Unwinding Covered Calls When They Are Deep In-The-Money

Updated: Aug 6, 2019

Besides taking action when the share price of the underlying security we sold options against starts to depreciate in value, we should also factor in the opportunity of potentially closing our position much faster than initially anticipated. As I've discussed in an article about unwinding our short puts, it's now time to scrutinize unwinding covered calls. It's quite special to buy back an option with a value greater than our sales price and that's the main argument why retail investors hesitate to enact this strategy. Let me explain the concept of unwinding utilizing the following example with Alteryx.

  • On June 9, 2019 shares were trading at $99.57 and the out-of-the-money calls were sold with a strike price of $105 expiring on July 19, 2019 for $2.14. There was no upcoming earnings date during that contract cycle.

First, our initial returns perfectly met our guideline of at least 2%. Including upside potential, the trade should - theoretically - produce a maximum return of 7.65%. So, if the price goes up to the strike or higher, we won't get our hands on upside BEYOND the strike. However, if we close the trade and generate another income stream, we can improve that maximum return by leveraging a completely NEW trade.

Including upside potential, a mammoth annualized return of 69% could be generated if the price is at or higher than $105 on expiration Friday.

  • By July 7, Alteryx shares had shot up to a humungous $118.07, leaving our short calls deep in the money at $13.78.

So, the trade turned out much better than we foresaw. Despite the fact that our short calls are now deep in the money and thus are trading at much higher levels than our sales value, is there a way we can put our cash even more efficiently to work and generate a second income stream in the same month (12 days before expiration Friday) ? Let's take a look at the calculations to verify whether exiting our trade before expiration Friday would make sense.


First and foremost, why was Alteryx an extremely attractive candidate for our system? The no. 1 rule is that shares must be trading above the SMA20 with the 20-day moving average above the longer-term 50-day moving average. There was a breakthrough backed by noticeably higher volumes, while the Slow Stochastic Oscillator entered positive territory, along with a bullish MACD line and ascending bars. Less than a month later, shares crushed the $118 barrier but then started to zigzag with declining volumes, negative divergence in the Stochastic Oscillator, the MACD which turned negative and descending bars.

Recapitulating the items discussed above, the option we sold became deep in-the-money, the technical conditions weakened. So, we maximized our profits but we now own a stock that will very likely underperform the broader market or go nowhere. In other words, does it make sense for us to keep the stock, knowing it's 'dead money' with less than two weeks left before expiration Friday? Just buying back the option and getting rid of the shares may be a good solution to react to this dilemma.

What will be our actual time value cost-to-close and can we generate a greater return than that cost-to-close in a completely new position in the two weeks remaining in the options cycle? The actual cost-to-close is 0.71%, while we have a REALIZED PROFIT of 6.89%. The time value component left in the option right now is just 5.15% of the total premium. The return we lost is reasonable to make up for. For example, if the cost to close is 0.5% and we can generate a 1.5% initial profit in a new position, it is worth considering (like with this trade). If not, we just wait for our shares to get called away (while enjoying plenty of profit protection), or we close our positions on expiration Friday. Under certain circumstances, if the stock still meets our system criteria, the technicals remain favorable and there's no upcoming earnings report, we might consider rolling our options to the next month's period.

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