Exit Options Strategies: Ready to Get Out or Roll On?

For all the information that's out there about how to enter into 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 option 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:

1. Treat any adjustment as a new position. Have P/L exits mapped as you would for any new trade.
2. Match your new position with your market outlook and volatility backdrop.
3. Don’t make any adjustments that add risk to your trade.

Remember the Multiplier!

For all of these examples, remember to multiply the option premium by 100, the multiplier for standard U.S. equity option contracts. So an option 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 ideas.

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 6 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, 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, less 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, less 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 places 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.

Which adjustment do you make? Ask yourself what 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

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 option 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.