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Published On: Tue, Mar 12th, 2013

Managing an open options position

Introduction

Some traders prefer to set up an options position and then forget about it until the expiration date. While this might be possible with strategies such as buying calls or puts, or even in the case of a long strangle or long straddle, a trader can often a) maximize profits more effectively or b) minimize losses better if he or she manages the trade between the opening and expiration dates.

In this context ‘managing’ an options trade refer to specific steps that can be taken in order to walk away from the deal with a profit or at least with a smaller loss.

Managing long positions

Fig. 9.28(g) below is an example of one of the simplest possible options strategies, the long call.

Fig. 9.28(g)

Fig. 9.28(g)

 

While one could certainly follow a ‘buy and forget’ approach to this trade, it doesn’t really make sense. If the price of the underlying asset starts falling immediately after the options were bought and keeps on falling to the extent that it becomes clear that it will never turn around and reach the strike price of the long calls before the expiration date, it makes more sense to sell the options for whatever the market offers and get out of the trade.

If the trader still thinks the price might turn around and close somewhat to the upside, he or she could sell OTM calls to at least recover part of the cost of the long calls. This would change the risk/reward payoff to what we see in Fig. 9.28(h) below.

 

Fig. 9.28(h)

Fig. 9.28(h)

If the price does not turn around, the trader will at least not make as big a loss as before and if it does turn around and move somewhat to the upside, the trader could still walk away with a profit on this trade.

Managing short options positions

What does one do if you’ve sold a naked call or a naked put and the trade starts to go bad? In Fig. 9.28(i) below the trader sold a naked 110 call when the price of the underlying stock was at 100.

 

Fig. 9.28(i)

Fig. 9.28(i)

By the time the price reached 105, it was clear that it would probably close above 110 or even above the breakeven point which in this case is somewhere between 110 and 112.

One possible way out of the conundrum is to do the following:

a)     Sell two 95 puts for every 110 Call which was originally sold and

b)    Buy back the 110 Calls with this premium, which should result in a net credit

The profit/loss scenario would then change to the following:

 

Fig. 9.28(j)

Fig. 9.28(j)

 

What we have here is that the trade has been converted from a naked call to a naked put. This required selling more puts than the number of calls that were originally sold, so the risk element has been increased, but if the trader is relatively certain the market is on its way up, this is a good way getting out of trouble.

Rolling the trade

Another possibility is to get the premium needed to buy back the calls that are in trouble by selling further OTM Calls. Since the premium for these would normally be fairly low, the trader might need to:

a)     Sell two or three times the original number of Calls or

b)    Roll the trade horizontally to the next month, i.e. sell further OTM Calls for the next calendar month in order to get sufficient premium.

This is really a completely new trade and can only be recommended if there is a very high probability that the price of the underlying asset will not keep on going up.

 

 

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About the Author

- Marcus Holland has been trading the financial markets since 2007 with a particular focus on soft commodities. He graduated in 2004 from the University of Plymouth with a BA (Hons) in Business and Finance.

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