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Friday, November 6, 2009

Covered Calls Position Management -- When to Roll

Does covered calls investing have any inherent advantages over a basic buy-and-hold strategy? That is, whenever we analyze our own investing methods, it is important to try to identify advantages that our own methods might have when compared with other approaches. The Covered Calls Advisor's term for this thought process is identifying our 'investable edges'.

Do covered calls provide us with any investable edges? This advisor has observed that many covered calls investors have transitioned to covered calls after having been primarily a stock market buy-and-hold type of investor. This evolution is a natural one because when compared with buy-and-hold, covered calls have an edge for investors who seek to reduce risk while still retaining an opportunity to obtain a competitive overall rate of return. This 'investable edge' is achieved primarily from the immediate options income cash flow that is received each time call options are sold when establishing a covered calls position.

Compared with buy-and-hold, are there any other 'investable edges' that the covered calls investor has? This advisor says "Yes".
Another 'edge' is available from disciplined covered calls position management. The 'investable edge' provided by this active position management can be exploited by the process of 'rolling' an existing covered calls position at an opportune time -- but just when is an opportune time for rolling an existing covered calls position to a new covered calls position? This is the question addressed in the remainder of this article.

First, for the sake of clarity, let's briefly define terms. What exactly is meant by 'rolling' a covered calls position?
On page 70 of ‘New Insights on Covered Call Writing’ by Lehman and McMillan, they succinctly define the relevant terms:
“Rolling: The process of closing the short call position in a covered write and opening (substituting) a different covered call position on the same stock.
Rolling Up: Substituting a call with a higher strike price.
Rolling Down: Substituting a call with a lower strike price.
Rolling Out: Substituting a call with a more distant expiration.”
‘Rolling Up and Out’ would be the combination of simultaneously ‘rolling up’ and ‘rolling out’ -- for example, ‘rolling up and out’ from the XYZ Nov2009 $50s to the XYZ Dec2009 $55s.

Now, the crucial question: When should we 'roll'? This is one of the most popular topics raised by members of the 'justcoveredcalls' Yahoo Group site. Yet despite the numerous occasions that this topic has been broached and the numerous responses posted, this question continues to frequently re-appear -- it just keeps coming back! Why?
I believe it is because it is difficult to develop a set of relatively easy-to-apply decision-making rules for this relatively complex question.
My own thinking on this question is a testimony to this difficulty. In the short two year history of this blog, this will be the Covered Calls Advisor's third post that attempts to specify a workable approach to 'rolling'. Both my first (link#1) and second (link#2) articles on this topic were reasonably solid approaches to aid our decision-making process concerning when to roll an existing covered calls position. But the specific criteria developed were too cumbersome to be followed easily and consistently.

During the past six months, the Covered Calls Advisor has been testing numerous covered calls positions with the objective of developing a set of criteria for rolling that would have the dual benefit of:
(1) achieving net incremental returns in comparison with simply always holding our existing positions until expiration; and
(2) being reasonably easy to apply.
The criteria described below are the result of this effort and are as close as the Covered Calls Advisor can currently come to achieving both objectives.

The guidelines that will now be used by this Covered Calls Advisor to determine when and how to 'roll' any existing covered calls position are as follows:
1. Roll up(down) when the current equity price is more than 10% above(below) the current strike price; and
2. Make the roll transactions when the current equity price is very close to the new strike price (within + or - $.25 of the new strike price) -- i.e. very close to at-the-money; and
3. Roll (within the same expiration month) if more than 1 week (7 calendar days) until expiration. Roll out to the next expiration month if 1 week or less from the current expiration.

In the interest of brevity and simplicity, a detailed explanation of why each of these three guidelines are what they are will not be presented at this time. For now, suffice it to say that when initially establishing a new covered calls position, this advisor advocates establishing positions with short-term (i.e. nearest-month) expirations. Consequently, in a practical sense, the relatively large 10% price change threshold required in #1 above is likely to result in relatively infrequent rolling transactions.

If you have any comments or questions on this article or on any of the three criteria presented, please feel free to submit them by clicking on the 'comments' link below. If you prefer confidential communications, my email address is listed at the top-right sidebar of this blog site. Your comments are always welcomed.

Regards and Godspeed,


  1. Jeff,

    I am planning on writing the second installment of my covered calls investment guide on my blog, and I was wondering if you have a word copy of your most up to date investment strategy that I can use as a source to integrate.



  2. Jake,

    The articles in the right sidebar on my blog in the "Covered Calls Processes" Category provide the best description of my investing processes. I have not tried to compile them into a single manual (it would probably require a book to do it justice) -- which definitely won't be happening anytime in the forseeable future.


  3. Jeff,

    I looked thru my positions to see if any CCs are near-term and meet your conditions for rolling. One that does is SOHU and that seems to be a common position with you. But looking at your Blog I don't see that you have rolled this position. How come?


  4. Gary,

    Very valid challenge -- I should practice what I preach! Just finalized my criteria yesterday when I made the post, so I will begin to apply these criteria on Monday. Note: SOHU a good roll-down candidate at $55.00 strike if stock trades between $54.75 and $55.25.


  5. Jeff -

    Picking up on Gary's SOHU example, I purchased this stock @ about $62 in late July, and currently have about a $6.50 per share book value loss. How would this capital loss affect a decision to roll down, or should it even be a factor in the analysis?


  6. Dick,

    I know it seems counter-intuitive, but the answer to your question is that it should not be a factor in the decision. Read my comments related to the concept of 'sunk costs' on my two prior posts (i.e. link1 and link2 embedded in this article) -- hopefully that will help to clarify why original purchase cost should not be a factor. If further clarification is needed, email me at and we can discuss in further detail.


  7. Jeff

    Great blog!! I just found it thru the yahoo group Justcoveredcalls, I am a member there. Even tho my strategy uses buying options rather than selling them, I have already learned a lot from your blog, namely this article that discusses rolling out of options.

    One question: is there any advantage to rolling out long calls/puts? I currently hold a SPY Dec 108 put, and am starting to think I should have bought Jan instead. Not sure if I should just sell the Dec and buy the Jan. thx for any info on this, Mike

  8. Mike,

    I'm pleased you have found this blog and are finding it useful so far. I won't provide you any suggestions on managing your long option positions since my preferred strategy involves only selling options (never buying). Academic research has convinced me that over time, options buyers achieve net losses whereas options sellers achieve net profits. Since our investing objective is to buy appreciating assets (such as stocks) and sell depreciating assets (the time value inherent in options prices make them depreciating assets). My preferred strategy, covered calls, takes advantage of both of these situations. As you continue your study of investing strategies, perhaps you will come to a similar conclusion as I have in this regard.
    Best wishes in your investing,

  9. I think in determining investment decisions which relates to this discussion the key question is - Were I to come across some extra cash at the moment would I buy this stock? (this ignores the criteria of diversification, I know.) Too often investors become, in my opinion, emotionally attached to stocks where the company's performance has not equaled the goals one had when one originally purchased the company. It all comes down to admitting that we are not (and cannot be) 100% right all the time.. There are times when we should roll up and out and stay with our winners, but if a stock does not perform as well as we had at first hoped we should treat it like a cancer in the body and get rid of it as soon as possible and look for greener fields to invest our necessarily scarce resources.. Even Mr Buffett at Berkshire presumably does not have all the money he would like to invest and has to choose between which are the strongest and fastest horses.. This is not to say that if the whole market goes in for a correction that so long as one's stocks behave in line with the whole market we should necessarily sell..