r/thetagang
Risk Mitigation on Short Calls
Author explores setting a limit buy order at the short call strike plus premium to mitigate risk in PMCC campaigns.
I’ve been running some PMCC campaigns and had an idea to experiment with setting a buy order on the underlying if the stock gets to my short call strike. I limit the order to my short strike price plus the credit received from the short call.
I’m curious if anyone else does something similar? I understand that it doesn’t help me with overnight gap risk, and that I could lose on the stock if it is chopping up and down. Even so I thought it was an interesting idea and was curious if anyone else does this and has experience you want to share.
If you’re doing this because you’re worried about missing out on gains if the price blows through your strike, it’s cheaper to buy calls instead of shares.
That is a good idea. I’d be reluctant to set an automatic buy order on a call, but could see buying a call manually in this case.
If you fear the risk of a far gap up and „losing“ the upside of a cc or a pmcc then it’s because the strategy is not right. A cc/pmcc will enhance returns of a „slow“ stock or accompany a dividend strategy. On a growth strategy aiming for price action gains it will just cap the upside. An exception might be earnings on your conservative stock. To manage upside risk there, just sell cc that expire before earnings and sell new ones afterwards. Of course you have to sell into the iv crush then but there’s no way around it. If you buy a call for protection before earnings and sell it later you also buy high IV and sell lower IV. But, if the price falls after earnings a long call will lose a lot. Having the cc expire before lets you choose a fitting price for the new cc and with a sharper drop even with quite good IV to sell.
Interesting idea, and you’ve already spotted the two main holes in it yourself, which is more than most people do before posting.
What you’re basically describing is a synthetic conversion of your PMCC into a fully covered position right at the strike. If the stock runs up to your short call, you buy 100 actual shares so you’re no longer relying on your long LEAP to cover the assignment. The logic makes sense on paper. If you get assigned on the short call, you deliver the shares you just bought instead of having to exercise or sell your long call.
The thing I’d push back on a little: what problem are you actually solving by doing this? With a normal PMCC, if the short call goes ITM and gets assigned, your long call already covers it. You just close both legs, or exercise the long to deliver. You capture the spread between your strikes plus the net credit. Buying shares at the strike doesn’t really improve that outcome in the clean scenario. It mostly changes which leg does the heavy lifting.
Where it does matter is early assignment and pin risk. If your short call gets assigned early, having shares already in hand means you’re not scrambling to exercise your LEAP or eating a bad fill. So as a mechanical hedge against assignment mechanics, there’s something to it.
But the chop scenario you mentioned is the real killer. Stock taps your strike, your buy fills, stock drops back below, now you’re long 100 shares you didn’t want at close to the high of the move. Do that a few times in a choppy tape and you’ve bled out way more than the convenience was worth. You’re essentially buying breakouts with a stop that’s your own pain tolerance, and that’s a rough way to trade a sideways name.
The credit-as-buffer idea (strike plus credit received as your limit) is clever but it’s a thin cushion. On most PMCC short calls the credit is small relative to the share price, so you’re really only protected against a few percent of immediate reversal. It feels like protection but it’s mostly cosmetic.
If the goal is dealing with assignment cleanly, I’d honestly just manage the spread directly. Roll the short call up and out when it goes ITM, or close the whole thing for the spread gain when your thesis plays out. That avoids introducing a third leg with its own slippage and whipsaw risk.
That said, if you want to experiment, I’d do it on a name with decent trend persistence rather than a choppy one, and I’d size it knowing some of those share buys are going to turn into small losers. Track it as its own line item so you can actually see whether the convenience is paying for the whipsaw. My guess is it’ll be roughly a wash on trending names and a slow drain on choppy ones, but it’s worth running the experiment if you’re curious. Would be a fun thing to backtest.
Feels clever in theory, but wouldn’t this just add whipsaw risk around the strike? Curious why not just manage/roll the short call earlier based on delta instead.
In the past I have just rolled the short call. But that is effectively taking a loss on the original short call. Which is fine but I just had a thought that this might be a better way to mitigate the loss. I do think the whipsaw risk is the real risk, I just don’t know on balance how that risk compares to the roll.
Yeah I think that’s the tradeoff. Rolling is a realized loss on the short call, but at least it’s a known/controlled adjustment. Buying shares at the strike feels like it could easily turn into death by a thousand cuts if the stock chops around the level
My gut says the main question is whether the extra upside captured actually outweighs the whipsaw risk over time. Have you backtested it at all or just thinking through it conceptually?
