Let’s face it. Sometimes we are wrong. Even when it comes to selling options, where we can make money if the market moves in 3 different directions (but not too much in one direction) at times the market WILL move too much in that one direction. So, how do we deal with a losing trade? We already talked about the stock repair strategy, which is a cool way to potentially get back to break even on a stock trade without the stock having to go all the way back up to your original purchase price. Here is another way to recoup a loss or turn a loss into a winner on an options trade. We have learned that if we are going to trade options, the odds of winning are stacked in our favor significantly more if we are option sellers instead of option buyers, so this strategy refers to when we are selling a put to potentially buy a stock at a lower price at some time in the future or when we sell a covered call to sell a stock at a desired price at some time in the future. Let’s take a look at an example of a put option that is currently at a loss and see how we can potentially turn this into a winner: We will use Gilead as an example.
The price of GILD is currently 73.66 as of December 13, 2016. In April, GILD was over $100. Over this summer many investors thought that the $80 price tag presented an opportunity, but there were a few things regarding some of their drugs (sluggish sales on their premier drug) that caused people to think twice about an $80 entry price. As an alternative, they could have sold a put option and collected a premium. On TD Ameritrade’s Think or Swim software, they have a tool called Think Back, which is used for back-testing strategies based on real quotes. If we go back to July 15th, GILD closed at $86.67 and the Put option expiring in January 2017 with a strike price of $77.50 was $3.42. So if we decided to do that trade we would sell that put and collect $3.42/share. The price of GILD has come down and is now trading at $73.66. If we wanted to close out that put we would have to buy it back and the cost today to buy that put option back is $5.27/share resulting in a loss of $1.85/share.
We are still interested in GILD, but now we don’t want to buy it at $77.50, we want to buy it at a lower price. Or we are still ok with a $77.50 purchase price, but we don’t want to buy it by Jan 2017, which is just one month away. Here is what we do with a loser to turn it into a winner. It’s called a rolling out: First, we close out the existing trade and take a $1.85 loss. Then we need to create a new position, so we sell another put. When we do that, we can adjust the strike price, so in this example we can pick the $75 strike or $72.50 instead of the original $77.50. We can extend the duration, so instead of having an expiration month in January 2017, we can extend it to February or longer. Thirdly, you can do both at once. Let’s do both and see how this trade looks. We closed out the Jan 2017 expiration with an original strike price of $77.50 and took a loss of $1.85. Now let’s sell a put expiring in May 2017 with a strike price of $72.50. If we do that, we collect $4.25/share. So we had a loss of $1.85 but we just collected an additional $4.25, so we effectively pocketed an extra $2.40 and we lowered our potential cost basis from an “if put” price of $77.50 down to $72.50 (not including the premiums collected). We turned a loser into a potential winner, as long as GILD doesn’t go below this price by May of 2017. If it does, we can roll out again.