Covered Calls: When to Roll for a Better Trade

Movie character Ferris Bueller once said that life moves pretty fast, and that statement can also be true regarding markets. A trade that may have looked good on paper when initiated could drag down your account later. Investors who layer their trades with options might have more difficulty entering and exiting positions when their original thesis goes awry. A covered call is one of the simpler options strategies available, but

these trades don’t always work as planned, and investors might need to roll their options into a new contract. In this article, you will learn when to potentially roll covered calls and how investors can benefit from this type of strategy.

What Does Rolling a Covered Call Mean?

A covered call is an options strategy where you can purchase shares of a particular stock and then sell a call option(s) on the same stock with a slightly higher strike price than the current market price. This moderately bullish trade is performed when investors expect the stock to rise slightly or remain range-bound in the short to intermediate term.

But suppose the outlook of the trade changes thanks to a negative earnings report or an accounting scandal, which would push the underlying stock position in opposite directions far beyond the initial parameters of the trade. If the trade goes awry,

investors don’t need to exit the position entirely — they can roll the call option by buying back the initial call option and writing another call with a different strike price.

How Can You Roll a Covered Call?

Traditionally, the covered call option trade is exited in one of two ways: through the expiration of the call option or the assignment of the 100 shares of stock. But what if the stock rises, and you don’t want to have your shares called away?

In this scenario, instead of sitting on the assignment risk, you can buy-to-close the existing call option and sell-to-open a new call option. Rolling a covered call reduces assignment risk should the stock price rise too high and limits downside risk should the price decline too low.

When to Roll a Covered Call?

Covered calls usually work best in a Goldilocks range where the price runs neither too hot nor too cold.

The next section explores five unique covered call rolling strategies and discusses what scenarios warrant their implementation. Rolling a covered call isn’t always the potentially recommended option strategy should the trade turn against you, but it's sometimes wise to consider these five techniques before closing out your trade entirely.

5 Strategies for Rolling Covered Calls

Here are the five basic options strategies for rolling covered calls and the market conditions where you can consider executing this trade adjustment. The underlying principle of rolling covered calls is remembering that the stock position is the primary asset, and the option is secondary.

Rolling Up

When rolling up a covered call, the investor will buy back their existing call option and sell a new one with a higher strike at the same expiration. Covered calls are rolled up when the stock price exceeds the strike price, but the investor doesn’t want their stock called away.

For example, if you own 100 shares of XYZ stock at $10 per share and sell a call with a strike price of $12, you might employ the roll-up strategy if the share price rises to $14. In this scenario, you’d buy-to-close the $12 call and sell-to-open a $16 call with the same expiration.

Rolling Down

Rolling down is the exact opposite of rolling up. Should the stock price decline below your purchase price, the call option will likely expire worthless, but your stock position could suffer losses. In this scenario, you’d buy back the call option and sell a new call with a lower strike price.

Rolling Out

Suppose you don’t want to adjust the strike price of your call option but instead want to push the trade timeline further out. In this scenario, you would roll out the covered call by buying-to-close the existing call and selling a new call with an identical strike price but a later expiration date. If you expect the stock to continue trading in the same range for a longer-than-expected time frame, rolling out is a potential strategy to consider.

Rolling Up and Out

If your expectations of the underlying stock change significantly, you can adjust the parameters by closing your current call option and selling a new call with a higher strike and later expiration date.

Suppose company XYZ projects increased sales growth for the next four quarters. This could result in a higher stock price in the short and long term. So if you own 100 shares of XYZ at $10 per share and sell a call with a $12 strike and July expiration, you could roll up and out by buying back the $12 call and selling a new call with an $18 strike and August expiration.

Rolling Down and Out

Rolling down and out is the inverse of rolling up and out. If company XYZ reports bad sales numbers, you could lower your strike price and increase the timeline of your

covered call trade. To roll down and out, you’d buy-to-close your initial call option and sell a new call with a lower strike price and later expiry.

Potential Benefits of Rolling Covered Calls

Here are the upsides of rolling covered calls:

• Enhanced flexibility: Traders can adjust to changing market conditions without completely exiting their position.

• Limit assignment risk: The risk of shares being called away should the stock price rise near the initial call option strike price decreases.

• Increase cash position: By closing an existing call and selling a new one, investors will increase the option premium they receive, adding capital to their accounts.

Risks of Rolling Covered Calls

Here are the drawbacks to consider when rolling covered calls:

• Trade continues going sideways: If the stock price continues its unexpected momentum, you may find yourself in a constant position to roll calls when exiting the trade entirely may have been the better choice.

• Added transaction costs: Buying and selling options can involve commissions and fees, so the more contracts you move around, the more transaction costs will cut into your profits.

• Limits profit potential: A covered call naturally limits upside potential. By rolling your covered calls, you’ll limit your maximum profit without mitigating much risk.

Rolling Covered Calls Gives Investors Flexibility But Doesn’t Eliminate Risk

If your initial covered call trade thesis proves to be off base, you don’t necessarily need to exit the position entirely. By rolling calls up, down or out, you can adjust the parameters of your trade without suffering excessive losses or having your stock called away. But remember that opening and closing options contracts carry costs, and the trade could continue moving in the wrong direction after you’ve rolled your position.

Frequently Asked Questions About Rolling Covered Calls

Here are some commonly asked questions about rolling covered calls:

What happens if the underlying asset significantly increases in value after I roll my covered call?

If you roll your call and the underlying asset increases, you may need to roll your call up or down even further should the current strike price be reached.

How can I determine the best strike price and expiration date for my covered call?

The best strike and expiry will depend on your goals and timeline as an investor. Options trading isn’t a one-size-fits-all endeavor.

What happens if I don't roll my covered call?

If the stock price rises drastically and you don’t roll the call, you could risk having your shares assigned.