Four Ways to Save a Losing Options Trade: Reversing a Good Trade That Went Bad

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Consequently, you have a loser, yet you do not want to end it. It might be a sophisticated transaction like the iron condor. Or perhaps there is just one long option. Or maybe it’s simply stuck. Can you do anything? Keep calm first. Better judgment wins out. Second, don’t wait until nothing is left to “correct” your deal if you want to do so.

At what point does losing become too much? Cut your losses if the deal loses 50% or more of its initial risk. This is a common trading guideline. But not all tactics may be a suitable match for that.

You must realize that you are not actually “fixing” anything before you can repair a deal. Any attempt at a remedy is a fresh transaction because the loss is actual. Therefore, the most pertinent query is, “Does my initial analysis still hold, and would it be preferable to change my position or abandon the trade and move on?”

Think about the following four scenarios and their solutions.

Long Stock

The circumstance: If you purchased shares at the incorrect moment, this could be the ideal opportunity to become familiar with the short-call option. When you sell a call option, you grant the buyer the right to purchase the stock at the strike price. You are compelled to sell the shares if the buyer chooses to exercise their right. So be careful while selecting your strike price. You will be compensated for this responsibility by receiving the trade’s premium and fewer transaction fees, which lowers your break-even point. Consider purchasing 100 shares of stock at $85, which dropped to $80.

The fix: For instance, using the option pricing in figure 1, you might sell the 85-strike call for $1.30. Your break-even price is $83.70 after deducting $1.30 of the premium from the $85 stock purchase price. And after selling the call against your long stock, you now have a “covered call,” which is a tactic some traders employ right away to make money when purchasing stock.

Your option will expire worthlessly, and you may get on with your life if the stock price stays below $85 until it expires. To cut your break-even price even further, you may sell another call.

The stock might do one of two things if it rises above $85 before or at expiration. 1 Nothing. You may be able to purchase back the option to close it at a lower price than you sold it, depending on how many days remain until expiration and how high the stock rises. Then everyone would benefit. Alternatively, you can elect to hold the position until expiration and watch how the cards land.

Two: You can be “assigned,” a term traders use to indicate that you must sell your shares in this situation. Take it easy. You just sell the stock for the same amount you originally paid for it, or $85. The $1.35 premium you received as a profit is also yours to keep (minus commissions and fees).

The result: You don’t raise your risk by selling the call option. Simply put, you’re simultaneously giving up potential profit above your strike and decreasing the break-even point. Nevertheless, if it is in the money before expiration and you don’t want to lose your shares, it would be smart to buy the call to close it out.

Long Call or Long Put

The circumstance: Long calls and long puts can be profitable if the underlying stock trends in the right direction. However, what if the stock falters or even begins to move against you? What if one or more of these things, or other reasons, causes the option’s implied volatility to decrease?

The option: Selling an option that is further out of the money (OTM) than the one you hold but has the same expiration date might be one approach to rescue this deal. Because of this, your long option becomes a long vertical spread (see figure 2). The premium from the additional OTM option sell reduces the trade’s total negative by the premium you got, but it also restricts the position’s potential profit.

The result: A few positive things could occur. Your overall financial risk is decreased first. Second, a larger price reversal in the stock or a decline in implied volatility should no longer be able to wipe out your transaction. Last but not least, your trade might still be profitable if the stock continues to rise in the correct direction.

Short Put

The situation: If a short option position is going against you, either the stock is going down, the implied volatility is going up, or potentially some combination of the two. Selling an at-the-money (ATM) or out-of-the-money (OTM) call vertical might help to sell the loss on the short put. A bullish transaction would be the shot put. However, selling a call spread is a negative investment.

The solution: You could wish to close your initial deal if you believe that selling the call spread is smart since you anticipate more declines in the stock price. Selling a short-term call vertical can be a suitable solution if you believe the decline is temporary. In addition to the premium you received for the put, you also received a premium for the call spread. If the stock is above the short put strike but below the short call strike at expiration, all the options will likely expire worthlessly, and you keep the net premium.

As a consequence, selling the call spread won’t raise your overall dollar risk, but it can put you in danger if the stock deviates from its trend and rises as you anticipated. Remember that “fixing” a trade is just putting on a new trade. Recognize the new trade’s structure and make plans for a novel result.

Short Vertical

What would happen if you sold an OTM call or put, and it started to resemble an ATM spread? Here are two viable strategies for short verticals that approach the money too closely. There are generally several ways to “fix” transactions against you.

The remedy: To begin with, think about assuming an iron condor posture. You would sell an OTM put vertically if a call vertical was damaging your position. You would sell an OTM called vertical if a put vertical was to blame. The iron condor, a novel position, seeks the stock to settle in the area between the short strikes of both vertical spreads.

As a result, the premium you receive increases your overall position credit. You now have additional potential weak points in the stock, even though your overall dollar risk hasn’t grown. You’ve also increased transaction charges.

The second solution is to think about rolling into a new vertical spread. Transforming a short vertical position into an iron condor may not reduce losses on the side approaching the money if the stock is on the verge of trending through it. Instead, you could want to “roll” your deal to a different area.

Consider selling an 82-84 near-month call spread for $0.30 with a few weeks left before expiration utilizing an underlying stock price of $80 as an example. After some time, the stock increases to $82 with one week before expiration. You can think about “rolling” the spread by purchasing it before the close for a debit of $0.40 and then selling it to initiate the 84-86 call spread later for a profit of $0.80. The roll plus the new vertical may be finished for a credit of $0.50 when using the pricing in the table in figure 3, excluding transaction fees.

The second outcome is that your short strike is now $2 further from the money, allowing you some breathing room. But the amount of time left before the deal expires has increased. As a result, you’ll need to keep an eye on things in case you need to change your mind and decide to quit or roll again. Finally, keep in mind how quickly commissions may mount up.

Pros and downsides may be found with any “repair.” However, you may reduce your losses by reselling your option’s premium without closing the deal. If you do, you might be able to recoup some of your loss and wait a little while longer to find out what happens next. Many professional traders automatically do this; they know what to do when looking at a losing position.

https://www.cmegroup.com/education/files/ofm-spread-overview.pdf

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