Exit Covered Calls Early with Gain?
Normally with a covered call trade, we are not looking to exit early, especially if the stock has gained value. Under most circumstances, the cost of buying back the option will offset the premium received, plus any potential gain in selling the stock. You usually are better off letting your stock be called out. Even if you are really bullish on the stock, most cases would work out better by having your stock called out and then buying back the shares at a higher price.
However, there are some occasions where it can be beneficial to buy back the option when your stock has gained value. The typical scenario would involve high implied volatility options. If a covered call trade was created at a time when implied volatility was high, the option was sold at a high premium. These trades may be a candidate for an early exit – even if the stock climbs higher.
The possibility would be based on a drop in the implied volatility. Implied volatility will drop after news comes out, whether the news was on earnings or some other expected major announcement. After the news is released, the stock will react to the news. The expectation would be a big reaction to the news causing a big gain or drop in the stock price. After news is released and the stock reacts, there is no more expectation of a big move. Option prices will drop since big moves are no longer expected. This represents a drop in the implied volatility.
Sometimes the news ends up being insignificant. The stock won’t move or moves just a little. Option prices will still drop. Now you have an opportunity to buy back the option at a much reduced price. If the stock is a company you are bullish on and the option price has dropped significantly, you may consider buying back the option. The cost to buy back the option should be less than any gains expected in the stock prior to option expiration.
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