From the April 2013 issue of Futures Magazine • Subscribe!

How do I protect myself in a rising market when I write covered calls?

Solution: Roll the call up and out

Rolling your covered call up in strikes and out in time accomplishes the same thing as the previous technique, except that you get more time in the covered call position and it opens the possibility to roll the calls for a credit rather than a debit.

To illustrate, consider the following option chain. The front month is identical to the one in the previous image, but now, there are two additional expirations listed. 

Using this option chain, you can perform the same rolling technique as before, except that in addition to moving up in strikes, you also move out in time. The advantage is that you may no longer have to roll your short call for a debit. For example, if you wanted to roll form the 150-strike call in March to the 155-strike call in April, you would:

  • Step 1:  Buy back the March 150-strike calls for $3.80 to close.
  • Step 2:  Sell the April 155-strike calls at $3.80 to open. 

By following the aforementioned steps, you not only would have successfully rolled your position from an in-the-money strike to an out-of-the-money one, but you also would have increased your breakeven level from $153.80 to $158.80, and for no additional cost.

Now what if you thought GS was poised to move even higher? You could roll your covered call position even further out in time. For example, if you wanted to roll from the 150-strike call in March to the 160-strike call in July, you would:

  • Step 1:  Buy back the March 150-strike calls for $3.80 to close.
  • Step 2:  Sell the July 160-strike calls at $5.15 to open.

With this roll, you would have moved your short call position even further out-of-the-money, you would have increased your breakeven level from $153.80 to $165.15 and you would have collected a credit of $1.35, or $135 per contract.

    The covered call is a very popular strategy among money managers, and for good reason: It has been shown not only to be able to enhance standard market returns, but to do so potentially with less portfolio variance. In strong markets, as your stocks continue to outperform the limits set by your covered calls, you may just want to allow the stock to run uncovered. Of course, if you decide to keep the covered call position, then knowing how to roll your calls can give your portfolio some much-needed breathing room. Furthermore, rolling up and out can give you breathing room without having to shell out extra money. 

Alex Mendoza is a former CBOE market maker trained by Susquehanna International Group, and founder of option education firm OptionABC.com. Alex has written extensively on options and has presented option seminars around the globe.

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