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 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.
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 option premium by 100, the multiplier for standard U.S. equity option contracts. So an option 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 ideas.
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.
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.
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 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
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 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.
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