Three options strategies on how to exit a winning or losing trade: long options, vertical spreads, and calendar spreads.
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.
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:
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.
THE WINNING LONG CALL STRATEGY EXAMPLEYou’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.
THE WINNING LONG VERTICAL SPREAD STRATEGY EXAMPLESticking 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.
TABLE 1: ADDING A SHORT VERTICAL TO A LONG VERTICAL EXIT. Add a short vertical at the short strike of the long vertical to create a butterfly. This should lock in some profit and possibly squeeze out a bit more. For illustrative purposes only.
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).
TABLE 2: ROLLING A LONG VERTICAL. Roll a vertical spread to higher strikes to take profits on the original trade and use those profits to try it again. For illustrative purposes only.
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.
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 EXAMPLEYour 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.
THE BROKEN LONG VERTICAL STRATEGY EXAMPLEOf 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 EXAMPLESimilar 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.
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