Please Note: This recommended trade only applies to those Personal Finance Income Plus members who already have a position in Chevron stock and the corresponding covered call. Do NOT do this trade as an initial position.

Diagonal Spread Roll of Chevron to December (NYSE: CVX)

and

“Sell to Open” December $115 Call

Option Symbols: CVX120922C105 and CVX121222C115

Limit Order Price: Net debit of $5.15 or less ($515 per spread)

If your broker doesn’t allow option spreads, then you’ll have to do two separate single-option trades:

(a) “Buy to close” September $105 call for a debit of $8.35 or less ($835 per contract)


(b) “Sell to open” December $115 call for a credit of $3.20 or more ($320 per contract)

Directional View for Underlying Stock: Neutral

Personal Finance Portfolio: Income

•    Tell your broker:

For a diagonal spread (preferred):

I’d like to enter an option spread order on Chevron (CVX) stock. Specifically, I want to buy to close the September $105 call and sell to open the December $115 call for a net debit of $5.15 per share or less.

• For a two-part trade:

I’d like to buy to close the September $105 call on Chevron (CVX) stock for a debit of $8.35 per share or less.

I’d like to sell to open the December $115 call on Chevron (CVX) stock for a credit of $3.20 per share or more.

Please note: The important thing is to achieve a net debit on the roll (i.e., both trades) of $5.15 or less. The specific limit prices of the individual “buy to close” and “sell to open” trades are just starting points and should be adjusted as needed, keeping the net debit of the overall roll in mind.

Rationale for Trade:

On August 15th, Chevron goes ex-dividend, which means that today (i.e., August 14th) is the last day for the call owner to exercise the option to buy the stock and be entitled to receive the stock’s $0.90 per share quarterly dividend. 

Early exercise is likely if the call owner will receive more money by exercising and receiving the stock dividend than he loses by forfeiting the time value remaining in the price of the call. When you exercise an option, you only receive the intrinsic value of the option and forfeit any remaining time value.

In the case of Chevron, the stock has rallied above the $105 strike to $113.28, making the September $105 call in the money by $8.28 per share. In many cases, 38 days of time value (i.e., until September expiration) for a stock that’s $8.28 in the money would be worth more than a $0.90 quarterly dividend, but Chevron is a low-volatility stock (implied volatility of September options is 20 percent), so time value is not worth much. The result is that the September $105 call has only four cents of time value remaining. Early exercise is therefore likely to occur because the $0.90 dividend received from exercising the September $105 call to obtain the stock is larger than the $0.04 in time value forfeited by exercising early.

There is a $5.15 cost for doing the recommended roll and protecting our Chevron stock from early exercise. But by rolling our September $105 call strike to a December $115 call strike, we are increasing our appreciation potential in the stock by an extra $10 through December options expiration.

Rolling Chevron for a Debit?

An important concept to remember is that the $5.15 per share debit on this roll is not a loss. As owner of a stock currently trading at $113.28, you have captured the full $8.28 in price appreciation that Chevron stock has achieved above the September $105 call strike. The debit price paid for rolling the covered call reflects the stock owner/call seller’s obligation to give that $8.28 in share price appreciation to whomever owns the September $105 call.

In other words, the $8.28 per share is a forfeited gain–not a loss. By selling the December $115 call for $3.20, we are taking back $3.20 of the forfeited gain in share price by rolling to a call with new decayable time value, which leaves us with a forfeited gain of only $5.08 ($8.28-$3.20). 

Over time, academic studies have shown that insuring your portfolio from price declines with covered calls is much more important for long-term wealth generation than simply owning the stock and benefiting fully from every gain in share price.

Stocks fluctuate in price and don’t always rise. When stock prices fall or remain stagnant, rolling covered calls brings in credits. Over the long term, the credits received from rolling covered calls far exceed the infrequent debits paid to roll. In addition, by rolling the covered call for a debit rather than allowing the stock to get called away, you continue to receive stock dividends, which in the case of income stocks like Chevron are substantial!

Bottom line: Don’t be concerned about rolling a Chevron covered call for a debit now and then. It’s just part and parcel of the journey to higher returns.

Price Adjustment Regarding Chevron Trade

Unlike when we open an initial trade, this trade involves closing an in-the-money call option before it gets exercised early against us. Consequently, we do not have the luxury of patience and possibly passing on the trade (unless you are willing to sell your Chevron stock). We will need to be flexible in our limit price and adjust if necessary as we get nearer to the market’s close on Tuesday, August 14th.

The limit debit price of $5.15 I suggest above is a starting point. If it doesn’t fill within a few hours, I recommend raising the limit debit price by a few cents per share and waiting a few hours. If this adjusted limit price doesn’t fill, adjust again by a few more cents. Repeat the process until you get filled.