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How Do I Handle A Losing Out Of The Money Option Trade That Has Lots Of Time?

Posted by Pete Stolcers on May 3, 2008

Option Trading Question

Please indulge a beginner. I have limited myself to buying calls and puts until I got more familiar with option strategies. As February expiration approached I found myself hopelessly out-of-the-money (OTM) on 4 SHLD Feb170 puts. I'd bought them four months earlier when they were in-the-money (ITM). I had made money on some SHLD calls and I felt confident that the stock would retrace. Feb arrived and the stock had made its way up over $180. I had been watching it and it was not unusual to see it up $3.00 or $4.00 one day then down $2.00 or $3.00 the next. But, alas, I waited too long and there was no way I was going to see any profit and it was now too late to bail out. How does one get out of a position that has plenty of time but is far out of the money. I'm in trouble again and I wondered if I might SELL March 80 puts on JCP where I paid $5.50 for May 85 puts. The stock was down $4.00 today and I could have sold them for about $3.75. I would recoup some of my money, but they have plenty of time left on them. I doubt they will go far enough for me to sell-to-close at $5.50 or better. I read about your strategy to sell OTM puts for a little each time and do it each month. If one had a few months and could capture around $100 each time I might get closer to recovering my initial investment. Does this make sense?

Option Trading Answer

There are a number of pitfalls that you have fallen into. Let’s look at the chart and address them one-by-one.


1. Don’t flip-flop on a stock. Either you like it or you don’t. Trying to time zigs and zags is a losing proposition (for option trading) and you will continually be second guessing yourself. Once you made money on the calls, you should have moved on to another stock and waited for an opportunity to get long again. A material business event that changes the long-term profit outlook would be the only reason to change your bias.

2.  I tried to find a time frame when you might have made money on the calls and bought the puts when they were in-the-money. If my assumption is right, it was in November (blue box). If that is where you bought the puts, you would want to see the stock stay below that support when it was violated. If you bought the puts when the stock traded below $170 and it gapped higher 2 days later, you could have stayed with the position knowing that you had time. Since the stock did not trade above $182 ( the high on the chart) you could have stayed with the position, waiting for a better exit price. The first two blue arrows show good exit points where you could have mitigated your losses. You stayed with the position and the stock broke $170 support. At this juncture, you were almost whole. I have found that when you have a bad trade right from the start and the market gives you a chance to scratch… take it. In any case, once the stock gapped back above $170, you had to get out. That old support level became resistance once the stock was below it and it should have been used for your stop loss.

3.This stock is not trending. It is chopping around in a random fashion. Hence, it is tough to predict. Trading is about forecasting the outcome and in this case, SHLD is a coin toss. Look for stocks that are trading in a very orderly manner.

4. Know in advance when you will get out of the trade. You should have specific price levels for both the target and stop. You should also identify the time horizon of the trade. If I am considering a 4-5 month trade, I will scale in and average my price. If the stock has not made a constructive move in 6 weeks, I may time-stop the trade. If I’m looking at a trade that will last 2-3 weeks, I’m anxious right out of the gate. With every hour that passes, the probablility that I’m wrong increases. I did the trade because I expected an immediate move. If it does not happen in a few days I may cut and run.

5. I don’t advocate trade repair. If you are wrong, get out, learn from your mistakes and move on. In the case of SHLD, you might have taken in some premium by creating a diagonal spread (sell front month out of the money options against the Feb put), but it would have only softened the blow. You would have lost less if you sold the Feb 170 puts at points 1,2 or 3. Spreads are great strategies, but they should be a part of the original game plan.

6.You are fighting the market. The trend has been up and you are buying puts. 75% of all stocks follow the market. If you are on the wrong side, you will lose money on 3 out of 4 trades. I have been losing money on puts during the last few months, but they have been a hedge for my larger position. In your case, I’m assuming these are your only trades. If they are not, hopefully your long call positions are offsetting the cost of your hedge. Before you can get long puts, this market will need to violate the major trendlines and horizontal support levels. It is very strong and you should not try to fight the trend. You should also take a look at the sector the stock belongs to. In the case of SHLD and JCP, they are retail stocks. Bring up a chart of the RTH - it is in a very strong trend. If you don’t like retail, wait for the market and the sector to roll over. In the meantime, find a sector you do like and get long.

In January when JCP brokeout above $82 resistance you should have been out of the trade. The market is giving you a chance to salvage the trade. I would not spread it, I would get out. The stock dropped to $82 support and bounced. At this stage I would set my stop at $84 and my target at $82.

Don’t feel bad about losing trades. They happen all the time. Just make sure you learn from your mistakes. You might consider reading my articles on how I trade options. The option strategy is a function of your opinion and confidence.

Thank you for a great, detailed question. I’m sure many other traders can relate. 

Option Trading Comments

  • On 05/22, Jai Guevara said:

    I’m looking at deep-in-the money LEAPS as a substitute for buying stock. For example the WMT 2010 30 call. With WMT at 56, the call is about 27, or about half the stock price. The premium over intrinsic value is less than $1. If the Delta is close to 1, isn’t it like owning the stock with half the investment?

    I know call buying has risk, but this seems no more risky than buying stock. Am I missing something here? What’s the downside of this strategy?

  • On 05/28, Pete Stolcers said:

    The down side is the same as owning the stock - initially. As the stock drops, the options will gain implied volatility and the risk of holding the options will be lower than the risk of owning the stock. For instance, if the stock droppped to $30, those calls would be carrying premium and your position would not have lost point for point with the underlying stock. On the flip side, the options will gain point for point with the underlying stock as it goes up. This is true because they are trading at parity.

    The position risk/reward is roughly the same as owning the stock. By owning the LEAPS you are not entitled to the dividend (1.7%), but you also don’t have to put up as much capital and that excess can be invested to earn more than the 1.7% you would have gained from the dividends.

  • On 11/23, Dave said:

    This is more a question than a comment..I am nairly new at trading options. I have had my ups and downs making money..I don’t use fancy option strategies..I simply buy and sell puts and calls… My question is this..I bought CME Dec 350 calls last week Tuesday Nov 17th. I paid 2.80 per contract. The stock price at that time was $321.40. The very next day the stock price moved to about 325 and my option moved up about .30 cents.  Here I am today Monday Nov. 23rd.  CME stock price has jumped and hit a high of 329.90. Yet my DEC 350 call has now fallen to 2.20 ?????  Can you explain to me how this can be. The stock price is up nearly $9 from when I bought only a week ago. COuld that much time value have been taken from my option.Just seems immpossible..and how would you have traded something like this Knowing from your tecnical analysis that the price should have been higher.  Any comments would greatly be appreciated..

  • On 11/24, Pete Stolcers said:

    I like your CME pick technically. It looks strong relative to the market and it is breaking out to the upside.

    The problem with out of the money calls is that the stock has to move right away. In addition to time decay, you are experiencing a decline in implied volatility. As the Thanksgiving holiday approaches, traders are selling premium. Wed, Thurs, Fri and even Mon will be slow.

    Try not to buy out of the money premium ahead of a holiday. I also suggest you learn spreading strategies. Selling an out of the money put credit spread would have worked out nicely on this stock. At the time, you might have been able to sell the $290 puts and buy the $280 puts for a net credit of $1.00. For this to get into trouble, the stock would have to break a 3-month trendline and horizontal support at $300 and $290.

  • On 12/07, tony said:

    Hello mate

    This question regards calculating risk reward with respect to selling OTM call spreads.

    While I know the reward is the income/premium.
    The risk I’m a bit confused by.
    Do you calculate the risk as the amount you could lose in the trade if it goes horribly wrong ie the difference in the two strikes minus the income you received. Or is your risk calculated by finding a resistance level/stop price, in the case of shorting call spreads,
    and setting it as that.
    Hope this makes sense and thanks for your time.


  • On 12/07, Pete Stolcers said:

    Great question.

    It is always important to know your max risk on a trade, just in case the unexpected happens. However, I use the probability of the stock staying below the short strike in a call credit spread in my decision making. The momentum, horizontal resistance, trendlines, prior movement all add to the probability that the stock will stay below the short strike.

    I have no intentions of letting the stock go all the way in the money without stopping out the trade. I usually place my stop below the short strike.

  • On 01/29, Kai said:

    Hi Pete, I have sold 3 SPX Feb 1085 put and bought 3 SPX Feb 1075. Right now, it’s ITM with about 3 weeks to expiration/exercise. SPX currently stands at 1073.87.

    Would it be better to bail out now and buy back the spread, or hold on to this credit spread?

    Your advice much appreciated.


  • On 02/01, Pete Stolcers said:

    The best advice I can give you is to devise a game plan before you enter the trade. That should include a stop where you have to get out. I place stops on put credit spreads below critical support. Once that support is broken, I know I was wrong and I have to get out.

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