Managing Option Positions

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An option buyer knows exactly the total risk of a long option position: the initial cost
of the options. And any option buyer should be prepared (psychologically and
financially) to see these options expire worthless. But this does not mean that once
options have been purchased all that is left to do is to sit back and watch either the
profits accrue until expiration day or watch the losses mount as the underlying does
not behave as predicted. Oftentimes follow up action can be taken, either to protect
unrealized profits, or to help eliminate or reduce accrued losses. This follow-up is
what we call "managing option positions".

In this module we will look at long call and put positions, plus short puts, examining
what, if any, follow up action is warranted in light of the underlying stock's
performance since the position was initiated and, if applicable, the trader's revised
forecast regarding this equity.

The following examples do not take into consideration tax implications

and the impact of trading fees. The last of these two can be significant, especially when
multiple trades are involved or when the number of option contracts traded is relatively
low and where the transaction fees tend to represent a greater percentage of the
position's value. Traders should obviously take these into account when considering any
managing strategies.

Options cannot turn lead into gold. If a position has moved against a trader options can
under certain circumstances help lower or limit potential losses, but don't look for a
solution to a call position that is 10% out-of-the-money with three hours of trading left
on the third Friday of the expiration month. Furthermore, we need to emphasize that
managing option positions can only be done successfully based on a forecast for the underlying stock.
This is why the following steps should be taken in deciding whether or not to take follow up action: 1)
Detail the current position (i.e., calls that were purchased at $3 are now worth $4.50 with stock up $5,
or puts that were bought for $4 are now $2 on $5 rally of the underlying stock); 2) Determine what is
your forecast for the underlying stock. If calls were purchased when a stock was expected to rise to
$60, maybe the original $60 target remains unchanged, maybe it needs to be raised or lowered; 3)
Take action, or no action, based on the current situation and the revised forecast.

Section 1 - Long Calls, Stock Up Since Purchase

Situation: A trader purchased 5 of the LKJ February 50 calls and since then the
stock has rallied nicely and is now trading at $55. There are 4 weeks left until the
February options expire.

Possible forecasts:

1. Stock has gone up and reached its expected target. No new developments to justify raising the
target price.

2. Stock is looking better than ever, and $60 appears a reasonable target for the next month or
two.

3. Stock may continue to drift up, but is expected to remain more or less at the current price for the
next month.

Current Prices
LKJ: $55

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 February 50 call: $5.70
February 55 call: $2.50
February 60 call: $0.80
March 50 call: $6.50
March 55 call: $3.50
March 60 call: $1.75
April 50 call: $7.40
April 55 call: $4.50
April 60 call: $2.60

Possible follow-up action:

1. Sell all or part of position. If the stock has hit its target price, the calls should probably be sold.
With LKJ at $55 the February 50 calls are trading at $5.70; this means that if the stock price
remains unchanged over the 4 weeks remaining until expiration the value of the calls will
gradually erode down to $5. The trader’s objective has been met, it’s time to get out. In certain
circumstances traders in this situation sell part of their position, usually a sufficient number of
contracts to recoup their initial investment. The reasoning is that they are “taking their money off
the table” and the remaining position is "the house’s money". A trader should remember that if
she is long 5 calls trading at $5.70, the value of this position is $2,850 and this is all her money.
Part of this may be unrealized profits, part of it may represent the initial capital committed to the
position, but it is all “her money”.

2. Trade-in. LKJ is looking better than ever and has just broken through resistance. It may take a
month or two, but this puppy is going higher. Our trader is now looking at $60 as a possible
target price but she expects the stock to reach this level “in the next month or two”. Her first
choice is to sit tight. She is bullish on LKJ, she is long calls, and she is sitting on some accrued
profits. She still has 4 weeks, after which she could decide to roll her position out to March or
April. But trading-in her calls at this point in time may still make sense. First let us look at trading
in for the February 55 or for the February 60 calls. Assuming our investor does not wish to
commit additional capital to this position, she could sell her 5 February 50 calls and buy either
11 of the February 55 calls, or 35 of the February 60 calls. Both of these switches can be done
for small credits. The result of these switches is a greater number of contracts (a positive) with a
higher strike price (a negative). The question then becomes how bullish should she be before
considering trading-in her 50 calls. Roll your mouse over here to see a table that calculates the
value of her current options and the two possible switches at February expiration. Her second
choice is to give herself more time by moving out to the March expiration. A straight roll-out
(staying with 5 options with the 50 strike) would cost her $400. If she does not want to commit
additional capital to this position, she could replace her 5 February 50 calls with 4 March 50
calls, 8 March 55 calls, or with 16 March 60 calls. Roll your mouse over here to see how these
three rolls compare at the March expiration.

3. Spread. If the stock is expected to remain at the current price, there would appear to be no
reason to hold on the long option position: as expiration nears the calls will loose the $0.70 of
time value they still possess. But by turning the long call position into a bull spread, a trader
could actually benefit from time decay instead of seeing it erode the value of her calls. This
could be done by writing 5 of the February 55 calls at $2.50. If LKJ remains unchanged at $55
for the next 4 weeks, the long 50 calls would see their value decline from $5.70 to $5.00, but the
short 55 calls would become worthless. The profit on the overall strategy would be $1.80 more
than would be realized by simply selling the calls at $5.70. Investors considering turning a long
call position into a bull spread should be aware of how these spreads behave over time. Roll
your mouse over here for an analysis of the spread illustrated above.

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 Time Decay
Early Exercise
Section 2 - Long Calls, Stock Down Since Purchase
Situation: A trader purchased 10 of the GFE December 90 calls about a month
ago, and to his great surprise, GFE has drifted down to $85, leaving him with an
unrealized loss on his options and 5 weeks to go until expiration. How much did
this trader pay for his calls? Is this important in helping him decide which
follow-up action to take? Roll your mouse over here to learn more about sunk
costs.

Possible forecasts:

1. The pullback is just a glitch, the original price target is unchanged and the stock should be up
significantly over the next 5 weeks.

2. The pullback is a temporary setback and the stock should rally as previously expected, but this
will probably take more than 5 weeks.

3. Stock should bounce back up, but with the new revised target price, to no more than $90 over
the next 5 weeks.

4. Stock has probably stopped going down, but not much can be expected over the next 5 weeks.
It should hang around the current level.

5. The drop to $85 is nothing compared to what is in store. The bears have taken over.

Current Prices
GFE: $85
December 80 calls: $7.20
December 85 calls: $4.30
December 90 calls: $2.40
December 95 calls: $1.20
January 85 calls: $5.80
January 90 calls: $3.80
January 95 calls: $2.40
March 85 calls: $8.30
March 90 calls: $6.30
March 95 calls: $4.70

Possible follow-up action:

1. Do nothing. If the pullback to $85 is seen as just a glitch, the original target price is unchanged
and the investor just as bullish as he was on the day the options were purchased, then nothing
need be done. Of course this investor should realize that if the stock remains at its current price
of $85, or even rallies to $90 over the next 5 weeks, his long calls will expire worthless.

2. Buy more time. If 5 weeks now appears to be too few, our investor probably wants to give
himself more time. Of course there will be a cost: either cash will be required upfront, or our
investor will have to move to call options with a higher strike price. For example he could sell his
December 90 calls at $2.40 and purchase the January 90 calls at $3.80 for a net debit of $1.40.
The overall risk of the position will be increased by $1,400 and our investor should be confident
enough in his forecast that he doesn't end up "throwing good money after bad". His second
choice would be to sell his December 90 calls at $2.40 and purchase the January 95 calls at

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 $2.40, a trade that can be done for even money, except for transaction fees. Even though this
last trade does not require additional funds, the break-even point of the call position has been
raised by $5, since the calls' strike price has been increased by this amount. What if our
investor is neither willing to commit additional funds to his position nor willing to increase his
options' strike price by $5? Is there any hope? Since our investor is long 10 of the December 90
calls, he could sell these and purchase 6 of the January 90 calls for a small credit. He would be
"buying more time", but in this instance his cost would be the reduction in the size of his
position. How can our investor determine which of the three ways of "buying more time" works
best for a given stock price in January? Roll your mouse over here here for a summary table.
For hints on entering orders to roll out a position, roll your mouse over here .

3. Trade-in. If the stock is expected to rally to "no more than $90 over the next five weeks", holding
on to the December 90 calls does not appear to be the optimal position. If the forecast is correct
and GFE is at $90 at December expiration, the 90 calls would end up expiring worthless. Better
to trade the calls currently held for another series that fit in better with our forecast. Two choices
present themselves: sell the 10 December 90 calls and purchase 10 of the December 85 calls,
or sell the 10 December 90 calls and purchase 5 of the December 85 calls. Trading for an equal
number of the 85 calls would cost $1,900 while switching to 5 of the 85 calls would result in a
small $250 credit. The trade-off is between the need to allocate additional funds to the position
versus a slower recovery in the overall value of the option position. To see a table comparing
these two alternatives, roll your mouse over here .

