No. of Recommendations: 6
Part 2:
Rolling Up Call Options:
'Rolling Up' basically means to sell a call option (that is already owned) and buy another call option on the same underlying equity for the same expiration date but with a higher strike price. Occasionally, Call options purchased using the Options 6/3 criteria above will move deep ITM prior to the scheduled contract sale date. As this happens the contract price will move sky-high (as with most deep ITM options) possibly making the contract harder to sell and also causing the owned option's intrinsic leverage to fall to insignificant levels. If this happens use the following procedure to determine whether to a) stay with the current contracts until their scheduled sell date, b) sell the current contract and roll up into a new contract for the remainder of the period, and c) if rolled up, what contracts should be pursued.
Step 1, check the scheduled contract sell date. Do not roll up an option with less than one month to go before the scheduled contract sell date.
Step 2, assess whether or not the market predicts significant additional gains for the underlying stock. To do this, recalculate the current PEG and CAPRS screens to see if the underlying company is still recommended as one of the top ten companies satisfying the screening criteria. If it is, then continue on to steps 3 and 4.
Step 3, calculate the 'tradeoff ratio'. Subtract the current ask price of the Call to be bought from the bid price of the Call to be sold. This is the Gain. Divide the Gain by the difference in strike prices of the two contracts. Do the subtraction so that the result is a positive number (use absolute value).
¬¬ Bid Price of Call to be sold - Ask price of the Call to be bought > 0.7
| Strike price of Call to be bought ' Strike price of the Call to be sold |
Roll up options at least two strike prices, staying with a Delta of 0.9 or greater that will still have a qualifying Tradeoff Ratio higher than 0.7
An example: CSCO 85 Oct99 has a current bid price of 37 3/4. CSCO 95 Oct99 has an ask price of 30 1/2. The difference in bid/ask is 37 3/4 - 30 1/2 = 7 1/4. The difference in strike prices is 95 - 85 = 10. The tradeoff ratio is (7 1/4) / 10 = .72. The tradeoff ratio measures how much is gained for how much is given up. The transaction gains cash and gives up intrinsic value. To make 'rolling up' a call option something that is worth doing the tradeoff ratio should be greater than 0.7.
In order to qualify, an option must be very deep ITM (In the Money). For instance, AOL 95 Oct99 is already owned. AOL is presently about 147, so the option is about 35% ITM. It doesn't even come close to qualifying for rolling up. On the other hand, ANN 30 Jun99 is also owned. ANN is about 51, so the option is about 42% ITM. It not only qualifies to be rolled up, but it can be rolled all the way to ANN 50 Jun99 and still have a tradeoff ratio higher than 0.7.
Step 4, Use Delta to determine how far up to roll the option. Take the case of the ANN option. It can be efficiently rolled all the way up to ANN 50 Jun99, but the ANN 50 Jun99 option has a current delta of about 0.58. That means that the option will only increase in value $0.58 for each $1.00 that the underlying ANN stock increases. Not nearly good enough.
It turns out that the ANN 40 Jun99 option has a delta of about 0.9. and still satisfies the Tradeoff Ratio.
Also, never roll up an option just one strike price - i.e. going from a strike of 45 to a strike of 50. Even if the tradeoff ratio is over 0.7 - which would be rare - the gain isn't sufficient to provide any significant advantage. Roll up options at least two strike prices, staying with a Delta of 0.9 or greater that will still have a qualifying Tradeoff Ratio higher than 0.7.
