Saturday, September 8, 2007

When to Close a Covered Call Position Early

Occasionally, it's advantageous to close an in-the-money (ITM) covered call (CC) position early and establish a new position. This week I closed two positions early, EBAY and RS. Then I used the proceeds to establish a new position, CTSH, in the same option expiration month. The net effect will be an increase in the original profit of $134, if CTSH is called away on 9/21.

Here are the guidelines that I used for making this decision.

1. The actual profit if closed early should be at least 80% of the original profit potential If Called at expiration.

2. The annualized return if closed early should be greater than the annualized return If Called at expiration, preferably by 5% or more.

3. The amount of profit given back should be less than or equal to $50, the lower the better.

For example, EBAY's original profit potential was:

Net Profit If Called: $139.50
Percent Return If Called: 4.23%
Annualized Return If Called: 27.60%
Days to Expiration: 56 days

The actual profit from closing early was:

Net Profit: $129.50
Percent Return: 3.93%
Annualized Return: 34.99%
Duration of Trade: 41 days

The percent of original return was about 93% (129.50/130.50), the annualized return was increased by 7.39% (34.99-27.60), and the amount given back was $10 (139.50-129.50). So, this met all three criteria for closing early.

For example, RS's original profit potential was:

Net Profit If Called: $198.00
Percent Return If Called: 4.28%
Annualized Return If Called: 48.85%
Days to Expiration: 32 days

The actual profit from closing early was:

Net Profit: $179.00
Percent Return: 3.87%
Annualized Return: 83.13%
Duration of Trade: 17 days

The percent of original return was about 90% (179.00/198.00), the annualized return was increased by 34.28% (83.13-48.85), and the amount given back was $19 (198.00-179.00). So, this met all three criteria for closing early.

Ideally, there should be sufficient time (e.g. a week or more) left in the current expiration month to establish a new position in the same month. However, sometimes you have to go out an additional month for the new position.

The closer we get to options expiration the harder it is to find positions that provide enough return. What's enough return? For me, it's 24% annualized if called or if not called. Also, the amount of return, on the new position, has to be greater than the amount given back to close the previous position(s) to make it worthwhile. Otherwise, you could just let the previous position(s) run until options expiration and get called away, assuming it's/they're still ITM at expiration.

CTSH was an ideal position.

Net Profit If Called: $163.00
Percent Return If Called: 2.29%
Annualized Return If Called: 59.64%
Days to Expiration: 14 days

It had the same expiration month, provided more than 24% annualized return If Called, and the profit was greater than the amount given back on EBAY & RS, providing an extra $134 (163.00-29.00) in profit within the same time frame.

These opportunities don't always present themselves, but when they do you should take advantage of them. This requires monitoring your positions daily. I use a spreadsheet which automatically calculates the return if closed and compares it to the original return. That way I can see at a glance which positions are eligible for an early close. When I find one, I immediately start looking for a new position to establish in the same or the following expiration month. This is one way to increase your profits by taking advantage of what the market gives you.