Our IC on ABT lost money this week as ABT stock increased in value. The table below shows the current status (ignore the -15 ABT 02/19/2021 $127 Calls as they are part of a covered call).
The “wings” of our IC include a call spread of $125/$135 (10 point spread) on the upper side and put spread $110/$120 (10 point spread) on the lower side. When we established the IC we received $13,255 in premium for selling the two spreads.
Max Profit = Premium Received.
Max Loss = Spread between the wings (10) * #contracts (30) * 100 shares per contract – Premium Received = $16,745.
Current stock price of $128.23 is above the lower strike on our call spread.
To realize max profit we need ABT to be between $120 and $125. When we set up the IC it seemed like a reasonable assumption. In hindsight I should have used a wider range. A wider range would have reduced the premium received (Max Profit) but increased the probability of the stock remaining inside the range. Position is currently losing $1,225.
The position has a lot of time left (expires March 19) and ABT may drop back. If the price goes above $135 we will incur the maximum loss. We do have an option of rolling up the Put from $120 to $125 which would generate additional premium and reduce the maximum loss.
Yesterday I established a new IC on DXCM following the earnings announcement. Took the lesson learned about wider range. The options in the table below with the quantity 20 and -20 make up the IC. The spread between the put spread ($360) and call spread ($460) is much wider than what we did on ABT IC. The stock has a $100 range to move and allow us to make maximum profit. Our Max profit is the sum of the premiums received ($15,680). Max Loss is the spread of the wings (20) x number of contracts (20) x 100 shares per contract – Premium Received = $24,320. Current profit is $1,340…….
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.
Dexcom announced excellent quarterly results…..which resulted in a $90 drop in the stock price. I copied the earnings announcement at the bottom of the post.
How to react when one of our stock implodes …..
The “covered call” offered some protection (it was sold for $28.82 a share or $57,640 on 10/16) but the drop (2,000 shares x $90) resulted in losses far beyond what the call premium could offset.
Dexcom has a history of big swings around earnings so we expected some volatility but nothing this extreme. Based on the earnings announcement and content of the call we decided to purchase more shares as it dropped. We purchased shares at $349 when we started to see a bounce…..but we should have waited as the stock bounce was short lived and hit a bottom just over $330. The stock did bounce back from the bottom to $349 by the end of the day. We don’t anticipate hanging onto the incremental shares but selling if the shares continue the upward trend.
We also rolled our 20 Nov 20 $410 Call options to Dec 18 $370 Calls for a credit of $18.22. Things were happening very quickly when I did the roll down…..and the Schwab system defaulted the Dec 18 option into the Diagonal Roll template when I thought it was Nov 20 option. I didn’t notice the Dec date until the confirmation came in. I might roll this back to Nov 20 today as I feel the stock will come back over the next couple of weeks.
It is hard to watch a position devolve and see tens of thousands of dollars disappear from your account. Knowing how you will react helps…..but it is still tough emotionally….and makes you wonder what else you should have done to prevent the loss.
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.