4. Trade-in for a bull spread. If the price of the stock is expected to do no better than remain at the
current $85 dollar level trading the long calls for an 80/85 bull call spread may be one way to
recoup part or all of the initial investment. This switch involves selling the 10 December 90 calls
at $2.40, buying 10 December 80 calls at $7.20 and selling (to open) 10 of the December 85
calls at $4.30. The net cost of this operation is $0.50, and the resulting position is long 10 of the
80/85 bull call spreads. The maximum theoretical value of this spread at expiration is $5 and will
be realized if GFE is trading at $85 or higher. Our investor had to increase his capital allocated
to this position by $0.50 per spread, or $500. A trader who is reluctant to commit additional
funds could sell his 10 December 90 calls and purchase 8 of the 80/85 bull call spreads, a trade
that would result in a small $80 credit.

5. Exit. There is no point in holding on to calls or converting these to another bullish option position
if GFE is expected to continue on its southward journey. The calls should be sold and the losses
cut. If our trader has a strong bearish opinion, then he should look at possible bearish
strategies.

Section 3 - Long Puts, Stock Down Since Purchase

Situation: Sometime ago a trader purchased 10 AEIO June 30 puts. The stock
has since moved down to $25 and she is sitting on a nice unrealized profit. The
June options still have 5 weeks until they expire.

Possible forecasts:

1. This is where she expected the stock to go, this is where it's trading, looks
like the end of the southbound trip.

2. There is further downside, with $22.50 looking like the most likely target.

3. Lookout below! The stock's broken support, analysts are downgrading it, and we are nowhere
near the bottom.

Current Prices

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 AEIO: $25
June 30 put: $5.00
June 27.50 put $2.90
June 25 put $1.20
July 30 put: $5.30
July 27 put: $3.20
July 25 put: $1.60

Possible follow-up action:

1. Sell. If the stock has hit its forecasted target price our trader should sell and lock in her profits.
Some traders are at times hesitant to sell options that still have 5 weeks left until they expire.
The trader's reasoning is that they could be selling "prematurely". But holding on to an option
simply because it still has x number of days left is totally missing the point. It would be
interesting to ask a trader using this type of reasoning if they ever sold any of their long stock
positions.

2. Trade-in for different June. If our trader has $22.50 as a downside target and believes this will
be reached by June expiration, there may be an argument for trading her options to a different
series. We will assume that our trader does not wish to commit any additional capital to her
position. This means that she could hold her 10 June 30 puts, or trade these in for either 17 of
the June 27.50 puts or 41 of the June 25 puts. Note that both of these switches can be done for
a small credit. The following table calculates the value of these three option positions for various
AEIO prices at expiration.

AEIO Price at Expiration +10 June 30 Puts + 17 June 27 Puts +41 June 25 Puts
$30 $0 $0 $0
$27.50 $2,500 $0 $0
$25 $5,000 $4,250 $0
$22.50 $7,500 $8,500 $10,250

Note that the values calculated in the table above do not take into account the initial cost of the
10 June 30 puts. If AEIO does drop to $22.50 as forecasted by our trader, then trading in for the
June 25 puts is the strategy that will maximize the value of the options' position. From the table
above we can calculate the following cross-over points: at $23.93, the value of the June 27.50
puts catches up with that of the 30 puts, and at $23.23 the value of the 25 puts catches up with
that of the 27.50 puts. A trader who switches out of in-the-money puts to either at- or out-of-
the-money puts must be aware of the trade-offs: in our example, if the price of AEIO remains
unchanged at $25 after the switches, our trader's option position could be worth less at
expiration (as with the 27 1/2s) or could even become worthless (as with the 25 puts). Switching
increases the position's leverage, but at an additional cost if the revised forecast turns out to be
too aggressive or inaccurate.

3. Trade-in for July. If our trader is even more bearish than she initially was, she may want to
trade-in as described in the previous section, or she may want to trade-in for a deferred
expiration to give herself additional time. Once again we will assume that she does not want to
commit any additional funds to her position. She could therefore trade-in her 10 June 30 puts
for any one of the following positions: buy 9 July 30 puts at $5.30, buy 15 July 27 puts at $3.20,
or buy 31 July 25 puts at $1.60. All three of the switches can be done for a small credit. The
following table calculates the value of these 3 July positions for various AEIO prices at July
expiration, without including the cost of the original 10 June 30 puts.

