What happens if you do not have enough cash?

You can buy some of them back with the cash you have and let the rest go, roll out to the next month, or do a combination of buying some back and rolling others out. Rolling out involves buying the calls back and then selling the next month out at the same strike price or at a higher strike price to bring the price of the stock and the calls you sold closer together. The theory is that the next month out will have more premium based on the time element. As you get deep in the money, however, that time element becomes less and less-another reason not to let these things go too deep into the money. Anyway, you buy back the calls you sold, say January calls, and sell the February calls. You can roll out to the next month at the same strike price, and you will usually be able to do that without coming out of pocket with any cash. You then have to wait for the stock to fall. If there is enough difference in the premium, you may be able to step up to the next higher strike price without coming out of pocket any cash. This is not easy to do unless the stock you are playing is very volatile and the options have a lot of premium. You will usually have to make up some difference with cash.

Now if you are dealing with a fairly volatile stock, you can get fancy. We got turned over in some AOL calls once. They got too far in the money, and it looked grim. We had some time, and we started working the play. AOL was bouncing up and down $4 or more a day, and it would start down and then rally up about each day. Well, we would buy the calls back when the stock dropped a few bucks, and then when it rallied up for the day, we would sell them again for more money, thus generating cash on a losing position. We did this several days in a row before the pattern stopped, and we were able to put some good cash in the account, thus reducing our cost basis in the stock. We ultimately rolled the calls out to the next month, took in a credit and used the money we generated in buying and selling the calls back and forth to buy the calls back when the stock dipped without losing too much money-it was a lot of work, but we did it without damaging the account very much. We made up our mind we wanted the stock, so we were willing to sacrifice some of our cash to get it. Not all stocks give you such a nice up and down move, but it is worth trying. Our broker thought we were crazy until the money started piling up from the call sales. We were really working it.

That brings us to another point. Let’s say you buy a stock and it drops on you (gee, that is something new). No matter how astute you are and how good the stock looks, the unexpected can happen (e.g., CNET getting downgraded today on a ‘valuation’ basis; with internet stocks running $30 and $40 a day and hitting $200, $300 and $400, little old CNET at $70 was overvalued-interesting how that came two days after a $9 spike in price-was someone at the brokerage short the stock?). You are mad because a lot of your capital is tied up in the stock. You see other trades moving where you could be making money, but you are stuck. Do you sell? Yes, you could (and maybe you should-have sell rules and stick with them-8% on stock buys), but you did not stick with your sell rules and if you sell your account will be decimated. If the stock is optionable (it has to be or this won’t work), you can start the covered call game just like we do with our long term holds. Study the stock’s pattern. Get to know support and resistance, what is unusual volume, when earnings are reported, etc. Then start selling calls when the stock hits resistance or a top and starts to come down and buying them back when it turns back up. You have to work it hard or it can take forever. What you are doing is lowering your cost basis in the stock by taking in cash on the net credit after selling and buying back the calls. Eventually you can build up enough cash to the point where you can go ahead and let the stock get called away and your account won’t be in total shambles.

The best alternative is to avoid this situation. If a stock starts to fall after you buy it, and it loses 8% of its value from where you bought it, sell. If a stock you want to keep but sold calls on starts to rise, close the position fast. Don’t get yourself into a position of hoping the stock will fall or having to really work the buying and selling of calls. We love to work the call selling and buying when we are ahead and not underwater-that is fun because it is extra money. If you are underwater, it is like trying to work off debt. All that hard work just to hang on. If the stock keeps rising on you, it gets even tougher. Better to nip it in the bud because believe us, if you do this long enough, the unexpected will happen.