Wheel Option Strategy: Selling Calls Before Expiration?

   

Introduction: Selling Calls Before Expiration

By now you all know that I love trading using the Wheel Strategy. But at a certain point, there is always a decision to make: Should you sell your call options on Friday to get additional premium from what is known as the ‘weekend time decay’?

Sounds tempting, doesn’t it? As options traders, we love to lock in our profits. But in this article, I’m going to show you exactly why selling calls before the expiration date can be a HUGE and very costly mistake

What is the Wheel Option Strategy?

Let’s start with a quick review of the Wheel Strategy, just so we’re all on the same page.

“The Wheel Strategy” is an options trading strategy that consists of three parts:

  1. Sell Put options and collect premium on those trades.
  2. Eventually, you might get assigned the shares from your trade.
  3. If you are assigned shares, start selling covered call options to earn even more premium.

As you can see, the idea is to collect premiums and take advantage of “time decay.” 

So here’s the great debate when trading options: Should you sell calls on Friday’s expiration BEFORE you get assigned? 

As an option seller, you’re taking advantage of “time decay,” and holding options over the weekend may work in your favor. 

So wouldn’t it make sense to sell the calls as soon as possible? Let’s take a look at why this might be a costly mistake!

Why Selling Calls Before Expiration Can Be A HUGE Mistake

Let me show you a very specific example of a trade that I made last week:

selling calls before expiration

As you can see, I sold the $108.00 put options for Alphabet (GOOGL) that expired on September 2nd. 

But on the Friday before Labor Day, GOOGL was trading all over the place. It was a volatile session, which can be difficult to navigate when trading options. 

selling calls before expiration

So during intraday trading, GOOGL reached as low as $100.74, and as high as $107.26. That is quite the swing.

In the last 30 minutes of the trading session, GOOGL was trading below $108.00, which meant it was very likely I was going to get assigned those shares. 

So here’s where I could have taken advantage of ‘time decay.’ I can sell calls against the shares that I will probably own by the end of the day. 

selling calls before expiration

Okay, so if I were to have sold the $108.00 calls expiring on September 9th, I could get $1.72 for them. That is, of course, $172.00 per option contract since they trade in packs of 100 shares. 

Based on my trading account size, I would be able to trade 12 call options for GOOGL. 

12 * $172.00 = $2,064.00. An extra $2,064.00? That sounds pretty tempting to me. 

Don’t Count Your Eggs Before They Have Hatched!

But here’s the problem:

The closing price of the option on the expiration date doesn’t matter!

Let me explain what I mean by that:

Typically, a broker will exercise an options contract automatically when it is at least $0.01 in the money. 

In this example, I sold a put for GOOGL, and whoever bought the put option, now had a put that was “in the money.” That is to say, GOOGL was trading below $108.00 which was the strike price. 

So normally, the broker would exercise it automatically, BUT….

The options buyer can actually send a “do not exercise” request to the broker. This means they themselves would just keep the premium they made on the put option and not take the shares of GOOGL. 

According to FINRA, “option holders who hold expiring options have until 5:30 p.m. Eastern Time (ET) on the day of expiration to make a final exercise decision to exercise or not exercise the option”

The markets close at 4:00 pm ET. Can you see the problem now?

So at the end of the day on the date of expiration, option holders still have 90 minutes after the close to decide whether they want to exercise the option or not!

And to make things even more complicated, each broker has different cut-off times for these requests.

Take a look:

Here we can see that Tastyworks only gives you until 30 minutes after the close.

But as another example, Robinhood gives you until 5:00 pm ET, that’s 60 minutes after the close.

Long story short:

Even if the option closes “in the money” you don’t know whether you will get assigned or not. 

Why Is It So Bad To Sell Calls Even If You Don’t Own The Shares?

So there are a couple of different scenarios in this situation. Let’s talk about the ‘normal’ scenario first:  

In a true covered call, you own the shares and then sell calls against those shares. Typically you would only sell the contracts that cover your position. For example, if you own 200 shares, you would only sell two call options since you are ‘covered’ for those 200 shares. Remember that each option contract is worth 100 shares. 

So for my GOOGL example:

  • I would have been assigned at $108.00.
  • I would then sell calls against my existing shares for around $1.70.
  • and if GOOGL closes above 108 on expiration date, my shares are getting called away.

So I’m not making any money on the shares, but I can collect a juicy $2,000 premium. This is great. Now I can continue to sell covered calls on GOOGL until my shares are called away. This is the third step of the Wheel Strategy. 

But here’s what could happen when you sell calls too early:

  • You sell the calls for $1.70 against shares that you don’t own (yet).
  • The trader who bought the puts from you chooses not to exercise the options.
  • Now you don’t own the shares.

Okay, so now you own naked calls meaning you sold the calls on GOOGL but you don’t have the shares if they are called away. Here’s how this can backfire.

You Can’t Control News Outside Of Market Hours

Let’s say the markets or GOOGL get some good news after the markets close on Friday or over the weekend. When the markets open again after the weekend, the stock opens 3.0% higher at $111.20. This is all hypothetical, but also very possible. 

Since you sold the call already you are obligated to sell 100 shares of GOOGL at $108.00 for each option contract. 

This means you would lose $111.25  – $108.00 = $3.25 per share. Then multiply that by 100 shares and you would lose $325.00 per option. 

At 12 option contracts that is a loss of $3,900. Ouch. 

And that is just at the open. If GOOGL keeps going up and you don’t close the trade, it could get even worse! 

How To Avoid This Costly Mistake

Of course, there’s only one way to avoid this costly mistake: Don’t sell call options before you get assigned!

The best thing to do is wait until Monday to see if you were assigned those shares. If you were, then you can start to sell covered calls on them. 

Most brokers will let you know by Saturday if you were assigned or not. Your account should be updated by then. 

So when the markets opened again on Tuesday after Labor Day, I had multiple choices:

I could sell calls AT the price I was assigned, or I could choose 1-2 strike prices above my assignment price.

So what’s the best strike price when selling options? Lucky for you I made another video that explains this in detail using my own real-life trades. 

Check that video out right HERE, because when you choose the wrong strike price, you might leave a lot of money on the table.

I hope you found this article on selling calls before expiration helpful!

Read Next: How To Find the Best Strike Price To Sell Covered Calls



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