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Managing Long Options Positions

Key Points
  • Not every stock you buy will go up or will every bullish or bearish options strategy go the direction you expect.

  • What should you do when things don't go as planned?

  • Find out how to adjust your original long options strategy to potentially recover some or all of your losses, or even turn a losing trade into a winner.

If you are bullish on a stock, you might buy it. Or, you might decide to buy a long call option—giving you the right (but not the obligation) to buy the stock if it reaches the specified price during a specified amount of time—in order to limit your losses in case you're wrong.

These two strategies are not perfect substitutes for the following reasons:

  • Long stock involves ownership whereas an option position does not.
  • Small declines in a stock position may eventually be recovered, whereas similar declines could cause an option to become completely worthless.
  • Stock positions exist indefinitely in most cases while options always expire.
  • Long stock owners have voting rights and can receive dividends if paid whereas option owners do not.

Long call options can also give you leverage that can result in a larger profit (from a percentage standpoint) than purchasing the stock outright. But you generally have to be right about the stock's direction, the magnitude of the move, and often the time frame.

If you're wrong about any of these items, the option can lose value and eventually expire worthless, resulting in a total loss. That's the bad news.

The good news is, just because you bought a long call and the stock price has not increased, it doesn't mean all hope is lost. It may still be possible to "manage" the position for a slightly modified expectation.

How can you manage your position?

Let's review some examples. Assume it's May 31, 2014 and you are bullish on XYZ with its $87.50 current price. Rather than buying 1,000 shares of XYZ, you have decided to make the following trade:

Buy 10 XYZ July 90 calls @ $3.50 (to open)

Net cost = $3,500 (3.50 x 10 x 100)
Days until expiration = 51
Breakeven = $93.50 (strike price + options premium)
Maximum loss = $3,500 (cost of the trade)
Maximum loss occurs at $90 or below, at expiration
Maximum gain = Unlimited

Commissions, taxes and transaction costs are not included in this discussion. Please be aware these costs can affect the final outcome significantly, and should always be considered.

Your original position

Long calls example

Source: Schwab Center for Financial Research.

Now, two weeks later, XYZ has dropped to $85.00 and your calls have fallen to $1.88. As a result, you currently have an unrealized loss of -$1,620. What do you do?

First, reassess your opinion of XYZ and ask yourself the following questions:

  • Is my original price target still valid?
  • How bullish or bearish am I on this stock? Am I still as bullish as I was? Slightly less bullish? A lot less bullish? Have I turned bearish?
  • Can I lower my breakeven price?
  • Should I lower my profit expectations?
  • Am I willing to spend additional money to adjust this trade?
  • Would it be better to just close my position and cut my losses?

There are many possible ways to manage your original position, but your answers to these questions may provide guidance.

A little less bullish than before

If you are still bullish (though a little less so), you might consider converting the original long call position into a bullish call spread by selling some higher strike calls.

Buy 10 XYZ July 90 calls @ $3.50 (to open) ◄original position
Sell 10 XYZ July 95 calls @ .75 (to open)

Net credit = $750 (.75 x 10 x 100)
Days until expiration = 37
Breakeven = $92.75 (original breakeven – new credit) or ($93.50 - $.75)
Maximum loss = $2,750 (net cost of both trades) or (-$3,500 + $750)
Maximum loss occurs at $90 or below at expiration (both options expire worthless)
Maximum gain = $2,250 (difference in strikes – net cost of both trades) or ($5,000 - $2,750)
Maximum gain occurs at $95 or above at expiration (stock is bought at $90 and sold at $95)

Net new position

Bull call spread

Source: Schwab Center for Financial Research.

The effect of turning your long call position into this bull call spread is by forgoing any additional profit potential above $95, the maximum potential loss is reduced by $750 (to $2,750), the breakeven price is lowered by .75 points (to $92.75), and your unrealized loss is reduced by $750 (to $870).

A lot less bullish than before

If you are still bullish (though a lot less bullish than before), you might consider closing the original long call position, and creating a bullish call spread by reversing the original position and purchasing some calls with lower strike prices.

Buy 10 XYZ July 90 calls @ $3.50 (to open) ◄original position
Sell 10 XYZ July 90 calls @ $1.90 (to close)
Sell 10 XYZ July 90 calls @ $1.90 (to open)
Buy 10 XYZ July 85 calls @ $3.80 (to open)

Net debit/credit = $0 (($1.90 + $1.90 – $3.80) x 10 x 100)
Days until expiration = 37
Breakeven = $88.50 (long strike price + net cost of all trades) or ($85 + $3.50)
Maximum loss = $3,500 (net cost of all trades) or (-$3,500 + $1,900 + $1,900 - $3,800)
Maximum loss occurs at $85 or below at expiration (all options expire worthless)
Maximum gain = $1,500 (difference in strikes – net cost of all trades) or ($5,000 - $3,500)
Maximum gain occurs at $90 or above at expiration (stock is bought at $85 and sold at $90)

Net new position

Bull call spread

Source: Schwab Center for Financial Research.

