Options Trading – Recovery Actions when a trade goes south

3/24

Options Trading – Recovery Actions when a trade goes south

So this is a special post concerning one of the monetization streams I mentioned, Options trading. Last month I made a covered call trade into a stock/option. It was not my first choice (lesson 1). I did review the expected finances for the company and all pointed positive from a trend perspective so even though it wasn’t my first choice it seemed to be a good alternative trade. I won’t name the stock until I’m completely out of the trade. So recalling from the selling covered options technique, the objective is to sell a call for which you receive a premium (insurance of sorts) while simultaneously buying the stock. Since you are buying the stock (an expenditure) and also selling a call (income) you effectively reduce your basis (net amount of money you have in the stock which when divided by the number of shares you have in the stock sets the effective price you paid for the stock. Real quick a stock priced at 10 / share. You buy 200 shares and sell 2 call options priced at 2.4. You’ve spent $2000 on the stock and received $480 for selling the options, so your net investment in the stock is $2000 – 480 or $1520. Dividing the $1520 / 200 gets you to a $7.60 cost basis. The goal is for the option period to end with you retaining the $480 and the stock being above the option strike price or certainly above your purchase price. Suffice it to say the purchase I made has decreased in value precipitously while my first identified option target has increased in value as one would desire. So now I need to either ride this out or attempt to save (some value) and exit the trade.

Save the trade? How, well I could acknowledge that this was just a bad choice and sell another option at a lower strike price and a closer expiration date, say next month. Since I don’t expect the stock price to increase then it would simply leave my existing call option (at the higher price with expiration in July) to expire worthless. I would be out of the stock quicker, limit my losses and be able to move on to another opportunity. I’m still pondering that choice. The lesson here is that investment choices may or may not work out and you need to have a backup plan in place to exit, preserve the majority of your funds so that you can quickly begin to put that money to use again in the next opportunity.