Systematic Covered Writing
... more than just covered calls!
BUY BACK AND ROLL OUT (BB&RO) STRATEGY CONTINUED
RULES:
Each strategy has its own set of rules. For the BB&RO strategy, there are only two.
The strike price must remain the same.
The premium paid to close the existing option must be less than the premium received for selling the roll out option.
When to Use: This strategy is used as expiration of the existing option approaches with a stock that is continuing to appreciate, and the status of the position is such that a writer would not want the stock sold at the current strike price.
The simplest way to explain this strategy is to use a hypothetical example. Let's pretend that some months ago you purchased a stock and sold a $42.50 call option against it, thereby establishing an Initial Position using the Systematic Covered Writing process. Months have passed and the expiration of the option is approaching. For review, all options expire on the 3rd Friday of the option contract month, and that Friday is known as expiration Friday. As that day approaches you notice that the stock is trading above the $42.50 strike price and you realize that if you just sit there and do nothing, the stock will be called (assuming the value does not decrease).
Rather than going down the DO NOTHING path, you choose to use the SysCW BB&RO strategy. You will need two pieces of information. One will be the option chain for the expiration month, and the other will be an option chain that is two to six months later. One other thing to remember is that you buy an option at the ASK and you sell an option at the BID. These are not magical terms, although they may not be familiar. You BUY for the retail price, but you have to SELL for the wholesale price. The price you can buy an option for is more than the price you can sell it for.
Take a look at the two option chains below. The last column lists the strike prices. The current trading price of this stock is shaded in green. In this case that price is $43.45. Remember in this hypothetical example the option you sold was the $42.50 for this particular expiration month. Now look in the Ask column for the current price. It is $1.55. Knowing this, you can compute what it would cost to BUY BACK the option, which will prevent your stock from being sold! The answer is, (using a figure of $25 for commissions), you will need to spend $180.00. The math . . . (100 * $1.55) + $25 = $180 . . . is simple.
Now take a look at the option chain below the horizontal green line. This chain is for the same stock, just four months later. The option expires four months after the current option. One of the RULES for the BB&RO strategy states that the strike price needs to be the same. Looking at the $42.50 strike price and remembering that this is going to be the new option you will be SELLING, look in the Bid column and find the current price of $4.40 per share. Selling this option would generate $415.00 is new cash. The math ... (100 * $4.40 - $25 = $415 . . . is also quite simple.
Now remember the other RULE for this strategy. The premium (amount of cash) you spend to close the existing option must be less than the premium you receive for the replacement option. If you spend $180.00 to close one and take in $415.00 to open the other, what do you have? You would have $235.00 more than when you started. How long would it take to figure this out? Guess that would depend on how fast you can do the simple math. Five minutes? Okay, say it's ten minutes. Think about it! You entered the Initial Position a number of months ago and generated some cash. How much? It doesn't matter. Whatever you generated is yours to keep.
Now, months later, you spend ten minutes looking up a couple of numbers, enter two transactions and you have another $235.00. Can you do this? Yes. Not only that, but you can do this over and over and over again! This is all part of that keep it simple and make it repeatable idea. The net amount of cash generated per BB&RO will vary from position to position.
There are some that may be thinking this was some kind of a 'set-up' when it comes to the option chains and the example. It could have been, but it wasn't, which brings us to a SysCW challenge. Recall that there are many a naysayer that will say your stock will be sold if the current stock price is above the strike price. SysCW is in the other camp that says . . . don't let them buy your stock, unless you want to sell it. Sorry, but someone has to be right and someone has to be wrong. Systematic Covered Writing states that they are only 'right' if the call writer does nothing. Rather then provide hundreds of examples to settle the issue, you will have the opportunity to see for yourself in just a moment.
You've been shown what to do. Now all you need to see is that YOU can do it. You are going to have that opportunity right here, right now! Here is the challenge. By clicking the challenge link below you will be able to find this month's current cost to Buy Back an option for any stock you want to check out. Then, if you look at an expiration month at least three of four months later and find what you could sell the replacement (Roll Out) option for, you will be hard pressed to find an example where the SysCW Buy Back and Roll Out strategy would not work. It doesn't work just 'some of the time', or 'occasionally', but the BB&RO strategy can be used on almost any possibility an investor can come up with.
Is there a possibility that you could not roll an option? There have been a few times when options cease to exist for a particular company. There are a number of reasons why this can happen. Are you going to 'worry' about the needle in the haystack, or are you going to just accept the fact that occasionally ... stuff happens! You are encouraged to check out the validity of the BB&RO strategy before you review some historical examples.
The point . . . all you have to do in order to prevent your stock from being
sold is to Buy Back the current option and Roll Out several months. How do
you know which month to roll to? Basically, it's just a matter of the
math! You want the time period to be as short as possible, but you want
the difference between the Buy Back and the Roll Out to be significant enough to
justify the transactions. By the way, the lower your transaction costs
(commissions), the shorter the time frame can be (hint hint).
Now it's time for some examples. You'll read this more than once, but please remember that the examples provided are for educational purposes only. It just seems more fruitful to use real data about real positions that really happened, rather than write about 'ABC' company or 'XYZ' position. It may, or may not, be appropriate for you to enter covered positions using the same companies. That choice is between you and your advisor.
