Finance Roll

Exercise     Sale 
Basis in 100 shares of stock     -2,100 
Call premium received               400 
Call premium paid                  -600 
100 shares deliver at $25         2,500 
100 shares sold at $30            3,000 
Net profit                         $800 

This comparison appears to conclude that you have a better outcome by allowing exercise of the call. That is a fair conclusion only if you would be willing to give up the 100 shares; but it excludes two very important considerations. First, upon exercise you have a capital gain on the stock and a tax consequence. Second, if you keep stock you are free to write covered calls again after expiration or close of the current positions, meaning more income in the future. Exercise ends that possibility.

Tip: A careful comparison between choices is the only way to decide whether to accept exercise or to close out the whole position.

Method 2: Roll options to avoid exercise. A second technique to avoid exercise involves exchanging one option for another, while making a profit or avoiding a loss in the exchange. Since the premium value for a new option will be greater if more time value is involved until expiration, you can trade on that time value. Such a strategy is likely to defer exercise even when the call is in the money, when you remember that the majority of exercise decisions are made close to expiration date. This technique is called a roll forward.

Example: Trading Expirations: The May 40 call you wrote against 100 shares of stock is near expiration and is in the money. To avoid or delay exercise, you close the May 40 option by buying it; and you immediately sell an August 40 call--this has the same striking price but a later expiration.

You still face the risk of exercise at any time; however, it is less likely with a call three months further out. In addition, if you believe that expiration is inevitable, this strategy provides you with additional income. Because the August 40 call has more time until expiration, it also has more time value premium. The roll forward can be used whether you own a single call or several. The more lots of 100 shares you own of the underlying stock, the greater your flexibility in rolling forward and adding to your option premium profits. Canceling a single call and rolling forward produces a marginal gain; however, if you cancel one call and replace it with two or more later-expiring calls, your gain will be greater. For example, you own 300 shares and have previously sold one call; you can roll forward, replacing one call with either two or three which expire later. This strategy is called incremental return. Profits increase as you increase the number of calls sold against stock.