Just thinking it through. One thing I might do is go through 10 trades on the think back thing on think or swim and see what would have happened. Not scientific obviously but anything more systematic is beyond my abilities at this point.
Interesting idea, but feels like this might just turn your PMCC into a weird delayed covered call with extra execution risk. If the stock chops around the strike you could end up buying high and getting whipsawed. Have you compared this vs just rolling the short call earlier once delta gets too high?
You mean not waiting for my short strike to get breached before rolling I think. I’ve done that sometimes. I haven’t really had issues with that, but effectively when I do that I’m taking a loss on the initial short call. Which is fine but I just got to thinking maybe a better way to manage the loss would be to buy the shares to cover it. One advantage of buying to cover over rolling early is I potentially pick up a few “wins” in cases where the stock moves towards my strike but then goes back down.
As I’m thinking through this though, I think I remember seeing somewhere that the probability of touch is something like 2x the probability of expiring ITM. If that is correct, it would suggest I would lose money on the stock purchase more often than I would have thought intuitively.
The buy stop on the underlying recreates your upside but at the worst entry, right as price tags the strike, and if it whipsaws back down the stock loss is bigger than the call premium cushions. You also end up long LEAP plus long shares plus short call, which is just a covered call with extra capital tied up. In a PMCC the cleaner defense is rolling the short call up and out for a credit while it still has extrinsic, or starting at a lower short delta so you are not defending so often. One risk that actually deserves a hard rule though: when your short call goes ITM right before an ex dividend date, early assignment risk spikes because the counterparty wants the dividend, and that is the scenario that quietly blows up PMCCs since you do not own shares to deliver. Watch ex div dates on the short leg more than the gap risk.
I'm not keen on the 'buy a call'; just buy your damn short call back.
Couple of things I've done in the past.
- I'd own stock and LEAPS in equal stock count (100 shares = 1 contract). Alternate strikes/expirations. I'd look at the futher dated, higher strike as associated with the long call while the nearer dated, lower strike with the stock. I'm currently sitting on a $108 strike for CRWV expiring June 18 and a $125 strike expiring August 21. I suspect the June 18 will expire worthless, but you never know. If the situation warrants, I'll just not roll and hold the stock as insurance against the August 21 short call.
- I'd have enough cash on hand to buy the stock and would do so if the situation warranted.
At the end of the day, you can just accept assignment and using your own funds to make up the difference, buy at market (e.g., strike $100, stock at $105, you get $10,000 to sell the stock then buy at $10,500, only needing $500 to complete the transaction).
I do that but usually set the buy limit at the BE on the trade."IF" I have the Net LQ I will set an ATM or slightly OTM short put at the Strike. Example... strike is $125 and premium is $5 I buy X no. shares at about $130.00 and sell X no. puts at a $120-$125 strike. In the event my short call strike gets OBLITERATED I will just btc and wait for the price to settle down. If price keeps going I eat the loss on the btc and re-center my strike on the short call(s). If price drops I collect the premium on the original short call, even roll it down, and roll the short put down. You have to watch the price action and "crystal ball" what is going to happen next to "get it right". You can get whipsawed but with the strangle trade, short call/short put, you have lots of premium to play with and, hopefully, you have a good solid stock as your underlying. This can actually get quite lucrative. Best of Luck, Twilighter.
That’s interesting - thanks for the ideas! I have a lot of experience turning credit spreads into ICs or even iron flies to mitigate losses if my strikes get breached, and what you’re doing with the short put sounds similar. On my credit spreads doing this sort of mitigation was a game changer for me. Here I guess you could think of the long deltas on the put as offsetting the fact that I have more short deltas on the calls than I started the trade with.
I do that with more conservative tickers. Actually with a twist. If I have a company that I think will at least not go bancrupt, has been struggling and might be a lot higher in a few years then I’ll buy a leap call some years out at about 75 delta (and roll it above 90 delta). I’m doing this with P911 right now for example. Then I’ll sell a 16 delta strangle every 4 weeks to bring the cost basis down, preferably to zero or negative. Right now the call strike is 49.50 €. When I sold the strangle I set a buystop/limit order at buy over 48 but limit 49,50. If a stock really gaps far then I won’t have bought shares above the strike. This was executed a few days ago at 48. the strangle expires Friday and I’ll either keep the shares or they get called if the price is over 49.5p. Monday I’ll sell the next strangle. If I don’t have shares I’ll do another stopbuy/limit order. If I have shares and the call is close I’ll just leave it like that. If the strikes are far above the buying price I’ll do a stopbuy/limit order and sell a cc right above the price I bought the shares for to have them called away. I don’t defend the put side by shorting shares since I expect rising prices for the underlying, I just wheel that side by letting one lot get assigned and then sell cc on it. The next strangle wouldn’t be a strangle then but instead the 16 delta short call and the cc.
