The following content is intended for sophisticated option traders with substantial options knowledge. If you're not familiar with the terminology in this article, please review our options content for beginners available to Schwab clients.
The following, like all our strategy discussions, is strictly for educational purposes only. It is not, and should not be considered, individualized advice or a recommendation. Options trading involves significant risks and is not suitable for everyone. Certain requirements must be met to trade options through Schwab. Not all clients will qualify.
For all the lessons learned about how to get into a trade, not as much focus is given on how to get out. Whether you're winning or losing, at some point, you need to exit the trade in order to take a profit or chalk up a loss.
There are a number of options strategies to cover on the subject of exiting a trade, but here, we'll focus on three of the most popular—long options, vertical spreads, and calendar spreads.1
The winning long call or long put
Let's say an option trader was interested in XYZ Corp. and bought the September 50 calls for $1. Now those calls have doubled to $2. They can't be blamed for wanting to take a profit, but they're as bullish as ever and don't want to miss out on potential future gains their contracts might generate.
Here are three potential strategies the option trader could consider:
Sell part of the position: Although this is a potential adjustment almost every time, be smart about it. Consider selling at least enough contracts to bring in more money than the initial debit. For instance, selling 60% of the calls that now trade for $2 nets a credit of $1.20 minus transaction costs. This way, a profit is more likely, even if the remaining part of the trade fizzles.
Adjust into a vertical: Turn a long call into a vertical call spread by selling a call with a higher strike. For example, sell the September 55 calls for $0.80 minus transaction costs. Even though this adds a second trade to the trader's account, they now own the 50–55 call spread, which has a total risk of only $0.20. That's calculated by taking the initial $1 cost of the 50 calls minus the $0.80 credit from selling the 55 calls.
If this spread finishes fully in the money2 (ITM) at expiration, the trader can potentially realize the $500 maximum value per spread if, for example, the stock is bought for $50 after the long call is exercised and immediately sold for $55 after being assigned on the short call. However, some traders prefer to close the spread prior to expiration if it reaches a certain level of profitability, such as 75% to 80% of the maximum profit.
On the other hand, if XYZ drops below $50, and the spread expires worthless, the loss is limited to only $20 rather than the full $100.
Roll up: Cash out the long call that's made money by selling-to-close it but maintain a bullish position by "rolling" up by buying-to-open another call that's further out of the money3 (OTM). The roll likely nets a credit that reduces the overall risk. Bonus: If the credit's more than you originally paid, you've locked in profit.
The winning long vertical spread
Sticking with XYZ, let's now assume the trader originally bought the 50 call and sold the 55 call as a spread for $0.80 minus transaction costs. The first adjustment above—selling part of the position—is still viable. But so are the ideas of spreading off the trade or rolling it up.
Spread the spread: Butterfly spreads4 and iron condors5 are nothing more than combinations of vertical spreads. A trader can create their own combination by selling the 55–60 call spread and end up with a butterfly, with the 55 strike as the body (see table below). Calculate the new risk by subtracting the credit from this adjustment from the initial debit.
- CALL OPTION STRIKE PRICES
- ORIGINAL POSITION
- NEW POSITION
CALL OPTION STRIKE PRICES50>ORIGINAL POSITION+1>ADJUSTMENTS->NEW POSITION+1>
CALL OPTION STRIKE PRICES55>ORIGINAL POSITION-1>ADJUSTMENTS-1 (TO OPEN)>NEW POSITION-2>
CALL OPTION STRIKE PRICES60>ORIGINAL POSITION_>ADJUSTMENTS+1 (TO CLOSE)>NEW POSITION+1>
Rolling a vertical: The idea behind rolling up a vertical is the same as rolling up a single option: Take profits on the original trade, then do it again. There are more moving parts (and more transaction costs), but all you need is a "sell butterfly" order ticket.
For example, turn the long 50–55 call spread into the 55–60 call spread by selling the 50–55–60 call butterfly. Subtracting the butterfly credit from the original debit leaves the remaining net risk of the new 55–60 spread position (see table below).
- CALL OPTION STRIKE PRICES
- ORIGINAL POSITION
- NEW POSITION
CALL OPTION STRIKE PRICES50>ORIGINAL POSITION+1>ADJUSTMENTS-1 (TO CLOSE)>NEW POSITION
CALL OPTION STRIKE PRICES55>ORIGINAL POSITION-1>ADJUSTMENTS+1 (TO CLOSE)>+1 (TO OPEN)NEW POSITION+1>
CALL OPTION STRIKE PRICES60>ORIGINAL POSITION->ADJUSTMENTS+1 (TO OPEN)>NEW POSITION-1>
The first rule of adjusting a trade is to treat the adjustment as a new position. Have profit and loss exits mapped out just as a trader would for any new trade.
The winning long calendar spread
Rolling the calendar: Constructing a calendar with a little time between the long and short options lets traders roll the short option. If the short option is evaporated, use a "sell calendar" order ticket to bring in a credit by closing the short option and selling the same strike option in the next expiration.
Losing trades are an expected part of trading. Sometimes, simply closing the trade is the right decision. Other times, it might be appropriate to take another action. The assumption here, though, is that traders are managing their losing trades before they've gotten out of hand.
