So the first thing we will consider about position management is what to do when the underlying goes…nowhere. When the price oscillates up and down a little bit the entire contract period and stays below the strike as expiration approaches, we can be happy because our call value just erodes away to nothing due to theta decay. We saw an example of this already in our soft introduction:
Just letting the call value dwindle to nothing is pretty nifty, and is your first strategy over the life of a contract where the underlying does not surpass the strike price.
So Why Do Anything?
If you have a suspicion that the share price might jump up past the strike at some point in the contract (we are expecting our indexes to appreciate long-term, after all) then it would make sense to buy the call back (at a profit to you) after it has decreased in value some amount.1 If you don’t buy back your sold call and the share price rises suddenly past your strike before expiration, then you are going to be forced to sell your shares or adjust your position by buying back your call and selling (or not selling) a new one.
You Down With BTC? Ya, You Know Me…
When you purchase back a call you have sold, this is called “buying-to-close” or “BTC” and it relieves you of the obligation to sell your shares at a certain price— you effectively exit the option contract when you BTC. Additionally, if you sell a call and then buy it back later, at a lower price, it “locks in” profits from the call premium on your overall position.
Uncapping the Gains
One other advantage of BTC is that you have more days with your shares “uncovered”— meaning that the shares do not have a covered call sold against them, and can appreciate without having profits capped at the strike. These uncovered shares can be very helpful because they offer you the chance to have the best of both worlds by making a premium, BTC, participating in share appreciation, and then selling another call at an even higher strike after appreciation takes place.2
Can I BTC And Sell Another Call Right Away to Get More Time Premium?
If you are happy with your strike price, potential share appreciation, and monthly call premiums, then you also have the option to just BTC and simultaneously sell the call with the same strike price for next month. This is called “rolling out”,3 and allows you to adjust your position in one trade, resulting in a net credit to your account.4
“Roll” is a fancy way of saying closing one option contract and opening another. Although I presented it as buying to close and then selling to open another call, these two transactions are done simultaneously as one order with most brokers.
Normally the best reason to roll out instead of BTC and wait would be a situation where the underlying share price begins to drop, and for whatever reason you expect the drop to continue. Rolling out in this case would be better than BTC and wait, because you want to sell next month’s call while the underlying price is high and the premiums are still high. If you wait until the underlying price declines too far, you aren’t going to get much for next month’s call, and may have to go way into the future to make the returns you want.
Next: Article 24– Position Management- Falling Price– BTC
Previous: Article 22– No Action Overwriting
- That specific amount is up to you. You can buy to close at any time if you are happy with the profits. There is no magic point when you should always buy to close that maximizes profits- beware of anyone that tries to sell you that. [↩]
- There is a strong argument here for buying to close and leaving shares uncovered for some portion of time. Capturing additional price appreciation isn’t possible when calls are constantly rolled, as sold calls effectively ”cap” your profits. In general, you should never sell calls against all your shares for this reason— when the market is in bull mode and rises past your strike, portfolio overwriting can and will underperform buy and hold. Unless you are in dire financial straits and would rather sell calls and hope for the possibility of a flat month/pullback than you would cash out any index funds shares, always leave most of the FIRE nest egg uncovered. [↩]
- Rolling “out” refers to a future date. Rolling up or down refers to higher or lower strike prices. This is covered in detail in later chapters. [↩]
- You technically do “pay” to BTC with part of the premium of the new sold call. We do lots of accounting examples of buying to close and rolling (with pictures!) in future chapters. [↩]