How to Get Out of a Covered Call Position

A covered call is an options trading strategy where an investor owns 100 shares of a particular stock and simultaneously sells one call option contract against those shares. The sale of the call option provides the investor with an upfront payment, known as a premium, which they get to keep regardless of whether the option is exercised. This approach is typically favored in market conditions where the stock price is expected to remain relatively stable or experience only a moderate increase.

Closing the Covered Call

One direct method to exit a covered call position involves buying back the call option that was initially sold. This action, known as “buying to close,” effectively cancels the investor’s obligation to sell their shares at the strike price. The cost incurred to buy back the option directly impacts the overall profit or loss of the covered call trade.

After buying to close the call option, the investor regains full control over their 100 shares of stock without any further obligation. They can then choose to hold onto the shares or sell them in the open market.

Investors might choose to close a covered call position for various reasons. If the stock price has declined significantly, buying back the call option for a lower price than it was sold for can help to lock in a profit on the option side, or at least mitigate further losses. Alternatively, if an investor wishes to take profits on the underlying stock or reallocate their capital to another investment opportunity, closing the call allows them to sell their shares without potential assignment. This method provides flexibility in managing the position based on market movements or changes in investment strategy.

Adjusting the Covered Call

Instead of fully closing a covered call, investors can choose to adjust the position through a process known as “rolling.” Rolling involves simultaneously buying back the existing call option and selling a new call option, typically with a different strike price, expiration date, or both. This allows the investor to modify the terms of their covered call without completely exiting the strategy.

Rolling out involves buying back the current call and selling a new call with the same strike price but a later expiration date. This strategy is useful when the investor believes the stock will continue to trade near its current level and they want to collect additional premium income by extending the trade’s duration.

Rolling up entails buying back the current call and selling a new call with a higher strike price, often with a later expiration date as well. This adjustment is typically made when the stock price has risen, and the investor wants to allow for more potential stock appreciation while still generating premium.

Conversely, rolling down involves buying back the current call and selling a new call with a lower strike price, sometimes combined with a later expiration date. This defensive maneuver is often employed when the stock price has fallen, and the investor aims to collect more premium by bringing the strike price closer to the current market price.

Understanding Expiration Outcomes

If a covered call position is not actively managed through closing or adjusting before its expiration date, specific outcomes will occur automatically based on the stock’s price relative to the option’s strike price. These outcomes determine whether the investor retains their shares or is obligated to sell them.

When a call option expires out-of-the-money, it means the stock’s price is below the strike price at the time of expiration. In this scenario, the call option expires worthless, and the option buyer will not exercise their right to purchase the shares. The investor, as the call seller, gets to keep the entire premium received from the initial sale of the option. Furthermore, they retain full ownership of the underlying 100 shares of stock.

If a call option expires in-the-money, the stock’s price is above the strike price at expiration. In this situation, the call option will likely be “assigned,” meaning the investor is obligated to sell their 100 shares of stock at the agreed-upon strike price. The shares are automatically sold from the investor’s account at the strike price, regardless of the current market price, and the investor keeps the initial premium collected.