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Two Weeks Until Options Expiration, What Do I Do?

[this was originally posted on my blog Sunday evening, all prices are current as of COB Friday, INTC has made a run up today and has completely skewed the premiums described in the table below, will follow up on that at market close today]

Hi everyone! Another relaxing weekend behind us and a full week of trading ahead of us! We've got two weeks of trading until the June options expiration cycle, and I've got a couple positions that could play out either way. While I do regularly watch all my positions, I tend not to mess with most of my short calls unless I can buy them back for a decent gain. This month I have two in-the-money short calls that I need to start planning for. [Continue reading]

Intel (NASDAQ:INTC) - short $24 call

This is one that I wrote just to get enough cash to round out another purchase. I wrote it in late April for a reasonable premium, it was trading around $24 anyways, and my cost is $22.21, so I was already going to profit. Let's look at the trade:

Buy 100 INTC @ $22.21 $2,221.00
Sell 1 June $24 call $42.93
Profit on exercise ($24 - 22.21) $179
Including option premium ($179+42.93) $221.93
Yield on option premium (42.93/2221) 1.93%
Total % gain (221.93/2221) 9.99%
Dividends collected (3 cycles at $22.50 each) $67.50
Total return including dividends (221.93+67.50)/2221 13.03%
Holding Period 232 days
Annualized Return (365/232) * 13.03% 20.49%

Not too shabby, I won't be upset it this one gets exercised. However, INTC pays a good dividend, currently 3.7%, and based on the past two years of dividend history I believe they are going to raise on the next announcement in mid-to-late July. It makes me want to stick with the stock due to the increased income and the share appreciation associated with this. They raised the dividend 13.71% in July 2011 and 7.13% in July 2012. It may taper down around 5% this time, who knows, but a raise is good anyways.

In order to keep the stock I need to close the option, but I will take a loss for it and I don't want to spend my valuable spare cash covering a short. My best bet is to roll the option. Here I can either simply roll out or roll up and out. Either way it is somewhat of a losing game. First of all, I will book a loss buying back the initial option, but the premium I get should offset this. Secondly, if I perpetually roll the option as the underlying price increases over time, the spread between the two premiums will eventually diminish and the underlying gets deeper in the money. And finally, in order to offset the reduction in spread, the option writer may have to write contracts whose expiration is too far in the future. Some people are OK with the third point as long as there's an income stream, but it's somewhat painful in a young account.

Let's have a look at our choices. All prices are as of close on June 7. The first row is our price to buy back the June $24 call, the rest are the current bid prices of possible roll candidates.

  Strike Prices
Expiry $24 $25 $26
June 84    
July 118 65 32
Aug 131 79 44
Sept 145 95 57
Oct 162 111 74
Jan14 193 144 105
Jan15   233 n/a

The premiums in bold font are all higher than my cost to close the June $24. As you can see, in order to successfully roll up and out I have to roll out to a much later expiration date. This can be a disadvantage, but will allow me to at least lock in some dividends. Based on a very predictable history, I expect the the next ex-dividend dates to be August 3 and November 5. I'd ideally like to collect at least one dividend, since I expect it to increase on the next announcement, so I could write an August or September contract. Caution: the August contract is the most likely to get exercised early if it's in the money on August 2! Options are rarely exercised early, except in the case of an ex-dividend! This has happened to me before on a position that wasn't even that deep in the money.

If an ex-dividend falls before the option expiration, consider writing the following month or an out of the money strike. In this case, the Aug $25 strike has a premium less than the cost to buy back the June $24, resulting in a net debit, but increasing the exercise profit by $100. However, I am still taking a chance that the share price will stay lower than $25, which it probably won't if they bump the dividend, and so the August $25 is still likely to get exercised. The better bet would be the Sept $25, because it allows for an increase in exercise profit by $100, plus a net credit of $11 (95 - 84). Unless INTC is really deep in the money on the ex-div in August, it's not likely that the September expiration will get assigned/exercised early.

The result of that trade is that my cash balance increases by $11, due to the net credit; I take a ST loss of $41, due to the buying back ($84 - $43); the new call covers the loss, but I just dug a deeper hole that requires a larger downward price movement to start making up for the realized loss; my expiration horizon has increased by three months, meaning I can't really do anything with the underlying stock if it continues to run up, I have to just sit and watch the stock run while my short option goes the other way.

