Covered Calls and Cash Secured Puts (Part 27)

My last post included a backtested example illustrating why rolling is not a risk-free panacea for CC/CSP positions. Did the RO & Up adjustment for a debit truly violate MacDuff’s guidelines?

One thing I find debatable about the annualized adjustment calculations presented in the last post is whether to account for the change in strike price. One of MacDuff’s guidelines is that every adjustment should be done for a credit [ideally at a 15% annualized rate of return]. With MSFT at $20.99, I rolled the May(22) 20 call to Jun(57) 21 call for a debit of $0.24 (including commissions).

Usually when the RO & Up is performed, the strike price is moved OTM to reduce assignment risk. Because Nobody Knows whether the stock will reach the new strike at option expiration, I would not add the change to the return calculation.

In the MSFT example, however, the RO & Up adjustment moved the strike price from ITM to ATM. While I still agree that Nobody Knows whether the stock will reach the new strike price at option expiration, the stock is already there after the adjustment! More specifically, what I am adding to the return calculation is the difference in intrinsic value of the short call because this decrease represents money in my pocket right now:

-$0.24 (including commissions) + $0.99 = $0.75 on the roll for an additional 57 – 22 = 35 days. That amounts to an annualized return of 30.34%.

This seems like a useful rule of thumb by which to determine whether a roll is worth doing especially if the position is profitable. When profitable, the other possibility is to take assignment: “nobody ever went broke taking a profit”

If the position is underwater like the MSFT example, though, then MacDuff says we have no choice but to continue fighting because we should never lock in a loss. In that case, my goal is just to continue rolling out and/or up until the strike price exceeds the cost basis of the trade.

I will continue this debate in my next post.