AEIO Price at July Expiration +9 July 30 Puts + 15 July 27 Puts +31 July 25 Puts

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 $30 $0 $0 $0
$27 $2,250 $0 $0
$25 $4,500 $3,750 $0
$22 $6,750 $7,500 $7,750
$20 $9,000 $11,250 $15,500

We can easily calculate the following cross-over points: at $23.75 the value of the 27 puts
catches up to that of the 30 puts, and at $22.66 the value of the 25 puts catches up with that of
the 27 puts. In other words, if AEIO is expected to drop below $23.75 a switch to the July 27
puts makes sense, and if the stock is expected to fall below $22.66, then a switch to the July 25
puts will maximize the position's value at expiration. Even though the 3 switches described
above did not involve any additional funds, there is a "cost" to each of these switches: the
break-even point on the overall strategy is lowered (to a point lower than it was with the June 30
puts), and the more the strike price of the puts is lowered, the further down the break-even point
is pushed.

Section 4 - Long Puts, Stock Up Since Purchase

Situation: A month and a half ago a trader purchased 10 of the at-the-money
March VVV 45 puts, expecting the stock to fall in price. The stock has since
rallied to $48 and with 5 weeks until March expiration our trader is assessing if
follow-up action is warranted.

Possible forecasts:

1. Nothing has changed, the stars are still lined up and VVV is heading
south.

2. Still bearish, but 5 weeks does not appear to be sufficient time.

3. Still bearish, and expecting a move before expiration in 5 weeks.

4. Expect flat stock price during next 5 weeks.

5. Maybe original forecast was plain wrong. Looks as if VVV is heading higher.

Current Prices
VVV: $48
March 50 put: $3.50
March 45 put $1.05
March 40 put: $0.15
April 50 put: $4.20
April 45 put $1.70
April 40 put: $0.45
May 50 put: $5.00
May 45 put $2.40
May 40 put: $0.90

Possible follow-up action:

1. Do nothing. If VVV is still expected to fall in price before the March expiration, and if the

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 downside target price has remained unchanged, there is probably no need for our investor to do
anything. He should stick to his guns, remembering that his overall risk on this strategy is equal
to his original cost of the March 45 puts.

2. Buy more time. Still bearish but more time is needed than that afforded by the March expiration.
Assuming that our trader does not want to commit any additional funds to his position, he could
sell his 10 March 45 puts and switch into one of the following three positions: buy 2 April 50
puts, buy 6 April 45 puts, or buy 23 April 40 puts. Roll your mouse over here for a table
comparing these three strategies at expiration, including the cross-over points (the underlying
stock price where buying puts with a lower strike price becomes more profitable than buying
puts with a higher strike price).

3. Trade-in. Still bearish, and still expecting VVV to move down before March expiration. The first
reaction to this forecast may be: "do nothing". But it is still worth examining if anything could be
gained by trading in the March 45 puts. For example, 10 of the March 45 puts could be
traded-in for 3 of the March 50 puts, in an even money trade. The question becomes, under
what scenarios is it better to be long 3 of the March 50s instead of 10 of the March 45s. Roll
your mouse over here for a numerical analysis. As can be seen from the numerical analysis,
under certain circumstances owning fewer puts with a higher strike price makes more economic
sense than being long a greater number of options with a lower strike price.

4. Turn into a calendar spread. Our investor has gone from bearish, to neutral, expecting VVV to
remain flat over the next 5 weeks. His current option position, long the March 45 puts, is
squarely bearish, and will end up being worthless if his forecast is correct. One possibility is
simply to sell his long puts and cut his losses. A second alternative is to move from a bearish to
a neutral strategy, such as a calendar spread. A calendar spread is a strategy that consists of
writing a shorter-term option and purchasing a second option, with the same strike price, but
with a longer term to expiration. If the underlying stock remains in a relatively narrow trading
range, the spread's value will increase, as the shorter-term option decays more rapidly than the
longer-term one. Our investor could establish a calendar spread by selling 20 of the March 45
puts (10 of the puts sold represent his long position, and the other 10 are an opening sale) and
buying 10 of the April or May 45 puts. Let's assume our investor opts for April. He would then
sell 20 March 45 puts at $1.05 and buy 10 April 45 puts at $1.70, initiating the position with a
$0.40 credit. His risk on his new position would be the original cost of the March 45 puts, less
the $0.40 credit. If VVV remains unchanged over the next 5 weeks, the short March options will
expire worthless and our investor will be left with 10 long April 45 puts. At that point, he will
have the opportunity to reconsider: either he holds these puts (if he has turned bearish) or he
could sell them (should he be neutral or bullish). His best-case scenario is for VVV to end up
just above $45 at the March expiration, in which case the March 45 puts would still expire
worthless and the value of the April 45s would be maximized.

