Options Exit Strategies: Get Out or Roll On?

For all the information that’s out there about how to enter an options trade, there’s usually not as much focus on how to get out. Whether you’re winning or losing, and unless your plan is to hold an options position until expiration, at some point, you do need to exit in order to take a profit or chalk up a loss. There are lots of options strategies to cover on this subject, but for now, let’s focus on three of the most popular ways to “adjust” an options trade: long options strategies, vertical spread strategies, and calendar spread strategies.

Making Adjustments: 3 Things to Consider

Whatever your reason for needing to make an adjustment—exiting at a profit or a loss—realize that the trade isn’t the same trade you put on. Here are three things to consider:

Remember the Multiplier!

For all of these examples, remember to multiply the options premium by 100, the multiplier for standard U.S. equity options contracts. So an options premium of $1 is really $100 per contract.

Adjusting Winners

THE WINNING LONG CALL STRATEGY EXAMPLE
You’re a believer in XYZ Corp., and you bought 10 of the September 50 calls for $1, for an initial investment of $1000, plus transaction costs. Now the call price has doubled to $2. You can’t be blamed for wanting to take the money and run, but you’re as bullish as ever and don’t want to miss out. Here are three hypothetical scenarios.

1. Sell part of your position. One idea is to sell at least enough contracts to bring in more money than your initial debit. For instance, selling six of the calls that now trade for $2 would net a credit of $1,200, minus transaction costs. This way, you’re locking in a certain price gain, even if the remaining part of the trade fizzles.
2. Adjust into a vertical. Turn your long calls into a vertical call spread by selling 10 call options with a higher strike. For example, sell the 55-strike calls for $0.80, minus transaction costs. Even though this adds a short call to your account, you now own the 50–55 call spread, which has a total risk of only $0.20 per contract. That’s calculated by taking the initial $1 cost of the 50 calls, minus the $0.80 credit from selling the 55 calls. If this spread finishes fully in the money (ITM), then you’ll realize the $500 max value per spread. And if XYZ drops below $50, and the spread expires worthless, the loss is limited to only $0.20 rather than your full $1. The trade-off, of course, is that the vertical spreads place a limit to your upside potential at your short strike, the 55-strike, whereas a single-leg call option can continue higher if the underlying stock price rises above $55. And, keep in mind that a spread comes with commission and transaction costs for each leg, and those increased commissions can negatively impact potential returns. Additionally, spreads are available only in qualified accounts. 
3. Roll up. Cash out the long call that’s made money, but stay in the game by “rolling” up using a “sell vertical spread” order to buy another call that’s further out of the money (OTM). This involves selling the 50-strike calls to close and buying the further OTM calls to open. This trade will likely net you a credit that reduces the overall risk. Bonus: If the credit’s more than you originally paid, you’ve locked in a profit. Just remember, the new order carries another commission, which can affect potential returns.

THE WINNING LONG VERTICAL SPREAD STRATEGY EXAMPLE
Sticking with XYZ, let’s now assume you originally bought one 50-strike call and sold one 55-strike call as a spread for $0.80, plus transaction costs. You could consider spreading off the trade or rolling it up.

Spread the spread. Butterflies and condors are nothing more than combinations of vertical spreads. Create your own combination by selling the 55–60 call spread, and you end up with a butterfly, with the 55 strike as the body (See table 1 below). Calculate your new risk by subtracting the credit from this adjustment from the initial debit.

Roll a vertical. The idea behind rolling up a vertical is the same as rolling up a single option: Take profits on the original trade, then do it again. There are more moving parts, but on the thinkorswim® platform you can use a “sell butterfly” order ticket. For example, turn your long 50–55 call spread into the 55–60 call spread by selling the 50–55–60 call butterfly. This is accomplished by right-clicking on the 50-strike in the Option chain > Sell > Butterfly. Because you’ve chosen consecutive strikes, the system should load the 50-55-60 call butterfly, but double-check your strikes and corresponding quantity, choose the price at which you’d like to trade, and hit Confirm and Send. Subtracting the butterfly credit from the original debit leaves you with the remaining net risk of your new 55–60 spread position (see table 2 below).

Which adjustment do you make? Ask yourself which position you’d enter if this were a new trade. Why? Because it is a new trade. The first thing to consider when adjusting a trade is to treat the adjustment as a new position. Have profit and loss exits mapped out as you would for any new trade.

THE WINNING LONG CALENDAR SPREAD STRATEGY EXAMPLE

Rolling the Calendar. There’s nothing better than having a successful trade when a stock trends sideways, which is what calendar spreads are designed to do. Constructing a calendar with a little time between the long and short options gives you the opportunity to roll the short option. Once the short option has lost a significant amount of its time value, consider using a “sell calendar” order ticket to close the short option and sell the same strike option in the next expiration. 

Exiting Losers

Losing trades are an expected part of trading. Sometimes, simply closing the trade is the right decision. Other times, it might be appropriate to do something else. The assumption here, though, is that you’re managing this losing trade before it gets out of hand.

THE BROKEN LONG CALL STRATEGY EXAMPLE
Your long call position has eroded in time value because XYZ stock hasn’t budged. But you still believe the stock is poised to move higher. In the meantime, to attempt to salvage some of what’s left while still leaving yourself a chance for some profit, consider converting your call to a spread.

1. Spreading to a vertical. Just like with the winning trade, sell a higher-strike call in the same month. Deduct the credit from the original cost of your long call to arrive at the net debit of your trade. The second rule of adjusting trades applies: Match your new position with your market outlook. Since you’re still bullish on XYZ, it might make sense to maintain a bullish trade. But it’s best to do the math. If there’s not much premium left in the higher-strike option, it might be best to close out the trade and move on. Remember: additional trades mean additional transaction costs.
2. Spreading to a calendar. If there’s enough time left in your long call, another idea might be to convert it into a calendar by selling a shorter-term call with the same strike. This “buys” you some time for the stock to get going. And while you’re waiting, you’ll hedge time decay risk as well as some of the downside risk. If XYZ comes back to life, you could buy back the short option to return to your original trade. When assessing the strategy, just remember to include the P/L, plus the added transaction costs, of the shorter-term strike you sold and bought. 

THE BROKEN LONG VERTICAL STRATEGY EXAMPLE
Of course, converting to a vertical spread isn’t a choice if that’s what you started with. But all is not lost. One possibility is to roll the entire spread further out in time using a “vertical roll” order. Consider avoiding a net debit on the trade. That violates the third consideration of adjusting: Don’t make any adjustments that add risk to your trade.

To avoid adding risk, you’ll have to roll up the spread to strikes that are further out of the money than the current spread. This may not be ideal, but the longer time frame gives your trade time to work.

THE BROKEN LONG CALENDAR STRATEGY EXAMPLE
Similar to winning calendars, rolling out the short strike reduces the risk in the trade. But because calendars work best at the money, if the market moves, you might have to move with it. Rolling a calendar that’s gone in the money will cost you. But here’s how you might get around that.

Roll the long option up/down in the same month to the at-the-money strike. Then, roll the short option up/down to the same strike, going one expiration out in time. If the net cost of both trades is a credit, it might be a worthwhile adjustment. If it’s a net debit, it might be best just to close.

With any options strategy, simply winning or losing doesn’t mean you need to close your trade, although that’ll sometimes be the best choice. When you have a reason to stay in, adjusting a trade can help you cut risk, take money off the table, and give you time to make more plans.