Rescuing Stock From Being Exercised Through In The Money Covered Calls – Investor Questions

Rescuing Stock From Being Exercised Through In The Money Covered Calls – Investor Questions

This article is from the USA Members section. It pertains to rescuing a stock that has in the money covered calls sold against it that is valued at under $5.00. As the Toronto Stock Exchange has quite a large number of such stocks, especially in commodity related sectors, I felt this article would be of interest to Canada Members as well.

On my Yahoo Forum a conversation was underway on how to rescue a speculative stock Hecla Mining Co which trades under the symbol HL from being exercised away. The investor bought 1000 shares of stock and sold covered calls which are now in the money leaving the stock open to exercise but they want to retain ownership and enjoy further profits if the stock continues to rise.

Below is the question from the investor. I have added some details to provide full information on this trade. The investor has 1000 shares of HL stock and has written covered calls against all shares. The stock has risen above the call strike sold and the investor would like to hold onto those shares. Let’s review the question.

Investor Questions

A neighbor’s daughter asked me for help on HL and I think I came up with one. However, I can’t remember the last time I tried this and would be grateful for a critique. She owns 1000 shares of HL and sold 10 CC’s at the 2.50 strike set to expire this week (June 19). HL is currently at $ 2.95. Looking at HL it appears she will be exercised. My suggestion is to roll the 10 June 2.50 calls out to 10 July 2.50 and buy 10 puts for July at 2.50. This collar is much less expensive than exercise and salvage the stock ownership. Her account is $8400 in total and she sold 10 calls on HL for 2.50 call strike that expire 19 June. Bob.

My Answers

The first thing to mention is that buying the July $2.50 put strike will not result in the investor not losing her shares.

When an investor wants to retain stock ownership and is selling covered calls for income only, they should never sell calls against all the stock held. For example, this investor has 1000 shares and sold covered calls on all the shares. Instead if this investor had covered just half of the shares she could have used the uncovered shares to assist is rescuing those that ended up in the money. At the very least, by not having all shares with covered calls, she would have participated in more upside and still have earned some income on the remaining shares which would be exercised.

In the case of this investor, with the stock at $2.95 and expiry on June 19 the chance the shares will be exercised is presently very high. The only way they will not be exercised is if HL Stock falls below $2.50 which will leave the covered calls sold, out of the money and free from possible exercise.

Rolling The Covered Calls Forward

One way to avoid being exercised is to roll the covered calls forward. Normally rolling calls forward means trying to roll them higher. To do this profitably means moving further out in time, but in the case of stocks trading for under $5.00, often rolling forward and up profitably can only be done over long periods of time which means the capital in use is earning less income than it probably could, because it is tied up for an extended period of time.

In the case of HL Stock, the June 19 expiry $2.50 call strike can be bought back for $0.52 cents. The investor could roll to July 17 expiry at $2.50 for .47 cents which means a loss on the trade. Rolling up to July 17 expiry $3.00 call strike would earn .12 cents. This means rolling up to $3.00 one month out will lose profit in this trade and then if the stock falls back the investor will have added losses to their position. The September 18 expiry at $3.00 would earn .24 cents which is certainly better than July, but still would result in a loss on a roll-up.

The Jan 15 2016 expiry $3.00 call strike can be sold for .37 cents which still results in a loss. Therefore rolling up for this trade will result in a loss. As long as the stock moved higher following a roll-up, then rolling up and taking a loss to do so, would make sense, however if the investor rolled up, took a loss on the roll-up and then watched the stock fall, they basically rolled up when it was not necessary.

Sell Naked Puts

If the investor loves the stock and is simply disappointed that the stock has moved higher beyond their covered calls at $2.50, she could consider selling the July 17 expiry $3.00 put strike which could earn .17 cents. While it is not a lot to earn, it would mean if the stock stays above $3.00 by June 19, she would be exercised from her shares and lock in whatever profit selling the $2.50 calls created and if the stock stayed above $3.00 by July 17 expiry, she would also pick up another 17 cents through having sold the $3.00 put strike.

On the other hand, if the stock closed on June 19 above $2.50 she will be exercised from her 1000 shares and pick up whatever profit she has made. Then if by July 17 expiry the stock is below $3.00 she would be put or assigned 1000 shares at $3.00, with an average price of $2.83. This would allow her to sell covered calls at $3.00 for further gains in the stock into August or September.

While selling naked puts does not guarantee her being reassigned shares, it does assist in either case in her earning extra income in the trade.

Buy More Shares

Another easy method to retain shares is to buy more shares. At present this investor has $8400 in her portfolio with $2500 tied to this stock. She could immediately buy shares and set up a number of different strategies. The best two for this investor would be:

Strategy 1

Calculate the cost of the covered calls to buy back. In this case the cost to buy back the $2.50 strike covered calls will be .52 cents X 10 = $520.00. Then decide what call strike to sell next. Then calculate the cost to roll up profitably and buy additional shares to add in the required number of shares to keep the trade profitable. For example if this investor decided she wants to roll up to $3.00 for July 17 expiry she would earn .13 cents on selling the $3.00 call. Take the cost to close the June $19 call which is $520.00 and divide it by $13.00 which equals 40 which means she will need to own 4000 shares. She already owns 1000 shares so she will need to buy 3000 more shares. This will require more capital than she has available.

Therefore if she wants to roll up she needs to consider going further out in time. She could go out to September 18 expiry which would earn 24 cents. Taking $520.00 and dividing it by $24 equals 21.6. That means she would need 2200 shares to break even in a roll up to $3.00. As she already has 1000 shares she will need to buy another 1200 shares. She has enough capital to do this and it would place her trade at the $3.00 strike.

There are other factors to consider of course, including whether this investor likes the stock enough to risk more capital in the trade.

Strategy 2

The second strategy is to replace the 1000 shares that will be exercised with an additional 1000 shares. By Friday of this week (June 19), if HL Stock stays above $2.50 her shares will be exercised away. She can however replace these shares immediately through a purchase and sell covered calls at whatever strike she wants. This effectively allows her to hold onto her shares and the cost difference between what she earned on the covered calls and the cost to buy the shares back will be reasonably small. In other words if when she sold the calls and she had earned 25 cents, she basically would be selling her shares upon exercise for $2.75. If she bought stock on Monday for $2.94 and then sold the July 17 expiry $3.00 call for .13 cents, she is actually paying $2.94 less 13 cents = $2.81. The actual loss on the repurchase of 1000 shares would be 6 cents per share or $60.00. She would then own once again 1000 shares and be holding the trade against covered calls at $3.00.

Summary

These are a few strategies this investor could consider. There are other strategies as well but for HL Stock the best advice truly is to consider the stock itself and what the investor would like to accomplish. Whenever a trade is made an investor should have a goal and a plan on how to reach that goal. For HL Stock, the past three-year chart below shows how volatile the stock has been. When the investor bought this stock and then sold covered calls, perhaps the best advice is to take the profit and then wait for another opportunity such as a dip in the stock to buy the shares again and trade them for another profit.

HL Stock to June 12 2015

HL Stock to June 12 2015

Selling covered calls against all shares an investor has bought normally indicates a decision to accept being exercised from the trade. Rolling covered calls forward to avoid assignment is a strategy often used, but it should only be used when there is a profit to be made and there is little risk to the capital being exposed for a longer period in the trade.

Often investors who roll covered calls forward but have to go out far in time to keep a roll-out profitable, end up with a stock either higher or a collapse lower. Either way the outcome can turn out to be undesirable. This makes the rolling process a poor choice.

In the case of HL Stock, rolling out to January 2016 to make a roll-out profitable means the investor is earning a very small amount to roll far out in time, and is probably going to earn less by rolling out than they would by accepting exercise and then getting their capital back working again in either this trade or another one.

There is a lot to consider when investing and using options to assist in generating extra profits. But the deciding factor should always be how best to apply the capital at risk. In other words, what is the best way to grow the capital quickly.

If by rolling out many months to try to hold onto shares, an investor gives up better profit making opportunities, then rolling out is obviously never the best choice to make.

Investing is about growing capital and a portfolio safely and quickly. That should always be the focus.


Disclaimer: There are risks involved in all investment strategies and investors can and do lose capital. Trade at your own risk. Stocks, options and investing are risky and can result in considerable losses. None of the strategies, stocks or information discussed and presented are financial or trading advice or recommendations. Everything presented and discussed are the author’s own trade ideas and opinions which the author may or may not enter into. The author assumes no liability for topics, ideas, errors, omissions, content and external links and trades done or not done. The author may or may not enter the trades mentioned. Some positions in mentioned stocks may already be held or are being adjusted.

 

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