Wednesday, February 11, 2015
It's one of the biggest mistakes that many novice option traders make.
They place a bet, cross their fingers, and wait until expiration to see how it turns out. But they never make adjustments.
There's a way to get a big advantage over that sort of "one-step" strategy.
You see, even though options expire on a set date, you can get out of a position at any time by buying back the options you sold.
Plus, option prices fluctuate constantly. That creates an opportunity for nimble option traders to earn extra profits or reduce risk throughout the entire life of the option.
Let me explain...
Today's volatile market is tricky for option traders. We need to get our timing right for any particular trade to be profitable. When markets fall just ahead of our option's expiration, it makes it more difficult to consistently book profits...
But we can still do it...
Last week, I showed you one of the options strategies I use in my Retirement Trader newsletter to generate consistent, recurring income. Today, I'm going to show you how to use another one... It's called a "roll."
A roll allows options traders to do two important things:
That's a good combination.
Now, let me walk you through an example of how we recently used this strategy in Retirement Trader...
On October 10, Retirement Trader subscribers sold puts on telecom monolith AT&T... specifically the January $34 puts for $1.25.
By opening this trade, we essentially said: "We don't think AT&T shares will be below $34 in January. But if they are, we'd love to buy them for $34." That's a good deal on the stock. We received $125 upfront for our promise to buy 100 shares of AT&T at $34.
In early January, AT&T was trading for around $33.50 a share. We made a good guess on the price, only off by 50 cents, right? But it's even better than you might think. Even though shares were below our expected price, where we sold the put, it was still a profitable trade...
If the stock was still at that price when the option expired on January 16, we would have paid $34 per share and taken ownership of the shares.
At that point, we were still making a profit. We'd pay $34, but we already collected $1.25. So the shares really cost us $32.75. Since we could turn around and sell them in the market for $33.50, we'd make a profit of $0.75 per share.
That's not too bad. But what if AT&T shares dropped below $32.75 before our option expiration and we incurred a small loss? Or what if we didn't want to tap into our capital to pony up $3,400 for 100 shares? What if we preferred to keep earning income via put options with AT&T?
Instead of having an inflexible "one-step" strategy, we could keep our capital and earn even more income if we "rolled" the trade forward to another month.
So rather than wait until expiration to see if the price would rise or we'd have to take assignment of shares, we closed our current option position and got rid of our current obligation to buy shares. We did that by "buying to close" the transaction.
You see, as option sellers, we "sell to open" because we're opening a new position. When we close it, we have to buy back the option.
So on January 9, we bought back the AT&T put for $0.49. That's a good trade. We profited by $0.76 because we received $1.25 to sell the put.
But why stop there? We still like AT&T. AT&T is a quality stock at a cheap price. It's unlikely to decline much. And it's a stock we're willing to own.
So at the same time that we bought to close our January $34 put, we sold to open the AT&T March $34 puts for about $1.20. That means we collected a total of $1.96 per share (or $196 in dollars) by sticking with AT&T – $0.76 profit on the first put, and $1.20 premium on the second.
This also means that AT&T prices can fall as low as $32.04 by March 20, and the trade will still be profitable. We may have to pay $34 per share, but $32.04 is our real cost ($34 minus $1.96).
As long as we still like AT&T shares, "rolling" the trade simply puts more money in our pockets.
Many people come to think of options trading as a situation where you make a decision, enter the trade, and wait until expiration to see what happens.
But the truth is, by keeping a close eye on your option trades, you can make adjustments and create easy ways to earn extra income or keep your trades safe. We call this "trading" for income and a wealthy retirement.
"Rolling" is just one of the strategies I use in Retirement Trader to deliver winning trades each year. If you want to learn more about generating consistent, reliable income through options – and how to get one free year of Retirement Trader – click here.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig
"Most people say option trading is risky," Jeff Clark writes. "But it's not the option that's risky. It's the strategy. And when used the right way, options are far less risky than trading stocks." Learn how to reduce your risk in the market with options right here.
Jeff says there's one thing you should NEVER do when trading options. It's a common mistake, but it could cost you a lot of money. Find out what it is right here.
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