DXCM announced earnings today after the market closed. We decided to sell our shares and buy back the options to avoid the wild swing that follow the announcements. History was projecting the stock would move +/- 8% ($32).
We established the position on July 20/2020. We rolled the position 18 times. All of the profit was generated by selling the options. The stock was purchased for $432, dropped as low as $360 then recovered to $400.
DXCM has been a core holding in my investments for the past 10 years. When the dust “settles” I will likely start a new position.
Each of the charts below represents a covered call position in the IB account (with the exception of PINS which is a bull put spread). Total Profit/Loss is in the top section. Return on the position and annualized return is in the second table. Graphs show where the profit/loss is coming from (stock or option). In an ideal covered call the net profit would be higher than either the individual stock profit or option profit components (see ATEC at the bottom). With ATEC I added additional option elements at different times which seems to have helped with option profits. The bull market over the past eight months has pushed stock prices up making it difficult not to “lose” money when we buy back the short call options. Each time we “lose” money on an option roll up it creates a short term capital loss we can use for tax purposes. Once we establish a position we rarely sell the stock until we have held the position for 12 months so we only pay long term capital gains.
DXCM has been on a wild ride since early March (low of $182.07 to high of $428.59). Covered Call writing is not the right strategy when a stock goes on a run like that. Writing calls restricts the upside potential. The call writer maximizes the profit potential but leaves a lot of money “on the table”.
Stocks that rise as quickly as DXCM will correct or stabilize. That started to happen over the past week. During the week DXCM stock was under $340, down $88 from the high. Covered calls offer downside protection but are not designed to protect against volatility of this magnitude.
What happened to our position as the stock was falling? We were not able to protect all of the gain. In the chart below the decline in stock price is partially offset by an increase in value from the calls we are short. Stock lost $90,775. Options gain $59,265. Net loss $31,510 which is much better than just owning the stock.
Despite the loss the position has a profit of $90,305 in 44 days.
The preference is to not have the stock called away and trigger short term capital gains. Ideally we will hold the stock for 12 months and pay long term capital gains.
How do we protect our gain…..but leave room for appreciation if the stock regains momentum? We put a “ladder” of Jun 19 calls under the stock price. We are short calls with strike prices of $350, $360 and $370. The combination gives us downside protection of 4.8%. If the stock remains above $370 our potential gain is an additional 2.8%. The options create $71,400 of downside protection ($45,325 “in the money” and $26,075 of Time/Volatility). The time and volatility will erode until it hits $0 on Jun 19.
Covered calls are adaptable and flexible but are not always the answer. Sometimes it is better to just own the stock. When we enter a position we make an assumption about the range where the stock will trade. When the stock moves outside the range the CC strategy will not be as effective as other strategies.