Rolling Options on Volatile Equities Offers Several Benefits
Covered call options and cash-secured put options represent key components of valuation and volatility management at Solyco Wealth. We remained very active in the options markets in response to the heightened volatility in equity markets that characterized the close of 2022 and the beginning of 2023. Substantial moves higher and lower for well-held stocks such as NVIDIA, Amazon, Netflix, Tesla, and Meta, among many others provide motivation for having a well thought out strategy to roll contracts prior to engaging in an initial options trade.
We engage in the options markers with an explicit strategy in place to “roll” covered calls on stocks that appreciated well beyond, and on short puts for stocks that moved significantly below, the strike price of expiring contracts. The term “roll” describes the process of repurchasing an options contract prior to expiration and subsequently selling a contract on the same underlying equity at a future expiration date.
Our roll strategy encompasses several key tenets, including:
- Explicit valuation targets for the underlying equities
- Ongoing knowledge of earnings and ex-dividend dates that may trigger early exercise
- Sufficient account liquidity to fund repurchases of options contracts
- Minimum premia equivalent to 1% per month as compared to expiration
Rarely do we roll contracts before the day of expiration. The threat of losing a position to a dividend-driven call or pricing anomalies caused by event-driven volatility changes represent two instances that could demand an early roll.
The recent price action of NVDA provides an excellent illustration of the value of rolling covered calls. Whereas NVDA shares commenced 2023 trading in the $143 range, they recently were +60%, or $230 each. With solid, 20%+ appreciation by mid-January an investor could have sold a $200 call expiring February 17th for over $2 per share, or $200 per contract as each option contract represents 100 shares of stock. While this implied 1.2% monthly return may appear relatively innocuous, annualized on a monthly basis such actions represent a 15.4% return. As compared to 2022’s stock market returns +15.4% appears worth the trouble in our view.
However, many other investors concluded that NVDA shares represented a bargain early in 2023. By the time February 17th rolled around, NVIDIA traded to $214 per share. While the $143-investor could just allow their shares to be called and walk away with $202 per share, they also might have upwardly revised their NVDA price target to $250 on the basis of the company’s gangbuster 4Q22 earnings report. Rather than allow the shares to be called away at $200, the investor could pay the $14.80 or so to close out the covered call contract and “roll” to a future expiration. Notably, on 2/17 the $210 call expiring a well later on 2/24 generated over $10 in premium. One complication, though: the investor needs to fund the $4 per share difference in order to roll the contract.
NVIDIA shares offer a special, near-term example for rolling options contracts as its share price continued to escalate, reaching a recent $232. This ongoing appreciation theoretically provides several benefits for continuing to roll options on NVDA:
- Volatility likely remains elevated, offering attractive premiums for future contracts
- Shares edge closer to the ultimate $250 valuation target
- Trading volume probably remains highly active
Should NVDA shares achieve the $250 valuation target, rolling covered calls on the position also offers an investor time to evaluate and choose another target for their investment capital. This period of time also could prove valuable for end-of-year tax planning should an investor desire to push a capital gain to another year or from short- to long-term status.