5. Sell. If the bulls are taking over, there is no reason to hold on to a long put position. Sell and cut
your losses.

Monitoring Volatility

Situation: About a month ago, an investor wrote 5 of the ZYX April 40 puts. This
investor has $20,000 in a money market account ear-marked for the purchase of
500 shares of ZYX should the puts be assigned.

Scenario 1: About one week before April expiration ZYX is trading at $38 and
our investor is wondering if she should 'do nothing' and wait for her short puts to
be assigned, or if she should be taking any action. Possible revised forecasts our investor may have:

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 1. No change from her original forecast: she is bullish longer term on ZYX and purchasing shares
at $40 appears to be a good investment.

2. The slight pullback in the price of ZYX has sown some doubts in her mind. Her favorite analyst
has not downgraded the stock or revised earnings estimates, but still, she wouldn't mind a little
more time to see how things play out.

3. The decline in the price of ZYX does not bode well: the stock has broken through some
technical support levels, and a close reading of the analysts' comments indicate the bulls are
pulling in their horns.

Current Prices
ZYX: $38
April 40 put: $2.30
May 40 call $1.15
May 40 put: $3.00
June 40 call: $1.80
June 40 put $3.60

Possible follow-up action:

1. Do nothing, and wait for assignment. The reason she initially wrote the puts was that she was
looking to possibly add shares of ZYX to her portfolio. In one week, assuming no rally in the
price of ZYX she will be a proud shareholder.

2. Roll, or do nothing and convert to a covered write. If our investor is not as bullish as she
originally was, she may want to give herself a little more time by rolling out her puts to the next
expiration. This would entail covering her April 40 puts at $2.30 and writing the May 40 puts at
$3.00 for a net credit of $0.70. Is it worth rolling out this short put position for 'only $0.70?' One
way to answer this question is to look at our investor's incremental return. If she rolls her
position out, $0.70 per share represents a total of $350 before transaction costs. She currently
has $20,000 set aside for the eventual purchase of 500 shares of ZYX. So over the 4 weeks
from the April expiration to the May expiration she would be earning an incremental $350 on her
$20,000 or 1.75%. This represents an annualized rate of return of just over 22% for the 4 weeks
in question. An alternative to rolling out her puts is to wait for assignment, purchase the shares
and immediately write covered calls against this newly acquired stock. Looking at the current
option quotes she could write the May 40 calls for a little over $1.00. Of course, with still one
week to go before expiration she cannot at this point in time be sure she will be able to write the
May 40 calls for $1.15 as markets may change over the next week. It should be noted that the
two strategies considered above, rolling the puts out to May and writing the May 40 calls after
assignment, are equivalent strategies. In other words the have the same (or very similar)
downside risks and profit potential. For an individual investor the difference may only be the
transaction costs involved: two option commissions on the roll, versus an assignment
commission and one option commission on the covered write after assignment.

3. Cover. If the news is becoming negative, she should ask herself this question: 'If I did not have
an options' position, would I be looking to buy this stock at this point in time?' If her answer is
no, then she has no reason to maintain a short put position, which is the obligation to purchase
shares of stock. She should bite the bullet, cover her short puts and look for investment
opportunities elsewhere.

Scenario 2: One week before April expiration, but ZYX has declined all the way down to $34. Possible

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 forecasts:

1. No change from her original forecast: she is bullish longer term on ZYX and purchasing shares
at $40 appears to be a good investment.

2. The move down to $34 appears overdone and a rebound is expected. Still bullish but $40 now
appears to be a more realistic (and lower) target price.

3. Charts looks terrible, analysts are sounding pessimistic. Could this be the beginning of the end?

Current Prices
ZYX: $34
April 40 put: $6.00
May 35 call $1.30
May 35 put: $2.20
May 40 call $0.20
May 40 put: $6.10
June 35 call: $1.90
June 35 put $2.80
June 40 call: $0.55
June 40 put $6.40

Possible follow-up action:

1. Wait for assignment. Although it appears painful to be paying $40 for a stock that is currently
trading at $34, our investor's goal was to buy shares of ZYX at $40. She simply finds herself in
a situation similar to that of investors who bought ZYX at $40 a few months ago and have since
seen the value of the stock drop to $34. If these investors are still bullish on this equity, it is
probably not in their best interest to be 'selling low'. Hang on, since the fundamentals are
unchanged.

