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Stocks A to Z / Stocks B / Berkshire Hathaway (BRK.A)
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Author: mungofitch 🐝🐝🐝🐝🐝 BRONZE
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Number: of 12641 
Subject: Re: Second quarter comments
Date: 08/08/2023 2:35 PM
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No. of Recommendations: 23
If the market goes against you and you're losing money, you can "improve" your position by closing it at a loss and replacing it with a new position which is longer dated with a higher strike. Maybe another 3 months later.
...
Anybody want an example I did today?



Not a great example, not one of my best efforts.

But FWIW:

In July When BRK.B was trading at just under $350 I wrote January $350 calls for a premium of $19.35 net of commissions.
In effect, a wager that I'd be more or less equally happy with either $19.35 of "bonus" income between now and January, or with a net exit price of $369.35 on some shares (which looked not bad with the price a tad under $350).
Adding this call to an existing position is a slightly bearish move: moving some shares from long to neutral. The price looked high enough that a bit of lightening up didn't seem so bad.

Now, let's assume that I've changed my mind about the likely price trajectory.
The price is quite a bit higher than $350 already, so the original position is in a mark-to-market loss, and it's obvious that ~$369.35 is no longer particularly unlikely. It's only 1.6% above the price now.
So, is there a way to adapt the trade to a higher price expectation?
(This is not something you plan to do--it's something you might want to do when you're already a bit wrong!)

As an aside, the existing $350 calls are only a mark-to-market loss: if the stock price were entirely flat from now till expiry, they would still end in a profit position because today's price of ~$363 is less than the breakeven of $369.35.
I could just sit on my duff and wait for them to make money, but I didn't.

So, I closed my January $350 calls at a loss, and wrote new January $365 calls instead.
The time value in the $350s has fallen a lot, from the original $19.35 to $16.89.
This is because time value peaks when the stock price is at the strike price. As the stock has moved up, the time value has fallen.
So, that takes a few dollars of sting out of the mark-to-market loss I'm now realizing because the calls I wrote are now in the money by about $12.90.

So, the trades, including commissions:
Buy to close Jan $350 calls for $29.79, breakeven $379.79
Sell to open Mar $365 calls for $23.91, breakeven $388.91

The changes resulting from today's trades, relative to not having done them:

Outcome 1:
If the stock is high around next March, the underlying long positions get called away. My net sale price is improved by $9.13 per share relative to yesterday's situation.
However, the trade ties up more cash: I put in $5.87, "giving back" part of the $19.35 cash I originally received on opening the position.
So, in the scenario that the stock price is high and the shares are called away, I tie up $5.87 till March in order to get $9.13 more cash for my shares.
So, today's *incremental* trades could be thought of as a return of 55% on the additional cash tied up, or 91%/year rate.

Outcome 2:
In the scenario that the stock price stays lowish and the calls expire worthless, I get a lower net cash profit.
The original maximum profit falls from $19.35 to $13.48. This is worse, but still good.
It's unfortunate that the cash return is worse: it would not be the case if I had increased time duration of the calls by more by choosing a different roll.
Usually I'd be rolling perhaps 3 months to 6 months, not 5 months to 7 months.
You're only kicking the can down the road, but you do get paid for each additional kick. I can kick it again later if I want...each day that goes by, I earn a bit more of the time value.

Also:
By having a higher strike, outcome 2 (options expire and I keep the premium) becomes more likely than it would otherwise have been, since the strike price is $15 higher than it was.


One of the reasons you get this opportunity is that the time value in an option moves up and down a lot during its lifetime as the *distance* between strike price and current stock price narrows and widens.
If the stock price goes back down it could make sense for me to do the reverse trade, improving my breakeven at each trade.
But usually if the stock price falls I just close the trade for a nice profit. You can often make 80% of the maximum possible profit in under 50% of the maximum possible elapsed time.
Stock feeling high and toppy? Write a call. Down again? Close for profit.


Bottom line:
If you've written a covered call but now for whatever reason don't like the now-higher probability of the stock being called away, roll the position "up and out".
Higher strike, longer time to expiry, generally just as much cash profit if it expires, though it takes a bit longer.
When done at the right time and pricing and date selection, you can improve your cash position at the same time as improving the odds of the cash outcome which you may prefer.

Jim
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