You might have some options in your portfolio expiring at 3pm EST today that haven’t exactly been moving in your favor.
The question is… should you have held onto these trades or gotten out of them early?
This is one of the most challenging aspects of options trading that you can face – especially if you’re just getting started.
While it can sometimes seem as though there’s nothing you can do to save a losing trade, exiting your position early versus letting the option expire can decide between a 10% loss and a 100% loss (or worse).
And that’s why I want to help you get your timing down pat before we start a brand new week of trading.
So I’m going to tell you when it’s time to hold on to a losing trade and when it’s time to jump out early…
Exiting Your Options Trade before Expiration, Using the Trailing Stop, and Much More…
Q: When you have a losing trade, is it better to just get out or allow the option to expire?
A: Ultimately, it depends on how great the movement of the underlying stock is. For instance, if you’re holding call options, and the underlying stock drops to the point where you’re only talking about a loss of a couple pennies, it’d make sense to allow it to expire because it may cost you more to exit due to commissions. But… if you have a $5 option and the stock drops to a point where it’s looks like a new trend is forming, it’d make sense for you to minimize your loss and get out before expiration. Or maybe you close your $5 option for $2.50 and save that money for a new and better trading opportunity. I’ve done that quite a bit in my options career, and it helps.
Q: What’s the best strategy to set up a stop-loss on my trades so that I can manage my risk better?
A: There are several brokers that allow different types of stocks and different parameters. But one of the ones that I like the best is the trailing stop. OptionsXpress, among other brokers, lets you set a trailing stop.
Take a look at how you would enter a trade with a trailing stop, using AAPL as an example…
Q: I tried exercising a spread recently and found that I couldn’t sell-to-open the second option. I thought, for example, that if I bought a SPY $196 call, then even after designating that I was doing a vertical spread, I would be able to sell the SPY $200 call. I use Interactive Brokers and could only buy the $196 call. It did beautifully and gave me a triple. But I’m wondering if I was just lucky or if I should have stood down because I couldn’t exercise the vertical spread?
A: If you can’t do a vertical spread, then chances are you don’t have level two options clearance. So, you don’t want to try to buy the lower strike call first and then sell the higher strike afterward. Your broker won’t let you do this is if you don’t have level two clearance. if you do have the clearance but the lower strike call you bought didn’t fill, then maybe your limit was too tight – and you’ll want to loosen it up a bit.
What may have actually happened here, though, is you may have done something called legging into a spread, where you bought the call option first, and then sold a call option when the market was moving in your favor. That’s always great until it works against you. In most cases, it may not work unless it was part of your trading plan. So it might just be best to get the right clearance so that you don’t risk facing an unnecessary loss.
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Q: Would it protect you if you bought an option that’s filled AND THEN sell two options – one that’s a percentage point below your entry cost and one that’s at your expected profit price?
A: I want to just show you how this looks using AAPL as an example again…
This shows the purchase of one option on AAPL:
And this shows the sale of two options on AAPL. Keep in mind that the options you sold paid for the option that you bought.
Now keep in mind that the options you sold paid for the option that you bought. But the problem is… you’ve now created an unlimited risk and limited profit trade. You lowered your overall cost in the event that AAPL doesn’t move at all… but if AAPL has a bad earnings report, for example, and you fall below $90, you’re looking at a loss that could get worse and worse and worse.
So you want to be very cautious about doing this and be very disciplined if you decide to make this kind of trade.
Q: When I’m writing a put AND buying a put, am I at risk for having the stock “put” to me by the person at the other end of the trade?
A: If you’re writing a put and buying a put, then what you’re creating is a put spread. A put spread is profitable to the downside with limited risk AND limited reward.
Now with a spread, you could get assigned the stock… but if you have a stop in place and get out of your trade before expiration, you can avoid getting assigned the stock.
Have a great weekend!
Stay safe – and stay cool,
Tom Gentile
