Covered Call Option Case Study: Arch Resources (ARCH) from 11/2021 to 11/2022

Stocks that appreciate consistently in value over any significant period may be as much as surprise as a blessing. When an investor places hard-earned capital in a company’s stock, he can never know for certain whether that investment will turn out to have been a success story or a tale of woe. A covered call strategy as a hedge can be just as much an essential part of an investment in a stock — especially a volatile one — that later turns out to be successful as for an investment in a stock that later turns out to be unprofitable over an extended period.

Nonetheless, a myth exists in popular understanding of investments, perpetrated by egotistical simpletons in the financial news media (i.e., Jim Cramer on CNBC), that a covered call option strategy necessarily caps the upside potential of an investment that later turns out to be profitable. Such an outcome only results from passive lackadaisical management of covered calls. It can be avoided by careful maintenance of covered calls, using the time decay of options, availability for rolling those options up at higher strike prices at later expiration dates, and continuing volatility during inevitable directional changes in stock price movements. Proper maintenance of covered calls for upward moving stocks should allow not only preservation of underlying capital appreciation but also collection of some degree of options premium to serve as a “synthetic dividend.” Even if this “synthetic dividend” does not approach the levels for overall downward moving stocks during any time period, it nonetheless may serve to add to overall return, or at a minimum if it involves some degree of outlay to serve as insurance against depreciation for a volatile and uncertain stock.

Additionally, for stocks that are experiencing the enviable upswing, long stock positions may cautiously and appropriately be supplemented by trading positions in short cash-secured put options and long call options, further adding to the overall return provided by underlying unrealized capital gains and realized covered call options premium.

This case study examines this author’s own experience during the late 2021 sell-off and 2022 Bear Market with covered calls for an investment in a stock from one of the rare winning sectors during this time, namely the energy sector, which prospered considerably despite the overall bear market. The specific stock selected is Arch Resources (ARCH), one of the largest coal producers that is still publicly traded and one that is based out of the US. Since the onset of the COVID-19 pandemic, the price of coal (and thus the price of coal stocks such as ARCH) have been closely linked to the price of natural gas, as many electricity-generating utilities have turned to coal-fired plants to generate power as natural gas has become less plentiful or more prohibitively expensive. ARCH, which produces coal for primarily metallurgical purposes (i.e., coking iron ore to generate steel) but also for thermal purposes (i.e., electricity generation), has been a strong out-performing stock during the COVID reopening period of 2021 and the Bear Market of 2022. I have also selected it for purposes of this case study because I have held it since taking an initial position in August 2021, added to the position in December 2021, and held it throughout the Bear Market of 2022.

During the one-year period analyzed in this case study of November 22, 2021 to November 21, 2022, ARCH’s underlying stock price has increased from $79.66 per share to $154.33 — an increase of 93.7% percent. During this period it has had a low closing price of $76.22 and a high closing price of $179.47, with many zigs and zags in between those figures. I held 114 shares of the stock at the start of the period under study, initially allowing for one covered call contract to be written. Several months after the period began, on 12/2/2021, I purchased an additional 86 shares of the underlying stock, at a price of $79.50 per share. This purchase then allowed me to write an additional covered call option and have two outstanding covered calls at a given time. Similar to certain oil production companies during this period (such as Devon Energy), but starting only part-way through the period involved, the company has also instituted a rather substantial variable special dividend policy, which in this instance has resulted in dividend payments based on my 200 shares of $2872 (as well as an additional $2150 on 12/15/2022, just after the period covered in this case study).

The substantial, occasionally rapid underlying stock price appreciation coupled with periodic partial depreciation, interspersed with large dividend payments, has required nimble activity with regard to covered call option maintenance. Nonetheless, throughout this time I have never had any shares of ARCH called away. I have also sold cash-secured puts and traded long call options on a limited basis in a profitable manner to supplement the considerable unrealized capital gains based on the increase in the underlying share price.

