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Trade exit – Kodiak Oil & Gas Corp (KOG) covered call unwind (13.54% profit)

I had two reasons to exit my covered call against Kodiak Oil & Gas Corp (KOG) early. The first reason was that I wanted to release cash for another trade and KOG is quite volatile that I wasn’t sure it would grow and stay above the strike price. The second reason was that I wanted to practice a strategy called unwind.

What is Unwind and when you want to use it?

Unwind is a strategy allowing you to liquidate your covered call when the underlying stocks passed your strike by a large amount and your option is deep in the money. In this situation you can liquidate your covered call and take your money off of the table.

If your call is deep in the money, you have the following options:

  1. Wait until expiration, get assigned and collect your profit. You will be forced to sell your shares, make profit on the stock and on the option premium.
  2. If you do not want to lose your shares, you may evaluate rolling your call option higher and further in time. With this option you may be able to roll for free (the new higher strike and time value option will pay fully for buying back the old option), but from my experience this is quite rare situation. In most cases you will end up paying for this transaction.
  3. If you do not want to lose your shares but cannot find any suitable higher option, you can take a loss and buy back the call option.
  4. If your plan was to get assigned anyway and you still have a few weeks left until expiration, you may decide to use unwinding the position and liquidate earlier.

How you find out whether unwinding will be profitable or you should rather stay until expiration?

It is quite easy. First find out how many weeks you have left until expiration. Then calculate your total risk and total gain of the trade for its whole life span. Find out how much you are typically making per week with this contract.

Here is an example of my Kodiag trade.

I calculated how many weeks the whole trade from initiation until expiration would last. It was 37 weeks.

Then I calculated that over this period of time, the whole trade if called away would bring me $134 overall profit. That is a profit of $3.59 per week.

From the initiation of the trade until today, the trade brought in 117.90 (this is what the trade made me so far for the past 33 weeks – $3.59 x 33 weeks). So there is only $16.54 left until expiration.

Of course the current number would be a lot higher if the stock got deeper in the money than what KOG actually did. The profit by unwinding would actually be a lot larger than it was. I only took out $149.44 at the time of liquidation of this trade, but still more than if I waited until expiration (it would only be $134.44).

Trade detail

Since unwinding was profitable I decided to end the trade earlier and release my cash and collected 13.54% or 35.64% annualized profit.

08/28/2013 15:36:52 Bought 1 KOG Sep 21 2013 10.0 Call @ 0.45
08/28/2013 15:36:52 Sold 100 KOG @ 10.15

This trade released cash for my next trade in Realty Income.

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