I’m often asked how to adjust the options strategies I employ in Options Advantage, as well as High Yield Trader.
So, per your request, over the next three weeks I’m going to give a basic overview of how I adjust or more specifically, “roll” covered calls, cash-secured puts and call spreads.
Rolling is the most common form of adjusting a position. An options traders, we have the ability to roll short and long trades. I only sell options with a high probability of success, so therefore, I am always the seller. So, I never have to worry about rolling long trades, only short trades.
The objective of rolling a covered call, naked put or vertical spread is to put off assignment. In most cases we want to create more duration for the trade to work. The move is NOT a guarantee of success and often leads to further risks. But, it is an important tool that makes sense when used proactively.
I love selling puts. When used in a conservative manner, selling puts offers individual investors hands down the highest-probability strategy in the investment arena. No other strategy can even come close to attaining the statistical edge selling puts offers.
But, as I always say, nothing is free in the world of trading. Because a high-probability strategy offers such a magnificent win rate, the downside in losses can be significantly magnified if you don’t thoroughly understand the risks on the table.
Of course, position size is the most important factor in risk management. If you keep your position size at a consistent and reasonable percentage of your overall portfolio, you can survive a lot of losses. And as we all should know by now, losses are part of the process. In fact, they are a guarantee.
So, we don’t have the ability to give excuses when our positions are tested. We know losses are going to occur. Rolling gives us the ability to be proactive when we know a position is being tested.
Imagine that we recently sold a 43-day cash-secured put in Apple (NASDAQ: AAPL) with a strike price of $116 for $1.00 when the stock was trading for roughly $130. The 14-point buffer proved not to be enough, as the stock recently pushed slightly below the $116 strike to a price of $114.50.
If we wish to own the stock and are happy being assigned stock, everything is fine. Remember, your original goal was to own the stock for $116, or roughly 12% cheaper than the current price of the stock.
But, some of us like to sell puts for income. When we are selling puts for income, rolling can be a very helpful tool to avoid assignment.
Again, the stock has recently pushed to $114.50, $1.50 below our strike price of $116.
We don’t really want to be assigned Apple stock, so the only way to avoid assignment of the tech shares is to buy back the $116 puts. However, in order to take that sort of action, we must commit to taking a loss. The $116 puts that we sold for $1.00 are now worth $1.75 with 20 days left until expiration.
Our only other choice – roll the position.
Our goal at this point should be to take a small profit or at least break even on the position.
So, if we wish to at least break even we need to find a strike that is selling for at least $0.75. Remember, we originally sold our $116 puts for $1 and we are now buying them back for $1.75. So we have to make up that $0.75 loss by selling another put for at least $0.75, but hopefully more.
In order to accomplish our break-even goal we will need to roll down and most likely out to a further expiration cycle.
Here is our roll:
Simultaneously – to minimize commission – buy to close the $116 puts with 20 days left until expiration for $1.75, and sell to open the $110 puts with 85 days left until expiration for $1.00. We will make a small $0.25 profit on the trade, but more importantly, we increase our probability of not being assigned the stock.
However, every time we decide to roll down and out we typically take a loss on the transaction – especially if we are not proactive, like in our prior example.
Ideally, it would be far better to roll well before the stock price pushes through our short strike. But, we can’t control the market, and sometimes sharp directional moves happen. And I want you to be prepared for a worst-case scenario.
And in our example, we haven’t locked in any gains. We’ve locked in a loss of $0.75, only to sell more premium to make up for that loss. If the stock decides to push even lower and we once again do not act proactively, we will be forced to simply compound our original loss.
I know, it doesn’t sound like a great alternative, and that’s why we need to lean heavily on proper position sizing. I can’t say it enough: with an appropriate position-size plan, you have the ability to absorb numerous losses, thus eliminating the unnecessary stress that is involved with large positions.
But sometimes our risk management calls for additional tactics, and rolling is our only realistic adjustment when attempting to “repair” a losing position.
My plan is to follow up this post with a step-by-step instructional video on how to roll a position. Stay tuned!
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