by Mike Scanlin

Summary: I bought a stock at 18.41. It dropped 8.7% to 16.81. I should still make a profit by this Thursday (8 day trade).

This story begins last week, Dec 17, which was a Thursday morning before expiration Friday. Market seemed stable and I had some idle cash in my account. Looking to do an ITM covered call two-day trade.

I fire up my favorite covered call screener, set the expiration date Dec 18 and see that US Steel (X) is trading at 18.41 and the options with a strike of 18 are selling for 68 cents. So if they’re called I’ll make 27 cents per share. That’s 1.5% return in 2 days. The stock would have to drop by more than 41 cents (2.2%) for me not to be called, and drop by 68 cents (3.7%) before I’d start losing money.

Trade: Buy 400 shares at 18.41, sell 4 calls (Dec 18 expiration, with strike of 18) for 0.68.

Even The Best Laid Plans

Of course, the following day, Dec 18, stock opens lower and keeps going down all day. I make my first adjustment near the open, to average down my cost. I buy another 200 shares and sell another couple of calls:

Early Morning Trade: Buy 200 shares at 17.71, sell 2 calls (Dec 18 expiration (same day!) with strike of 18 for 0.18 (about 1% for 1-day trade if stock stays flat).

Trade works against me again. Stock drops more. I buy a little more:

Mid-morning Trade: Buy 100 shares at 17.40, sell 1 call (Dec 18 expiration with strike of 17.50 for 0.16 (again, about 1% of a 1-day trade if stock stays flat).

At this point I’m trying to lower my cost so that I can sell another call on the whole lot the following week.

X is not having a good day, and a couple hours later it’s trading at 16.81. I already own 700 shares so let’s average down one last time and make it an even 1000 shares:

End-of-day Trade: Buy 300 shares at 16.81, sell 3 calls for following week, Dec 24 expiration, with strike of 17 for 49 cents (about 3% for a 6 day trade if stock stays flat).

Here are my entry points:

Stock closes Friday for 16.87 and the 7 calls I sold for Dec 18 expiration all expire out of the money.

Partially Covered Over The Weekend

Going into the weekend I own 1000 shares with a cost of $17,689. I’ve received $471 in option premium and currently have 3 contracts with strike of 17, and 700 shares uncovered.

Monday morning, a few minutes after the open, X is trading around 17.13 and I’m looking for a way to turn this money losing trade into a winner. Decide to take advantage of X's mini rise and sell some in-the-money calls:

Trade: Sell 7 calls for Dec 24 expiration with strike of 17 for 0.51.

Now I have 1000 shares all covered with Dec 24, 17-strike options. If called on the 24th I will receive $17,000. My total cash outlay for this trade so far is $17,689 for stock, minus $471 for options sold last week, minus $357 for options sold this week. Net cash outlay = $16,861. I’ve also had $18 in commissions, so total cash outlay with commissions = $16,879.

Today is Dec 22 and pre-market X is 17.48. If it stays above 17 for 3 more trading days then it will be called away and I’ll get $17,000. If that happens my profit (after commissions) will be $121 on a cash outlay of $16,879. That’s less than 1% return over 8 days but annualized its 32%. More importantly, it turned a losing trade into a winner (just over breakeven).

Observations:

1. You can make money with covered calls even if the underlying stock falls.
2. If you plan to have 1000 share position on something, consider an initial purchase of less than 1000 shares so you can average down if you need to. You may not make as much if the stock goes up right away (because you have a smaller investment) but it's conservative and will help you live to fight another day if things don't go well.
3. If a short-term ITM covered call is not exercised, don't panic. There are strategies to work your way out of the position profitably.
4. Sometimes you’ve just made a bad trade. If this stock is not called away on Dec 24th I'll just sell it at a loss and move on. I don’t want something designed as a 2-day quick-hit trade, which has now become an 8-day trade, to become a multi-month losing trade. Better to take a small loss than let it fester into a much larger loss later.

---

Dec 26, 2020, update: Near the close on expiration day X was 16.79 so I bought back the short calls for 0.01 and sold the shares for 16.79 for a final net credit of 16.78. Small loss on this trade ($100) but better than it would have been if I hadn't averaged down or sold the 2nd set of calls. Not a horrible outcome considering the underlying stock dropped 8.8% from my initial purchase of 18.41 to 16.79.

Mike Scanlin is the founder of Born To Sell and has been writing covered calls for a long time.