How To Decide Whether To Let Covered Calls and Puts Trades Be Exercised Or To Buy Back The Options
The strategy is simple. Pick good under valued dividend stocks. I pick stocks with active and liquid options that can be used to generate weekly and monthly income by selling covered calls and puts.
By Donald E. L. Johnson
Cautious Speculator
Monthly puts and calls options expire today.
Buy calls options back when you don’t want to sell a stock or ETF.
Buy puts options back when you don’t want to buy a stock at the strike price.
Take assignments on calls when you are ready to sell.
Take assignments on puts when you want to buy at the strike.
Monthly puts and calls options expire today.
Traders who have sold puts and calls options can let them expire or buy them back and roll them by selling April 14 expiration options.
For example, if a trader sold Abbvie (ABBV) 3.18.22 $136 puts for $1.17 on 2.22.22, she could buy them back for $0.03. This would slightly reduce the 12.3% annualized RoR. And it would free up the cash needed to secure the sale of, say, ABBV 4.14.22 $150 puts for about $1.64, or a RoR of about 14.4%. ABBV opened at $157.58, down $1.045.
A trader who is deep under water on PayPal (PYPL) has a different decision to make.
In this example, say the trader bought PYPL at $150. It is trading at 113.58. On 3.11.22 he sold PYPL 3.18.22 $110 calls for $0.28. At the moment, the calls are at $3.67. Calls can be exercised at any time when the stock price is above the strike price.
Does he let PYPL be called at $110 and take the $40 loss? Or does he wait until later in the day and hope he can buy back the calls for less than $2? PYPL is up about $1.55. The calls can be exercised at any time.
So the trader is likely to take the small loss on the calls trade instead of a huge loss on the stock, but he might play chicken for a few hours before deciding what to do. In this case, the PYPL price action is saying, buy the calls now.
In cases where a stock may be assigned at a small loss, a trader might decide to let a stock be called or a put to be assigned and move on.
If a stock is called at loss on the stock trade, tax wash laws make it important to not buy the stock back until at least 31 days after the options were exercised. The trades will be officially closed on 3.19.22. So the tax loss date will be 4.20.22, a Wednesday.
When possible, I sell covered calls at strikes at or above my cost. That way, if the stock is called, it is called at a profit and I can buy it back at any time. But when a stock like PYPL is deep in the red, the options aren’t deep enough to let you sell the calls at, say, $150 or higher.
Generally, I let stocks be called and take the profits unless it involves taking big losses or big profits that I don’t want to take. I’ll buy back my PYPL calls at a loss. It will hurt, but not as much as selling the stock would.
When making these decisions, the most important thing to do is evaluate the stock or ETF involved. The current price and trade are what’s important because the price is what it is. PYPL looks like it’s rebounding. So, for now, it looks like a hold or better.
Because usually I can use puts and calls options to reduce my net debit on a trade to break even or better, I’m willing to ride a stock like PYPL down and sell covered calls and puts on it until it bounces back and gives me only a small loss or a nice profit.
If a trader does out of the money (OTM) puts and calls trades on a dozen or more stocks and ETFs, most of the options will close OTM and will not be exercised. If one or two trades have to be closed at a loss, the covered calls and puts portfolios usually will still make money every month.
To lower the risk of assignment, trade deltas (risk of assignment) below 15% to 20%. To maximize profits on calls and discounts on puts, trade high deltas. High deltas provide high returns on risk. Low deltas generate lower RoRs.
Question: Do you have any trades that you’d like to discuss? Please use the comments section below to discuss.
LINKs:
Home Page. See previous articles on other stocks and watch lists. If you read several of these articles, you’ll learn how this strategy is meant to work. No guarantees.
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A video on how to place options trades on Think or Swim.
Beware
Like all investing, trading stocks and options is risky. If you can’t sleep with market risks, you might want to let someone else do your trading. Consider an option trading ETF like XYLD, which I own. I also trade its calls and puts. I’m an active private speculator who trades covered calls and sells puts on stocks for my accounts. I am not a professional analyst nor a financial advisor. I don't take and won't take responsibility for how other people trade. This article is for educational purposes only. It is not advice. The data presented looked accurate at publication time except for intra-day fluctuations, but I can’t guarantee the accuracy. Traders should do their due diligence. I own and/or have options positions on the securities mentioned above. I reserve the right to trade any of the listed stocks and options at any time. I receive no compensation for producing this content.
@realDonJohnson. Because I don’t want to litter subscribers’ in boxes with emails, I write only one or two newsletters a day. I’m active most days on twitter where I tweet about stocks, options trades and other topics.
Don, excellent points you make on the decision--making process of whether for calls, to roll up and out or have them assigned, or for puts, to roll down and out or take assignment.
In December 2021, I bought 100 of MSFT for $330.00 (I actually took assignment of a cash secured put at that strike price believing MSFT would move higher). Of course it didn’t, so since then, I’ve sold a few low-delta (far OTM) calls on MSFT to chip away at my cost basis. However, my latest trade, a 03/18/2022 $292.50 Call, moved into the money yesterday, and today, it has continued rising above that strike.
I did not want to take such a high loss on the stock ($330.00 - $292.50 = $37.50 per share), so I rolled up and out one week to a $297.50 strike. The trade cost nothing (bought back the call for $3.30 and sold the 03-25-2022 call for $3.30), however, this buys me some time.
I’ll have to watch MSFT carefully over the next few trading days. With all the uncertainty geopolitically and economically, it’s anyone’s guess whether in the next few days MSFT will break higher or come back down to support. I’d like to hold MSFT in my portfolio for the long-term, so my thinking is, if early next week MSFT moves higher above its last resistance level of about $303.00 on March 3rd, I’ll sell a long-term call, perhaps out to October 2022, at $340.00 for about $10.00 per contract. However, if it pulls back down, I’ll hold on until next Friday, then sell another far-OTM call.
In any case, you are on point about the types of variables a trader or investor must consider when deciding whether to buy back an option (call or put) or take assignment. A lot depends on the individual investor’s objectives relating to the underlying. It’s a fascinating, and typically profitable (presuming one doesn’t get too greedy) game of probability and statistics.