Options that are more than $0.01 in the money are automatically exercised upon expiration. But how can you manage an open options position before it expires? This depends on a number of factors, such as your strategy and objectives, the type of option, whether you bought or sold, implied volatility, time until expiration, and more.
Here is a quick rundown of how you can manage an options trade.
What's your plan?
First and foremost, having an exit strategy before you enter into an options trade is crucial to both your short- and long-term success. Consider reviewing an options trading plan to build a comprehensive strategy.
Of course, you may need to adjust your strategy depending on how the underlying stock moves and other market conditions. Every plan needs to be tailored to the specific trade characteristics. For example, selling naked calls involves more risk than debit spreads. Consequently, planning to manage the risk of these 2 trades would differ dramatically. Nevertheless, a plan can help you better navigate your way.
Essentially, there are 3 routes you can take when managing an open options position: Wait, close, or roll. Let's look at a hypothetical trade to see how you might apply these 3 trade management strategies to an open options position.
Managing an open options trade
Suppose on February 1 you bought 1 contract of The Company (COMP) at a strike price of $20.00 with a premium of $1 and an expiration date of March 20. Excluding trading costs, this requires an outlay of $100 ($1 premium (×) 1 contract (×) 100 shares). It is now a month later on March 1 and you are evaluating the trade.
Wait and monitor
Suppose the stock is now trading at $20.50. If you think the stock could go even higher before March 20, say to $22.00, waiting might be your best tactic. Your outlook is critical when making this decision. Rather than just hoping it will go higher, there should be a valid reason why you think the stock will go higher (i.e., a better-than-expected forthcoming earnings announcement, a bullish technical trading pattern, etc.). You should also assess how much time until expiration you have for the stock to make the move you expect. In this case, there are 20 days. Ask yourself: Is this enough time for the stock to make the move you think it might make? You can also examine the implied volatility of the options contract to assess the likelihood of a move in the underlying stock. Waiting until expiration effectively means letting it expire if you purchased the option or being assigned the underlying if you sold the option.
Closing out the trade
Alternatively, if you think the stock will remain flat or decline from the current price, closing out the position might be the appropriate tactic. If it were trading at $20.50, this would result in a loss to the position. Recall that the outlay was $100. Closing the position at $20.50 would result in a gain of $50 ($0.50 (×) 1 contract (×) 100 shares) on the contract. Thus, the net loss would be $50 ($100 outlay - $50 gain on contract), excluding any trading costs. This might seem like a suboptimal outcome, but if your new outlook was that the underlying stock might decline in the immediate future, this is the optimal trade based on your new assessment of the position. Note that options traders who sold to open may choose closing out a position to avoid being assigned the underlying.
Roll the contract
You also have the ability to roll the contract. Rolling simply means you extend the trade by closing out the current open position, and opening another position with a similar outlook that has an expiration date further out. You might roll a contract if you still have the same outlook (in our example, for the stock price to go higher), but your current position is set to expire before your expectation may be realized. Suppose it is March 20 and the stock is trading at $21.00. You still think the stock will go higher in the coming weeks and months, but your open position is set to expire. You could choose to close out the open position and realize a $0 gain ($100 outlay - $100 gain on the option), and subsequently buy a COMP call option expiring in April. Of course, you would need to re-evaluate the strike price and other details so that the trade still aligns with your outlook and strategy. The end result of rolling a contract is that you have a similar exposure (with different features, such as a new expiration date, and potentially different strike price) as your previous position.
Managing an options trade
A plan can help you adapt to the changing dynamics of an open position. For example, before you purchased the March call options, you can decide at what potential higher price you might want to close out the trade to realize a profit, or at what potential price below the breakeven of $21.00 you might accept a loss. Obviously, your outlook can change over the course of the life of the contract—depending on if there is news that changes your expected trajectory of the underlying stock price or some other factor.
Remember, managing an options trade depends in part on the strategy you employ. In our long call example, there was only 1 position. Other strategies, such as spreads, straddles, strangles, butterflies, and condors utilize multiple positions. These more advanced strategies can necessitate different trade management tactics. For instance, in a spread, you have the option of closing out 1 leg of the trade while keeping the other open.
However, the end objective is the same when managing an options trade. You want to optimize your evolving position to capitalize on your current outlook. And there are a variety of tools that can help you along the way: