.  It seems like writing covered calls results in trading too much, often generating more for your broker than you receive.  Then again, maybe the way to look at them is a way to lower your risk, much like buying bonds.  You give up a bit in potential return versus holding a basket of growth stocks outright since your gains will be limited when stocks are going up, but you feel better when stocks are stagnant or going down somewhat since you either make a decent return (better than bonds) or don’t lose as much.  Theoretically you could do better writing covered calls than you would holding index funds since the potential returns are around 20 to 25%, versus 10-15% for the market in general, but it seems like holding individual stocks – the right stocks – provides the best return.  The problem is finding the right stocks.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

One comment

  1. My strategy would be to let them be called away. You chose the profit you wanted when writing the call and missed the buy-to-close opportunity when the shares fell to $33. You end up with a profit that can be invested elsewhere and still have some leftover shares in case things really heat up, but like you said that is unlikely in the upcoming months.

    Its May so closing a call with a sale isn’t the worst thing that could happen

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