Closing your Covered Calls early

by Wayne Ferbert on June 26th, 2013

If you remember, in Fall 2012, we wrote about how the low overall market volatility was making it hard to sell monthly calls to earn some income. We like to use that monthly income to pay for our long-dated hedged protection. But the premiums were so low, you needed to go much too close to the market to get the premium to pay for the hedges.
Our fix at the time: align your covered calls with expirations that match your laddered long-dated puts. This way, you locked in exactly how much of the put you would be able to pay for right out of the gate.
If you have been following that approach, then you likely have some 2nd-half 2013 and maybe even some 2014 calls that you have sold against our favorite ETFs.
If that is the case, you should quickly take the opportunity, while the markets are at these lows to close the calls that have already made a lot of their profits. Think about the trade off: you sold these calls to generate the premiums to pay of the hedges. The trade off was that you give up the upside above the strike on the call.
You expected these short calls to degrade in time value over months as the way to earn those premiums. The market has offered you this temporary reprieve where the calls dropped in value precipitously – and therefore is handing you that premium early.
You should take it as the gift that it is. And now you have already earned the premium – and you can sit back knowing that you can pretty much earn all of the upside in stock now if it runs up as you approach your put expirations.
A general rule of thumb: close any covered call position that expires in September or later if it has earned more than 80% of its value. For August or July expiration, you should close anything that has earned 95% of its value. For anything that expires in 2014, consider closing it if it has already earned at least 60% of its value.
With these calls closed, you can look at re-setting new covered calls in a few months to earn even more premium – just wait out the market here for a little bit so you can see whether the market picks a definitive direction.

Posted in not categorized    Tagged with no tags


Leave a Comment