The following chart depicts trading stock and option activity regarding ARCH during the affected time period, primarily encompassing covered call options trades with some supplemental long call and short cash-secured put activity and dividend accrual:

DATE	ACTION TAKEN	AMOUNT GENERATED	STOCK DAILY CLOSING PRICE	TOTAL STOCK PERIOD GAIN/LOSS	TOTAL OPTIONS PERIOD REALIZED GAIN/LOSS
11/22/2021	STO Call 85 1/21/22	659.34	79.66	0.00	659.34
12/2/2021	Buy 86 additional underlying ARCH shares (for total of 200 shares)	(6,837) (for stock acquisition, not options transaction)	79.50 (acquisition price)	(18.24)	659.34
12/2/2021	STO Call 90 1/21/22	409.34	79.91	63.76	1068.68
12/28/2021	BTC Call 90 1/21/22	(580.65)	92.04	2489.76	488.03
12/28/2021	STO Call 95 2/18/22	629.34	92.04	2489.76	1117.37
12/28/2021	BTC Call 85 1/21/22	(910.65)	92.04	2489.76	206.72
12/28/2021	STO Call 90 2/18/22	889.34	92.04	2489.76	1096.06
1/28/2022	STO Put 90 3/18/22	699.34	97.91	3663.76	1795.40
2/9/2022	BTC Call 95 2/18/22	(1420.65)	108.36	5753.76	374.75
2/9/2022	BTC Call 90 2/18/22	(1860.65)	108.36	5753.76	(1485.90)
2/9/2022	STO Call 100 5/20/22	1749.34	108.36	5753.76	263.44
2/9/2022	STO Call 105 5/20/22	1499.34	108.36	5753.76	1762.78
2/15/2022	BTC Put 90 3/18/22	(100.65)	119.37	7955.76	1662.13
2/24/2022	BTC Call 105 5/20/22	(1930.65)	113.97	6875.76	(268.52)
2/24/2022	BTC Call 100 5/20/22	(2230.65)	113.97	6875.76	(2499.17)
2/28/2022	STO Call 100 5/20/22	2229.34	119.37	7955.76	(269.83)
2/28/2022	STO Call 105 5/20/22	1929.34	119.37	7955.76	1659.51
3/4/2022	BTO Call 150 8/19/22 (long call)	(2310.65)	152.39	14,559.76	(651.14)
3/15/2022	Dividend Payment on Stock	50.00	141.47	12,375.76	(651.14)
4/20/2022	STC Call 150 8/19/22 (long call)	2819.34	154.19	14,919.76	2168.20
4/25/2022	BTC Call 100 5/20/22	(3530.65)	131.32	10,345.76	(1362.45)
4/25/2022	BTC Call 105 5/20/22	(3080.65)	131.32	10,345.76	(4443.10)
5/11/2022	STO Call 180 8/19/22 x 2	3118.68	164.18	16,917.76	(1324.42)
6/15/2022	Dividend Payment on Stock	1622.00	161.86	16,453.76	(1342.42)
7/1/2022	BTC Call 180 8/19/22 x 2	(1021.30)	143.80	12,841.76	(2345.72)
7/7/2022	STO Call 160 8/19/22 x 2	1918.66	139.58	11,997.76	(427.06)
7/28/2022	BTC Call 160 8/19/2022 x 2	(621.30)	128.59	9799.76	(1048.36)
7/29/2022	STO Put 115 9/16/22	849.33	129.14	9909.76	(199.03)
8/12/2022	BTC Put 115 9/16/22	(145.65)	151.70	14,421.76	(344.68)
8/19/2022	STO Call 170 10/21/22 x 2	1798.66	161.97	16,475.76	1453.98
9/2/2022	BTC Call 170 10/21/22 x 2	(581.30)	141.85	12,451.76	872.68
9/15/2022	Dividend Payment on stock	1200.00	127.64	9609.76	872.68
9/29/2022	STO Call 135 11/18/22 x 2	1434.67	122.32	8,545.76	2307.35
11/10/2022	BTC Call 135 11/18/22 x 2	(3621.30)	152.16	14,513.76	(1313.95)
11/10/2022	STO Call 135 Call 1/20/23 x 2	3878.61	152.16	14,513.76	2564.66
11/21/2022	Close of Period for Case Study	—	154.33	14,947.76	2564.66

During the one-year period depicted from 11/2021 to 11/2022, the underlying stock price of ARCH nearly doubled, appreciating as noted by 93.7%. This appreciation for 200 shares of the underlying stock resulted in unrealized stock appreciation of $14,947.76, NOT including dividends or call option premium. The total amount of net options premium generated was $2564.66, which includes profit from limited trading long call and short put options. From this amount, a relatively nominal loss of $254.77 was generated only from covered call options. A gain of $1517.06 additionally was generated from trading long call options and a gain of $1302.37 was generated from short put options. $2872 accrued from dividend payments during the period covered by this case study.