The effect of this new (lower strike) bull call spread is that while there is no additional upfront cost, you must be willing to forgo any additional profit potential above $90; the maximum potential loss remains the same ($3,500). However, the breakeven price is lowered by five points (to $88.50) and XYZ has to be below $85 (down from $90) at expiration in order to sustain the maximum loss. Finally, the unrealized loss remains at -$1,620 and the maximum gain is only $1,500 (rather than unlimited). 

You are bearish

If you've completely changed your perspective on XYZ and are now bearish, you might consider converting the original long call position into a bearish call spread by selling some lower strike calls.

Buy 10 XYZ July 90 calls @ $3.50 (to open) ◄original position
Sell 10 XYZ July 85 calls @ $4.25 (to open)

Net credit = $4,250 (4.25 x 10 x 100)
Days until expiration = 37
Breakeven = $85.75 (short strike + net credit from both trades) or ($85 + $.75)
Maximum loss = $4,250 (difference in strikes – net credit from both trades) or ($5,000 - $750)
Maximum loss occurs at $90 or above at expiration (stock is bought at 90 and sold at 85)
Maximum gain = $750 (net credit from both trades) or (-$3,500 + $4,250)
Maximum gain occurs at $85 or below at expiration (all options expire worthless)

Net new position

Bear call spread

Source: Schwab Center for Financial Research.

Now, the stock is already moving in the right direction, and at its current $85 price, is already slightly below your new breakeven of $85.75. Your original strategy was for XYZ to exceed $90, but if that occurs now, you will sustain your maximum loss. The new bear call spread strategy brings in a net credit, but your maximum potential loss actually increases by $750 (from $3,500 to $4,250). In addition, your risk has increased and your maximum profit is now limited to only $750 (versus unlimited previously), which occurs if XYZ is below $85 at expiration.

Stock stays flat

If you now feel that XYZ might just stay around its current level, you might consider creating a long call butterfly spread by entering a new ratio call spread. 

Buy 10 XYZ July 90 calls @ $3.50 (to open) ◄original position
Sell 20 XYZ July 85 calls @ $4.25 (to open)

Buy 10 XYZ July 80 Calls @ $8.00 (to open)

Net credit = $500 (4.25 x 20 x 100) – (8.00 x 10 x 100)
Days until expiration = 37
Lower breakeven = $83 (middle strike – max gain) or ($85 – $2.00)
Upper breakeven = $87 (middle strike + max gain) or ($85 + $2.00)
Maximum loss = $3,000 (net cost of all trades)
Lower maximum loss occurs at $80 or below at expiration (all options expire worthless)
Upper maximum loss occurs at $90 or above at expiration (1,000 shares are bought at $80 and sold at $85 and 1,000 shares are bought at $90 and sold at $85)
Maximum gain = $2,000 (middle strike - lower strike – net debit from all trades) or ($5,000 - $3,000)
Maximum gain occurs at exactly $85 at expiration (1,000 shares are bought at $80 and sold at $85)

Net new position

Long call butterfly

Source: Schwab Center for Financial Research.

The effect of turning your original long call position into a long call butterfly spread is that if the stock remains relatively flat, you'll end up in the profit zone. While hitting maximum profit on a long butterfly is virtually impossible (in this example, XYZ would have to be at exactly $85 at expiration) you have a four-point range ($83 – $87) over which it could be profitable. But if the stock moves above or below this range, you will sustain losses. If XYZ is above $90 or below $80 at expiration, you will sustain your maximum loss of $3,000. 

Because additional trades needed to create this butterfly bring in a small net credit ($500), your maximum potential loss from your original long call position decreases by this amount. Additionally, your unrealized loss also goes down by $500 to only -$1,120. While your risk has gone down slightly, your maximum profit is now limited to only $2,000.

Bottom line

There are many other possible ways to adjust a trade that hasn't quite worked out as you expected. Hopefully, these examples have given you some ideas for the next time it happens to you.

For additional information or for assistance with other options strategies, please contact a Schwab Trading Specialist at 800-435-9050.

I hope this enhanced your understanding of long options positions. I welcome your feedback—clicking on the thumbs up or thumbs down icons at the bottom of the page will allow you to contribute your thoughts. (If you are logged into Schwab.com, you can include comments in the Editor’s Feedback box.)

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Important Disclosures

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 before considering any option transaction. Call Schwab at 800-435-4000 for a current copy.

With long options, investors may lose 100% of funds invested. Multiple leg options strategies will involve multiple commissions. Spread trading must be done in a margin account. Writing uncovered options involves potentially unlimited risk.

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.

Schwab does not recommend the use of technical analysis as a sole means of investment research.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Past performance is no indication (or "guarantee") of future results. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.

The information presented does not consider your particular investment objectives or financial situation, and does not make personalized recommendations. Any opinions expressed herein are subject to change without notice. Supporting documentation for any claims or statistical information is available upon request.

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. Examples are not intended to be reflective of results you can expect to achieve.

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