You have a losing trade but don’t want to sell. Learn about rolling a losing call option and other strategies to save a losing trade.
So you have a loser, but don’t want to close it out. Maybe it’s a complex trade like an iron condor. Or maybe it’s a single long option. Or maybe it’s just stock. What can you do? First, don’t panic. Cooler heads prevail. Second, if you’re going to “fix” your trade, don’t wait until there’s nothing left to fix.
When is losing too much, well, too much? Many traders follow a quick rule: Cut your losses if the trade loses half or more of its original risk. But that may not be a good fit for all strategies.
Before fixing a trade, you need to understand that you’re not really “fixing” anything. The loss is real, and any sort of fix is really a new trade. So, the better question becomes, “Does my original analysis still hold, and would it be better to adjust my position or exit the trade and move on?”
Consider four common scenarios and potential ways to fix ’em.
The situation: If you bought stock at the wrong time, it might be the right time to introduce yourself to the short call option. By selling a call option, you’re giving someone else the right to buy the stock at a fixed price, meaning the strike price. And that means you’re obligated to sell the stock if the buyer decides to exercise their right. So, choose your strike price carefully. In exchange for this obligation, you’ll collect the premium from the trade, minus transaction costs, and that reduces your break-even point. Let’s suppose you bought 100 shares of stock at $85, and it promptly moved lower to $80.
The fix: Using the options prices from figure 1, you could, for example, sell the 85 strike call for $1.30. Subtracting $1.30 of premium from your stock purchase price of $85 leaves you with a break-even price of $83.70. And, once you’ve sold the call against your long stock, you now hold a “covered call”, which is a strategy some traders use from the start as a means of generating income when buying stock.
FIGURE 1: SELLING A SHORT CALL OPTION. Source: The thinkorswim® Platform. For illustrative purposes only.
If the stock remains below $85 through expiration, then your option will expire worthless, and you can go your merry way. Or, you can choose to sell another call to move your break-even price even lower.
However, if the stock moves higher than $85 prior to or at expiration, two things could happen. One: nothing. Depending on the days left until expiration, and how high the stock goes, you might be able to buy back the option to close it at a lower price than you sold it. That would be a win-win. Or, you might decide to ride the position out until expiration and see where the chips fall.
Two: you might get “assigned”—trader-speak that, in this case, means you have to sell your stock. Don’t sweat it. You simply sell the stock at $85, which is the price you bought it for anyway. And you get to keep the $1.35 premium you took in as profit (minus commissions and fees).
The result: You don’t increase your risk by selling the call option. You’re simply lowering a break-even point and giving up potential profit above your strike at the same time. But you may find it worthwhile to buy the call to close it out if it’s in the money prior to expiration, and you don’t want to lose your shares.
The situation: Long calls and long puts can be successful when the underlying stock is moving in the right direction. But what if the stock takes a break or even starts to move against you? Or, what if these or some other factors cause the implied volatility of the option to drop?
The fix: One way to save this trade could be selling another option that’s further out of the money (OTM) than the option you own but in the same expiration. This turns your long option into a long vertical spread (see figure 2). The premium from the sale of the further OTM option lowers the trade’s overall debit by the premium you collected, but it will also limit the potential profit on the position.
The result: A few good things can happen. First, your total dollar risk is reduced. Second, your trade should now be able to withstand a greater reversal in the stock’s price or a drop in implied volatility. Finally, your trade might still profit if the stock once again moves in the desired direction.
FIGURE 2. LONG CALL VERTICAL VS. LONG CALL.
The situation: If it’s a short put position that’s moving against you, then either the stock is moving lower, the implied volatility is ticking higher, or possibly some of both. It might be a good time to sell an at-the-money (ATM) or OTM call vertical to offset some of the short put’s loss. The short put is a bullish trade. But selling a call spread is a bearish trade.
The fix: If you think selling the call spread is a good idea because you believe the stock is going to keep moving lower, you might want to close your original trade. But if you think the move lower is short term, then selling a short-term call vertical may be a good fix. The premium you collect from the call spread is added to the premium you collected from the put. At expiration, if the stock is above your short put, but below the strike of the short call, then all the options would be expected to expire worthless and you’d keep the net premium.
The result: Selling the call spread doesn’t increase your overall dollar risk, but it could hurt you if the stock reverses course and moves higher like you originally thought. Remember, “fixing” a trade is essentially putting on a new trade. Understand the new trade’s structure and plan for a new outcome.
The situation: What if you sold an OTM call or put vertical and now it’s turning into more of an ATM spread? There’s usually more than one way of “fixing” trades that go against you, so here are two possible approaches for short verticals that are getting too close to the money.
The fix: First, consider turning your position into an iron condor. If it’s a call vertical that’s hurting you, you would sell an OTM put vertical. If a put vertical is to blame, you’d sell an OTM call vertical. The new position—the iron condor—wants the stock to settle in between the short strikes of both vertical spreads.
The result: Again, the premium you collect adds to your overall position credit. Although you haven’t increased your overall dollar risk, you now have more places where the stock can hurt you. You’ve also added additional transaction costs.
FIGURE 3: ROLL WITH IT. You could open a call spread that has more days to expiration. For illustrative purposes only.
The second fix: You could consider rolling into a new vertical spread. If the stock is threatening to trend right through your short vertical, turning the trade into an iron condor might not alleviate losses from the side that’s getting too close to the money. Instead, maybe pack up your trade and “roll” it to a new neighborhood.
For example, using an underlying stock price of $80, suppose you sold an 82-84 near-month call spread for $0.30 with a few weeks to expiration. Some time passes, but the stock has moved higher to $82, with a week until expiration. You could consider “rolling” the spread by buying it to close for a debit of $0.40, and then selling to open the 84-86 call spread further out in time for $0.80. Using the prices in the table in figure 3, the roll plus the new vertical can be completed for a credit of $0.50, not including transaction costs.
The second result: Now your short strike is $2 further away from the money, giving you some breathing room. The trade, however, now has more time before it expires. So you’ll need to monitor things in case you need to make another decision to roll again or exit. Finally, remember that commissions can really add up.
Every “fix” has pros and cons. But you can cut your losses by selling options premium elsewhere without necessarily cutting the trade. If you do, you can potentially amortize your loss, and hang around a little longer to see what happens next. This is what many pro traders do automatically—look a losing position in the eye and know what to do.
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2023 Charles Schwab & Co. Inc. All rights reserved.