Anyway you’re covered by the leap call all the time, so bpr is minimal and having cash or shares doesn’t change margin/bpr a lot and the strategy just goes along in the portfolio without obliterating the other trades in a significant way.
Greetings, Dan
Thanks this is helpful. In terms of how much capital you set aside for this, is it pretty much price of leap plus price 100 underlying plus price of put assignment or are you comfortable rolling with less than that? In my case I’m not as bullish as you on the underlying so I would be looking to turn the shares pretty quick no matter what.
Also, are you always selling your shorts at a strike equal to or higher than your long strike? I started doing that, but have migrated to buying a little farther out leap and selling closer in given that the longer still has a higher delta.
For my pmccs I’m basically selling weeklies on stocks that are very volatile, betting I can squeeze enough juice out of my short calls to cover any losses on my long, which I basically just see as a hedge that I open to be comfortable selling the shorts.
Thanks for the ideas!
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In terms of how much capital you set aside for this, is it pretty much price of leap plus price 100 underlying plus price of put assignment or are you comfortable rolling with less than that?
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the cash to buy the leaps is gone of course. on top, the "worst" that can happen is owning 200 shares for one "package" so to say. this would be one leaps call + 200 shares. If there's a lot of bpr in the rest of the portfolio, the shares could be bought/assigned on margin, but that's not the goal. since the other strategies don't involve holding shares, holding the shares here are not that big of a problem as they are almost as good as collateral as cash for options selling strategies.
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In my case I’m not as bullish as you on the underlying so I would be looking to turn the shares pretty quick no matter what.
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yes, I do that as well. the goal is to buy a leap and then trade around it as the price goes up over the years. you don't have to have the shares because the strangle upside is protected by the leap call all the time, this also keeps bpr for the strategy low.
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Also, are you always selling your shorts at a strike equal to or higher than your long strike?
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for the trading around the leap I set the strike at 16 delta on both sides 4 weeks out but the call has to be above. if I bought shares or got assigned then I'll sell cc right above the buy price with the goal to lose the shares quickly. I also roll the leap up (and out) if the thesis is still right and the delta of the leap is over 90.
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For my pmccs I’m basically selling weeklies on stocks that are very volatile, ...
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I sell the strangles 4 weeks out and the cc one week out.
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you can look at it as a covered strangle with the core stock holding replaced by a leap.
a real life example if you want to look at a chart would be p911. I bought the leap (32€, exp. december 2027) at the beginning of march for a little over 1000€. then sold a strangle right away, one April 17th and one may 18th (expires today) for about 200€. I bought "hedges" 3 times - two were called away for a gain of 70€. one is still on for the expiry today. the cc to get the shares called away sold for 88,90. so income of about 360€.
for the overall strategy I would see it as owning the leap call for about 700€ right now (1050 buy price - 360 cost reduction).
depending on the country you're in and the rules about wash sales and taxes this might or might not make sense. for me it's a low risk, low effort strategy. it works even better with a higher dividend stock that pays quarterly.
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That hedge can work mechanically, but it changes the trade into something more complex than a PMCC.
You are adding long shares at the same point where the short call is under pressure, so you now have gap risk, whipsaw risk, and timing risk. I would compare it against simpler choices first: rolling, buying back the short call, choosing a farther strike initially, or accepting that the covered-call structure caps upside by design.
What's the point?
I sell naked call n set price alert like this
the cleaner fix is what a couple people said, if youre worried about the upside blowing through your short strike, buying a call is cheaper than buying shares and it actually covers the gap risk your stock-buy order doesnt. setting a buy-stop on the underlying at the strike just converts you into a delta-one position right at the worst spot, you end up long the shares into a stock thats already run. ive turned breached PMCCs into verticals or just rolled the short call up and out for a debit when i still believe in the move. but honestly if youre fighting the upside this much the short strike was probably too close to begin with.