Sequenced covered-call repair after a growth-stock drawdown

A repair sequence, not a one-time hedge

This archive case follows one long stock book through a sequence of short-call overlays after a broad selloff. Editorial reading: covered-call writing is taught here as a multi-step option-income strategy, a repeatable overlay that writes, splits, ratios, or rolls short calls to harvest premium while the long remains open.

Covered-call writing means selling calls against a long stock holding so collected premium lowers net basis and supplies a limited cushion if the shares fall. Net basis is the purchase price of the shares minus cumulative net premiums, used as the overlaid book’s breakeven.

The opening covered write

The case opened by pairing 1,000 shares bought at 70.50 with 10 short April 70 calls sold the same day at 3.50, producing a net basis of 67 and about 5 percent of premium cushion versus the purchase price.

The initial covered-write payoff was described as sitting above an unhedged long at any expiration price below 74, in exchange for giving up further upside once the short 70 strike was reached.

After the selloff

After a second 1994 policy-rate increase triggered a broad selloff, the shares later broke well below the 70 strike toward 60. The open loss on the overlaid book was 7 per share versus 10.50 on the stock alone.

Editorial reading: the holding had left the market regime that supported the first write. The first premium is not treated as a completed hedge. Later overlays are scored as further changes to net basis, remaining shares, and residual exposure.

A split-strike overlay

The first repair sold five October 60 calls at 6 5/8 and five October 70 calls at 2 3/4, splitting the book so the lower-strike lot’s basis fell to 60.37 and the higher-strike lot’s basis fell to 64.25.

That structure is a split-strike overlay: writing mixed in-the-money and near-the-money calls on one holding so assignment of the lower strike can shrink inventory while the higher strike keeps some upside.

Longer-dated contracts were chosen because a longer remaining term was treated as raising both time premium and the chance the strike is reached, so the writer demanded more compensation. Editorial reading: that choice is option-premium analysis, splitting a call price into intrinsic value and time value, then choosing expiry and moneyness to size that time value against assignment and residual delta.

Assignment at the October expiry

At the October expiry the shares were near 61, the 60-strike calls were assigned, and that half of the holding was removed without a realized stock loss on the reduced-basis lot.

A short-of-neutral ratio write

A later overlay used a 3-to-1 write of January 70 calls, short of the roughly 5-to-1 count implied by a 0.20 delta for neutrality, because a possible rebound was still allowed for and the leftover uncovered shorts required a cover plan if price rose through the strike.

Ratio-writing means selling more calls than shares so short-option delta more nearly offsets the long stock. Delta is the fraction of a one-unit stock move expected in the option price, used here to scale how many calls would approach a market-neutral write. Leftover uncovered calls need an explicit cover rule.

A same-day roll and the write-up comparison

Near the January expiry the remaining cheap shorts were bought back and replaced the same day with April 70 calls, moving net basis from 62.75 to 64.07 and then down to 60.19.

At the write-up the shares traded near 71, close to the original 70.50 purchase, while the overlaid basis of 60.19 sat about 15 percent below that market price, so an unhedged long was near flat and the overlaid book still had unused premium cushion.