TUTORIAL: COVERED CALL STRIKE IMPROVEMENT VIA ROLL AND FINANCING
One of the primary reasons people poo-pah covered calls is because they cap out max profit. There are two things these naysayers overlook and they are (a) you can roll out your short call for duration and credit, thereby decreasing your cost basis and increasing your potential max profit; and (b) you can always "finance" short call strike improvement, albeit at the cost and risk of doing an additive adjustment trade in the event that you can't improve the strike satisfactorily.
Pictured here is a deep in-the-money SPY December 18th 255 covered call. If I do absolutely nothing, my SPY long shares are going to be called away, if not at expiry, then earlier by someone exercising their long calls. Say, however, I want to stay in the stock, as well as improve my cost basis and the short call strike such that my max profit potential is increased by the amount of strike improvement.
As previously mentioned, there are a couple of ways to do this. The first is to look at merely rolling the short call out in time and examining whether the strike can be improved while still getting a credit. One thing you'll immediately notice when you do this with the December 255's is that the strikes are five wides so that if any improvement is going to be made, it will have to be from the 255's to the 260's or higher. With the December 18th 255's going for 50.85 at the mid, I'll have to look at 260's in an expiry in which they pay more than 50.85 to get a credit on the roll, and the first expiry in which that occurs is in January of 2022 where the 260 is paying 51.00 at the mid price. In other words, I'd have to roll the calls out a whole year to improve them by five strikes, all for a measly .15 ($15) credit. That being said, I also increase my max profit potential by the width of the improvement (5.00) plus the credit received (.15) or for a total of 5.15, so that is not entirely a bad thing were I to do that. It is also the most straightforward way to improve your short call strike without adding risk or tying up additional buying power.
If, however, I'm not big on rolling out that far out in time, I can also looking at financing the strike improvement via an additive trade for which I receive a credit that exceeds the cost of the strike improvement, with the down side being that any additive trade has its own buying power effect and side risk.
Here are a couple of examples:
Roll the December 18th 255 up to the December 18th 265 for a 7.40 debit and sell the December 18th 240 put for a 7.64 credit. I improve the short call strike by 10.00 and receive a net credit of .24 (7.64 - 7.40). Net delta of the position increases from 20.99 to 42.18.
Roll the December 18th 255 up to the December 18th 269 for 10.37 and sell the December 18th 240/343 short strangle for 10.44. Here, I improve the short call strike by 14.00, and receive a .07 credit to do it. The net delta of the position increases more modestly from 20.99 to 28.02 because the short strangle is delta neutral, with all of the net delta pickup coming from the roll of the short call.
Pictured here is a deep in-the-money SPY December 18th 255 covered call. If I do absolutely nothing, my SPY long shares are going to be called away, if not at expiry, then earlier by someone exercising their long calls. Say, however, I want to stay in the stock, as well as improve my cost basis and the short call strike such that my max profit potential is increased by the amount of strike improvement.
As previously mentioned, there are a couple of ways to do this. The first is to look at merely rolling the short call out in time and examining whether the strike can be improved while still getting a credit. One thing you'll immediately notice when you do this with the December 255's is that the strikes are five wides so that if any improvement is going to be made, it will have to be from the 255's to the 260's or higher. With the December 18th 255's going for 50.85 at the mid, I'll have to look at 260's in an expiry in which they pay more than 50.85 to get a credit on the roll, and the first expiry in which that occurs is in January of 2022 where the 260 is paying 51.00 at the mid price. In other words, I'd have to roll the calls out a whole year to improve them by five strikes, all for a measly .15 ($15) credit. That being said, I also increase my max profit potential by the width of the improvement (5.00) plus the credit received (.15) or for a total of 5.15, so that is not entirely a bad thing were I to do that. It is also the most straightforward way to improve your short call strike without adding risk or tying up additional buying power.
If, however, I'm not big on rolling out that far out in time, I can also looking at financing the strike improvement via an additive trade for which I receive a credit that exceeds the cost of the strike improvement, with the down side being that any additive trade has its own buying power effect and side risk.
Here are a couple of examples:
Roll the December 18th 255 up to the December 18th 265 for a 7.40 debit and sell the December 18th 240 put for a 7.64 credit. I improve the short call strike by 10.00 and receive a net credit of .24 (7.64 - 7.40). Net delta of the position increases from 20.99 to 42.18.
Roll the December 18th 255 up to the December 18th 269 for 10.37 and sell the December 18th 240/343 short strangle for 10.44. Here, I improve the short call strike by 14.00, and receive a .07 credit to do it. The net delta of the position increases more modestly from 20.99 to 28.02 because the short strangle is delta neutral, with all of the net delta pickup coming from the roll of the short call.