The broken long call (or put)
Let's say a trader's long call is a relative mess because XYZ stock hasn't budged. But they still believe the stock is poised to move. In the meantime, to salvage some of what's left while still leaving a chance for some profit, a trader could consider converting their call to a spread.
Spreading to a vertical: As with the winning trade, consider selling a higher strike call in the same month. Deduct the credit from the original cost of the long call to arrive at the net debit of the trade.
The second rule for adjusting a trade is a trader should match their new position with their market outlook.
For instance, if a trader initially buys the September 50 call for $7, then adjusts by selling the 55 call for $1, they net a $5 wide call spread for $6, not including transaction costs. That's a guaranteed loss of at least $1, if not the whole $6. If the math doesn't make sense, it might be time for the trader to consider closing the trade.
Spreading to a calendar: If there's enough time left in a long call, another idea might be to convert the long call into a calendar by selling a shorter-term call with the same strike. This "buys" some time for the stock to get going. And while a trader is waiting, they can potentially hedge time decay risk as well as some of the downside risk. If XYZ comes back to life, they can buy back the short option, and they're back to the original trade.
The broken long vertical
Converting to a vertical spread isn't a choice if that's what a trader starts with. But all is not lost. One possibility is to roll the entire spread further out in time using a "vertical roll" order.
To avoid adding risk to the trade, a trader would roll up the spread to strikes that are further OTM than the current spread. This may not be ideal, but the longer time frame gives the trader trade time to work.
The broken long calendar
Similar to winning calendars, rolling out the short strike reduces the trader's risk in the trade. But, because calendars tend to work best when at the money6, if the market moves, the trader might have to move with it. Rolling a calendar that's gone ITM, though, does have a cost. But here's how a trader could navigate an alternative strategy.
Roll the long option up/down in the same month to the at-the-money (ATM) strike. Then, roll the short option up/down to the same strike, going one expiration out in time. If the net cost of both trades is a credit, it might be a worthwhile adjustment. If it's a net debit, it might make sense just to close the trade.
Simply winning or losing doesn't mean a trader needs to close their trade, although that strategy can sometimes make sense. When a trader has a reason to stay in the trade, adjusting the trade can help them mitigate risk, take money off the table, and give them time to plan their next move.
Three golden rules for "fixing" trades
Remember, there's no such thing as "fixing" a broken trade. Whatever a trader's reason for making an adjustment—whether exiting at a profit or a loss—it's important for them to realize the trade isn't the same one they put on. Here are some helpful guidelines to consider when adjusting trades:
- Treat any adjustment as a new position. Map out profit and loss exits for any new trade.
- Match new positions with your market outlook and volatility backdrop.
- Don't make any adjustments that add risk to the trade.
1A defined-risk spread strategy constructed by selling a short-term option and buying a longer-term option of the same type (i.e., calls or puts). The goal: As time passes, the shorter-term option typically decays faster than the longer-term option and can be profitable when the spread can be sold for more than you paid for it. The risk is typically limited to the debit incurred.
2Describes an option with intrinsic value (not just time value). A call option is in the money (ITM) if the underlying asset's price is above the strike price. A put option is ITM if the underlying asset's price is below the strike price. For calls, it's any strike lower than the price of the underlying asset. For puts, it's any strike that's higher.
3Describes an option with no intrinsic value. A call option is out of the money (OTM) if its strike price is above the price of the underlying stock. A put option is OTM if its strike price is below the price of the underlying stock.
4Typically a market-neutral, defined-risk strategy composed of selling two options at one strike and buying one each of both a higher and lower strike option of the same type (i.e., calls or puts). The strategy assumes the underlying will remain relatively unchanged during the life of the trade, in which case, as time passes and/or volatility drops, the combined short options premiums exhibit more decay than the combined long options premiums, resulting in a profit when the spread can be sold for more than its original debit (which is also its maximum loss).
5A defined-risk short spread strategy constructed of a short put vertical and a short call vertical. You assume the underlying will stay within a certain range (between the strikes of the short options). The goal: As time passes and/or volatility drops, the spreads can be bought back for less than the credit taken in or expire worthless, resulting in a profit. The risk is typically limited to the largest difference between the adjacent and long strikes minus the total credit received.
6An option whose strike is "at" the price of the underlying equity. Like out-of-the-money options, the premium of an at-the-money (ATM) option is all time value.
Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the options disclosure document titled Characteristics and Risks of Standardized Options. Supporting documentation for any claims or statistical information is available upon request.
Multiple-leg options strategies will involve multiple commissions. Spread trading must be done in a margin account.
Short options can be assigned at any time up to expiration regardless of the in-the-money amount.
With long options, investors may lose 100% of funds invested.
Investing involves risks, including loss of principal. Hedging and protective strategies generally involve additional costs and do not assure a profit or guarantee against loss.
Commissions, taxes, and transaction costs are not included in this discussion, but can affect final outcome and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.
Rolling strategies can entail additional transaction costs, including multiple contract fees, which may impact any potential return.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.0723-36ZS