What Next?

Covered call writing can be simple or complex, depending on your approach. Through the selection of the underlying stock to buy and the particular call option to Sell, the strategy can be tailored to a multitude of different risk levels and market conditions, as well as a variety of goals and approaches.

In the process of creating a covered call writing, one will discover that it alters not just the risk/reward parameters of your stock investment but the way you invest as well—your selection process, your expectations, and your follow-up activities. You may feel that it is not necessary to monitor a covered write as closely as a stock position by itself, and that is generally true. However, you should remember that the option has a limited life and that you will need to take follow-up action at some point. Follow-up actions can be taken at any time, even before the option expires, and may be warranted if the stock moves sharply or if you have reason to believe it may do so.

The follow ups are:

Doing Nothing until Expiration

Once you create a covered call position, you need not take any further action, even at expiration. You can do absolutely nothing—you don’t even need to be around. There is nothing about a covered call that adds any more risk than if you simply owned the stock. At expiration, the option will do one of two things: expire worthless or be exercised. In case the option goes worthless, you get the full credit to yourself. On the other hand, if the option is exercised, you give away your stock, just losing a notional upside.

Closing Part or All of the Position

There can be numerous reasons why you might want to close or modify a position before expiration. News affecting the stock may become public, or you may need the money for something. The reason is irrelevant. The ability to adjust your position on the fly is one of the great benefits of covered writing.

One alternative is to close out part or all of your position. You can do this

whenever you want, provided you have Of course, in closing, you will incur transaction costs and may realize a loss on one or both sides of the transaction, so you do not want to do intraday trading of covered calls. But when the necessity arises, the ability to close is there.

Rolling Options

While closing the entire covered write is sometimes justified, more often,

you will decide to hold the stock and close only the option or roll your call

position. Rolling refers to the process of closing out the short call position and opening a new one in its place. Think of it as simply substituting different calls for the ones you are currently short. This allows you to adjust the risk/reward potential of your position while leaving the stock holding intact. This can be done by:

• Rolling up: Substituting a call with a higher strike price. When, you feel that the stock could move even higher in the coming days, you can adjust your position to allow you more upside potential by rolling up the strike. In this way, one gets benefit of higher upside on the stock and lower risk of assignment.
• Rolling down: Substituting a call with a lower strike price. The rationale for rolling down would be that the stock has declined and

you are willing to give up some additional upside potential in order to protect your underlying position more on the downside.

• Rolling out: Substituting a call with next expiry. Rolling out (i.e., keeping the same strike price and neither rolling up nor

down) has less to do with movement in the stock than with time. The most common situation in which you would do this is when you are approaching expiration. When rolling out at the same strike price, you will always take in more money than you spend, because the more distant option will inevitably have more time value.

Happy Trading!!!

Cheers.