What other considerations go into making this decision?
What do you value more: money today for reinvesting in other stock, or a reasonable guarantee of money later? I think the reason why there's so much confusion, or at least indecision, about rolling options is because the trader really has to take a stance about what's important. If I really wanted cash right now, I would just let it get assigned and take all the cash. Or, more conservatively, I could roll out to the farthest expiration at the current strike of $24, all the way to Jan 2015, for a net credit of $109, and six dividend cycles to collect until they expire (another $135 - $145 income). The problem is that now the stock could keep running higher, to the point that I have absolutely nowhere to roll it to because it's so deep in the money and they don't list options with 10 year expiration, which is the kind of time value you would need to cover the debit needed to close your short!

But I also want capital appreciation of course, so I could sacrifice credit now while locking in gains down the road, so rolling up is the best bet. So where do I stand on this? Seriously undecided. I really need more money now in order to add to my other dividend stocks, but don't want to get locked into an ITM option for too long, especially during our current bull market! I'm going to take a balanced approach:
First: there are still two weeks to play out before this $24 call expires, I'll wait until next week to really look at where premiums are. The example above was just used to show what my choices are if I rolled today.
Second: I'll take a balanced approach, if the option is still ITM, I will roll up to the September $25 as explained above. This way I get the dividend and the extra $100 in assignment profit.
Third: continue to monitor the situation, I may need to roll again. If the stock breaks out it can sometimes be a good idea to roll sooner rather than later. As the Sept $25 call gets deeper ITM, the premium will consist of less time value, but a later expiration that is ATM or OTM may carry enough time value to offset the debit required to close the Sept call. Who knows, but always be aware of the price action on your short positions, duh!

Solazyme (SZYM) - short $10 call

Here's one I haven't discussed before, Solazyme is a company that makes synthetic oils from algae. Since I'm kind of a green energy nut I naturally got behind them. I bought at $8.96 and wrote the $10 call during a rally last month, it's continued to run since but I've since grown bored with it. It doesn't pay a dividend, it was waffling under $10 for so long, that when it finally broke, I got antsy for income and wrote a call. It's currently trading at $11.41, so I'm pretty deep in the money here. I don't have many choices to be honest. First of all, these options are highly illiquid, so getting out of one and into another for a good price is going to be difficult. Second of all, there are none expiring later than December, leaving me with a short time horizon to roll. And third of all, the strikes run in $2.50 increments, making it even harder to roll.

I won't go into the same level of detail as I did with the INTC example, because quite honestly I cannot roll this one up for a net credit. The best I can do is a $45 debit to roll to the December 12.50. I'm not too sure what this company is going to do in the intermediate term. There is a chance that they could explode, or at least continue to run up to $15 at a steady pace. They have a good business model and are starting to produce oils at a lower cost, but it's still anyone's guess as to when they'll become truly profitable. Therefore, I'm inclined to let this one expire so I can use the proceeds to fund my other pursuits, here's how the trade stacks up:

Buy 100 SZYM @ $8.96 $896
Sell 1 June $10 call $43.55
Profit on exercise ($10 - 8.96) $104
Including option premium ($104+43.55) $147.55
Yield on option premium (43.55/896) 4.86%
Total % gain (147.55/896) 16.46%

In this case my return on investment was actually better than the INTC situation, mainly due to the higher volatility of SZYM. Because of this, I was able to collect the same amount of premium against a much cheaper investment (about $43 premium on each trade, but divided over $896 versus $2,221). And in fact, my return on this position beats the dividend adjusted return on the INTC example! I'll take my 16.46% gains thank you very much, and $1,000 to invest somewhere else.

Closing ideas for the rest of June and into July

We've got some good ex-dividends coming up in the dividend aristocrats this month, and with an extra $1,000 to play with at start of trading on Monday June 24, I'll be looking at the following securities to improve my income stream:

Philip Morris Int'l (NYSE:PM) - ex-div not announced as of this writing, but it's expected to be June 25, just in time. $0.85/share, 3.6% yield
Illinois Tool Works (NYSE:ITW) - confirmed ex-div June 26, $0.38/share, 2.10% yield
Sysco Corp (NYSE:SYY) - confirmed ex-div July 2, $0.28/share, 3.3% yield, this price has dropped since I bought it, good chance to average down.
McCormick (NYSE:MKC) - not confirmed yet, but expected July 5, $0.34/share, 1.8% yield, also down slightly since buying.

Disclosure: I am long INTC, SZYM, PM, SYY.

Additional disclosure: The securities and situations described above, while real life, are not meant to be considered investment advice. The scenarios are presented to give an example of common option trading situations that can arise, and to offer a few ideas about ways to deal with them. I am not an investment adviser. I only share these in the hope that other young, non-professional traders like myself get exposure to what other like minded people are doing in the market.