As a trader, deciding when to close profitable trades has always been the toughest decision for me. What about you? The position is going in your favor, which means all of your analysis has paid off. Profitable positions "feel good," and we often like to let those positions ride.
But, when it comes to profitable short options positions, I always consider closing out risk. I try to keep it simple and keep the "feel good" (and greed) out of it. When a short options position has gone in my favor and is priced at or below $.05 per contract, I consider closing it. And since Schwab clients pay no commissions to close short options priced at or below $.05 per contract, there is very little disincentive.
For investors who utilize short options strategies (like covered calls, short puts, and spreads), here are some questions to consider when a position has reached close-to-maximum profit:
- How much time is left before the option expires? If there are more than a few days left before the option expires and the short option has lost the majority of its value, consider closing it. In most cases, the risk of holding the position probably isn't worth the remaining reward.
For example, if you sold covered calls for $1 per contract with 40 days until expiration, and those contracts are now priced at $.05 with six days until expiration, consider closing out those contracts. The maximum potential gain left is only $.05 per contract, and a lot can happen (buy-out, analysts upgrade, etc.) in the six remaining days. Closing out the options position gives you (theoretically) unlimited upside potential on the long stock position. Remember, you don't pay a commission to close short options priced at or below $.05, and in this example, the option position has lost 95 percent of its value (from your original entry price).
- What do you think about the underlying position now? If you hold a short options position that has gone in your favor, and you want to maintain the same bias on that position, consider rolling out to a further expiration.
For example, let's say you sold puts for $1.20 per contract with a $50 strike price and 38 days until expiration. The stock is now trading at $58 and the options are trading at $.05 with eight days until expiration. If you still have a long bias for that underlying position, consider rolling the short put position "up and out" to a higher strike and a later month (like a $55 strike price and 40 days until expiration). Note: in this scenario, you will not pay commission on the buy-to-close put contracts; however, you will be charged commission to establish the new position.
- Spread traders - why not remove the risk associated with the short option contracts and hang onto the long option contracts?
Let's say you sold a bear call (credit) spread for $1.50 per spread, with 30 days until expiration, using the $60/$65 strike prices. The stock went in your favor (down) and now the short strike option ($60) is priced at $.05 per contract. If you simply close out the short position for $.05 per contract and hold onto the long call position, you have removed the risk associated with the short option and you still have unlimited upside gain potential on the remaining long call. Even though at this point the value of your long call is likely very small, you should recognize that you could lose 100 percent of that remaining value should you choose to hold onto it.
So why are you waiting until expiration when the position has reached close-to-maximum profit? From a risk point-of-view, I have held onto short options positions priced at or below $.05 per contract only to see them go significantly against me due to a news announcement or event. Why didn't I close out the positions? I really don't have a great answer. Maybe it was greed. Perhaps I was just too lazy. Or, I didn't want to lose that winning "feeling." Who really knows – but I have learned and will try hard not to make the same mistake.
Schwab clients pay no commissions to close short options priced at or below $.05 per contract. I encourage you to learn from my past mistakes (and maybe yours), and take inexpensive risk off the table.