Rolling Up In The Same Month: A Viable Strategy?

Updated: Jul 2

Question of the Day

One of fellow premium members asked me the following question:

"Hi Hamish, I purchased 100 shares of Service Now at $322.84 on April 29. I then sold the June 5 call for $13.29 ($355 strike). With the stock currently trading at $354.64, should we roll up the option in the current cycle? The call is now trading at $20 mid-price."


To establish a profound analysis of this 'issue', we'll have to put the calculators to work. The reason why I put issue between parentheses is because the share price has run up, indicating this has been a successful trade so far.


Unwinding

Let us first take a look at the initial trade and the expected return before examining the current situation.

(Source: Option Generator Spreadsheets)


Based on the current share price, the one-month return would be 13.97% at expiration Friday, assuming that we take no action. On an annualized basis, this would translate into a stunning 324.62%. Now, let me re-iterate that it's impossible to get this kind of return on every position in your portfolio every month.


On the right side you note the breakeven level of $309.55. Our (unrealized) capital gains on the stock side amount to $31.80. Currently, the $355 call does not have intrinsic value. What's interesting is that the time value left in the $355 call is $20 per share, to 1.549 times the original time value we received. Stated differently, there has been little time decay because of the sharp increase in NOW's share price. Therefore, early assignment is highly unlikely.

(Source: Option Generator Spreadsheets)


If we opt for unwinding the position, our realized gain will be 7.77%, noticeably less than the projected 13.97% as the cost-to-close is 6.20%. We should ask ourselves: is it realistic to assume that we can generate more than 6.20% by the beginning of June? Probably not.

(Source: Option Generator Spreadsheets)


Rolling Up

What about rolling up the strike to generate a higher profit if you expect more share appreciation? We could sell the June 5 $370 call. This would generate a return on the option of 4.34%, still lower than the cost-to-close we'd like to gain back.

(Source: Option Generator Spreadsheets)


The question then becomes: what share price do we need to make up for the time value we lost on the initial trade? $361.24.

(Source: Option Generator Spreadsheets)


Conclusion

There are risks to rolling up in the same contract cycle, namely:

  • Losing the time value that's left in the initial trade

  • A high cost-to-close on the initial position means a higher portion of risk-taking for the second covered call trade (not appropriate for defensive investors who apply portfolio overwriting)

  • Rolling up in the same month reduces the chances of success if the market corrects

  • Buy and hold investors who apply portfolio overwriting better wait until expiration Friday to make rolling decisions

Option Generator AM

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