2. Wait for assignment, write covered calls. ZYX should rebound, but $40 now appears like a more
realistic target price. Wait, in one week at the most the puts will be assigned, the stock
purchased and covered calls, such as the June 40s at $0.55 could be written.

3. An alternative, and equivalent, strategy to waiting for assignment and writing covered calls
would be to roll out the puts, say to the June 40s. Rolling the puts only generates a $0.40 credit
(versus $0.55 if the June 40 calls are sold), but our investor would not be assigned immediately,
and would keep her cash, which is earning interest in her money market account.

4. Cover. If the storm clouds are gathering on the horizon, does our investor want to become a
ZYX shareholder? Probably not. It is high time to admit that the original forecast was incorrect,
cover the short put position and move on to a better investment opportunity.

Early Assignment

Section 6 - Short Puts, Stock Down Since Position Initiated

Situation: A trader sold 10 of the November 55 puts on CBA, and one week prior
to expiration CBA is trading at $51. This is a situation similar to the one in section
5 but with a major difference: these puts were sold by a trader who has no
intention of taking delivery of the underlying stock. With only a handful of trading

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 days left, and the risk of early assignment on these puts very real, this trader is
looking to take immediate action.

Possible forecasts:

1. Unchanged from the original. Still bullish on CBA and a rally to or above $55 is expected over
the next few months.

2. Less bullish, but confident that the downside move is over. The stock could hover around the
current price for the next couple of months.

3. Convinced that the stock has not yet bottomed out. And the next leg to the downside could be
significant.

Current Prices
CBA: $51
November 55 puts: $4
December 50 puts $1.90
December 55 puts: $4.90
January 50 puts: $2.90
January 55 puts $5.80

Possible follow-up action:

1. Roll out puts: If the original forecast is unchanged and CBA expected to rally back above $55,
our trader needs more time. He would obtain some by rolling out his position to December or
January. Rolling out to December generates a $0.90 credit (cover the November 55 puts at $4,
write the Decembers at $4.90), and rolling out to January produces a $1.80 credit. Should he
push the expiration out one month and get $0.90, or two months and pocket $1.80? If he is
bullish short-term he should probably opt for the December puts. The reason is that if before the
December expiration CBA is still around the current level he will probably be able to roll the
Decembers to Januarys for a second $0.90 credit, leaving him with a total of $1.80, albeit with
higher transaction costs. But if CBA rallies over the next 4 weeks, even if it does not reach $55,
he would then be able to roll from December to January for a credit greater than $0.90 (the
closer CBA gets to $55, the larger the expected credit). So it is really a question of fine-tuning
his forecast: if nothing much is expected in the next 4 weeks, move out to January. If the stock
is expected to start its rebound during the coming month, roll to December and be prepared to
roll the position a second time before the end of the year.

2. Roll puts down and out: Our trader is now less bullish, but confident that the stock's slide is
finished. He obviously needs to cover his short position, but rolling out to a deferred expiration
with the same strike does not fit in with his outlook. He should consider rolling down and out,
i.e., to a deferred expiration and to a lower strike price, such as the January 50 puts at $2.90.
Covering his short November 55 puts and rolling them to the January 50s will cost him $1.10
(pay $4 for the Novs, write the Jans at $2.90). Some traders will question the logic of executing
this trade, since it results in a debit. But let's review the situation: there are 4 days left until
expiration and our trader has no intention of taking delivery of shares of CBA: he must cover his
November puts and pay $4. His next trading step is not as obvious. If he truly believes that CBA
has hit bottom then writing the January 50 puts at $2.90 may represent a good trade. But he
could also elect to move on with his trading plans, forget all about CBA and write puts on a
totally different stock. If this trader has just lost some money on his CBA trade he is most likely
looking to make it back. But he need not stick to this stock: making his money back on a
completely different stock will have the same financial impact as making it back with CBA.
There are a lot of trading opportunities out there, and he should not limit himself to recouping
his losses with only one stock.

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 3. Cover: this trader has to face reality: his original forecast that CBA would be trading above $55
at the November expiration was wrong. It's now time to cut his losses and move on with his
trading. Taking a loss is never easy (both the pocket-book and the ego take it on the chin) but if
the outlook is for CBA to continue on its southward journey, better to take a moderate loss today
than a much larger one next month.

Pin Risk

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