In total, an initial investment valued at $15,918.24 in long stock and $2310.65 in one short-term long option (or $18,228.89 total) generated a one-year return of $14,947.76 in stock appreciation, $2872 in dividends from stock, and $2564.66 in net options premium. The total effective one-year return thus was $20,384.42, or 111.82% (not factoring in cash used to secured short puts that were not assigned). Not bad for an investment in an industry (coal production) and industry sub-grouping (energy exploration) that were considered to be dead only a few years ago.

With regard to the series of covered call options, as indicated in the chart above, the strike prices that were selected varied considerably, starting at 85, fluctuating upward and downward over the next several months between 85 and 105, then jumping drastically to 180 before fluctuating somewhat downward between 160 and 170, and finally going downward to 135. These strike prices generally (though not perfectly) tracked the market price of the stock, often in a lagging fashion as the stock price was at times “going parabolic” in rapidly increasing.

It should be noted that the roll over in April and May 2022 from strike prices of 105 to 180 was not an equivalent exchange of cost and premium, given the rapid increase in stock price and substantial lag behind of prior strike prices. This roll over required temporarily using approximately $3000 in additional funds to increase the strike price, which was done in order to avoid assignment near the ex-dividend date for a very high variable dividend that this author did not want to lose. In further support of this action, it should further be noted that additional proceeds from profitable short put and long call options trades were available to be leveraged towards this roll over transaction for the covered calls. Although these were a distinctive type of transaction, a close following of the momentum dynamics for the underlying stock enabled by managing the covered calls also allowed for an understanding of market conditions that enabled the successful long option trades. Finally, on the issue of this steep covered call roll over, most of the additional outlay ultimately was later recovered on subsequent profitable covered call roll overs when the stock went through a moderate pullback in market price.

Ultimately, this case study is an example of covered call management for a volatile stock that substantially appreciated in value, at times with sharp movements upwards and less sharp movements downwards. Unlike the prior case study for AirBNB during the same period when the stock lost a substantial portion of its market value, the covered call strategy did not generate substantial revenue through the covered calls themselves. Indeed, the covered calls resulted in a net nominal loss, of only $254.77, during the one-year period at issue in the case study. Though this outcome was far from a large “synthetic dividend” as in the other type of situation previously examined with ABNB, the nominal loss should be considered to be a form of insurance against the potential outcome of a declining stock price, with a much lower initial and ongoing outlay than would have been likely required to hold and trade long put options throughout this time period. Because the large increase in stock price was far from a certainty at the start of the period, this nominal insurance should be considered well worth the price and effort involved. After all, the efforts taken not only served as a hedge against possible losses that did not materialize, but these efforts also allowed for the covered call strategy to be used without placing any immutable cap on the returns from stock appreciation after the stock went up substantially in value.

As of the writing of this case study, on the last day of trading for the 2022 year in December, the market price for stock in ARCH is now approximately 142.50, just barely above the 135 strike price currently in effect for the extant covered call options. The coming of the New Year should be an occasion for portfolio rebalancing, which would include trimming stock positions for stocks that have increased considerably such as ARCH. This means that this author may soon unwind all or part of the underlying ARCH stock position, either by letting a slightly in-the-money call option be assigned or by closing the short call option position and selling the underlying stock at the market price soon thereafter. Either manner of unwinding the ARCH stock position in whole or in part allows for realizing both the benefits of the covered call strategy AND the substantial capital appreciation that was unrealized during the year of the case study time period.

The next case study in this series will examine the author’s experience with a covered call strategy with an underlying stock that demonstrated middling strength during the period of study, without the decline experienced by ABNB but also without the rapid price appreciation of ARCH.