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Gear Head: Covered Call Roller and Options Statistics

October 1, 2012

Covered Call Roller

As a child, I remember going to the library with mom and watching her comb through “Value Line” binders that were bigger than my booster seat. This was how she researched her stocks. Thanks, technology, for making our lives easier today, and well, less archaic.

But there are still some trading activities today that continue to be prehistoric. Take, for instance, the action of rolling forward on a covered call. What's that? Say you're long stock, and you sold short-term, out-of-the-money call options against your position to generate incremental income, and to drive down your position's cost basis by the amount of cash you received. This is the plain-vanilla covered call. To “rollover,” you buy to close your near-term option, and sell to open a slightly further-term option at the same strike price, while leaving the long stock position alone. If you keep rolling the short option from one expiration to another (month to month), you could potentially create a consistent monthly flow of income, as long as your stock doesn't get called away with an assignment and of course, transaction costs don't cut into your profits.

covered call roller


The Covered Call Roller in thinkorswim® allows you to customize your monthly rolls with so many levers, you'll start to wonder what to do with all your new free time. For illustrative purposes only.

Carpe Covered Call Roller

But why go through the hassle of initiating the roll each month? And what if one month you forget, and miss the opportunity? Introducing the “covered call roller.”

This new user-friendly feature recently introduced on the thinkorswim® trading platform, is designed to completely automate the process of rolling forward. You can now program virtually every consideration you would normally make in rolling forward, so you can completely define your parameters for future actions. What's more, the capability also has robust notifications so you are kept abreast of any automated adjustments made to your position for the life of your trade.

Let's start with the overall sentiment on the position. If I'm short-term delta neutral on the position—meaning the delta of all legs in the position net out to zero—I would want to roll forward into the same, or similar, strike. But if I'm more bullish, I would want to roll out and up to a higher strike in an attempt to capture a profit in the stock, should it move higher. You can program this easily with the Market Sentiment slider.

The same holds true for other custom capabilities. If you'd like to get the most out of these features, the best place to turn is the thinkorswim Learning Center. When the Covered Call Roller launches around November, you'll find a video of the same name to help you better understand this exciting new feature.

Options Statistics from thinkorswim

Digging deep into the market mood for clues to what might be next

Stock traders, here's a news flash: You don't actually have to trade options to potentially benefit from them.

Take implied volatility—the volatility of the price of a security that is “implied” by the price of the options. When it's high, that's generally a reflection of nervousness in a stock. As traders start putting on more hedges, put activity might increase, taking volatility in the options with it. When volatility goes up, option premiums tend to get inflated.

This information can benefit both the stock and options trader. As a stock trader, market “nervousness” is hard to gauge from charts alone. And, for the option trader, when option premiums are expensive, it's typically better to be implementing sell strategies, such as covered calls, rather than buying them. Higher premiums can erode quickly, making it difficult for long strategies to profit.

But what's “expensive” or “cheap” anyway? After all, volatility is relative. Just because a tech company has higher volatility than a paint company, doesn't mean its options are more expensive. The Options Statistics tool in the Trade page of the thinkorswim platform provides additional information that might be useful in helping you decide whether you want to trade tech or paint.

As you plan your next trade, take a look at a few items from Options Statistics that might help you make sense of things.

Current IV Percentile:

Most of the occurrences of implied volatility over the past 52 weeks have occurred above this number. This is key for factoring whether options are “cheap” or “expensive.” In the case of Figure 2, current volatility sits at the bottom 18 % of all other instances of volatility in the past 52 weeks—pretty cheap. This might be a candidate for a position that's net long vol (i.e., buy option strategies such as long vertical spreads). If it were on the high end—say, over 60 % —you might want to be net short volatility (i.e., sell option strategies, such as short vertical spreads).

Options Statistics

FIGURE 2: DATA IS KING. Take heed, stock traders. The Options Statistics tool in thinkorswim contains a bunch of information about the general mood of the market, and collectively, what other traders are thinking. For illustrative purposes only.

The area in the middle column of the tool under “Trade Analysis” takes it a little further, to help you determine if traders are actually buying or selling options.

Traded at the Bid:

Looks at how many traders are likely selling options, which likely indicates they are getting out of positions, or establishing short positions.

Traded at the Ask:

Looks at how many traders are likely buying options, which indicates they are likely entering positions or covering shorts.

Delta Between:

Traded at BID and Traded at ASK provides great info, but the challenge is, you can't tell if the trades were previously opened positions closed at the end of the day, or they're establishing new positions today.

Delta between” might provide clues. The delta of at-the-money options is typically .50. So, if a majority of options are trading in the money again, the question is, are they getting in or out? Typically (and this is anecdotal), seasoned traders will hedge with puts. If there are a lot of calls trading in the money, this could be a bullish signal, since it would be unusual for traders to buy in-the-money calls as a hedge. There's always a nugget or two of information traders can pull from the options market. But, just as important as making the effort to dig a little, is understanding what you're looking at when you find it. Options Statistics goes a little beyond your standard volatility readings, and hopefully offers some clues as to what to do next. This goes for you too, stock trader.

A Little Extra on Covered Calls

Tradewise is a great way to learn more about covered calls, and they have an advisory of covered-call trade ideas. Paid subscribers are notified each time the service recommends a new covered call trade, makes an adjustment, or closes a position. Then, once you find the right idea, you can automate your strategy with the new Covered Call Roller.

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