The Buyback – Taking your Option Selling Profits Early

The Buyback – Taking your Option Selling Profits Early
Feb

12

2018

The Buyback – Taking your Option Selling Profits Early

I am often asked if the objective of selling an option is to have it expire worthless. The answer is yes and no. Obviously, your short option expiring worthless is a successful conclusion to your trade. You’ve taken your full profit, the premium collected is yours. However, letting your option sit through expiration may not always be the most efficient course of action. After trading over a million option contracts in my career, I’ve found that buying back profitable short options prior to expiration can provide a number of benefits.

For instance, let’s assume you sell a Natural Gas call option for $700. Let’s further assume that sixty days prior to expiration, the option is worth only $20. Is it better to buy it back for $20, taking a $680 profit? Or is it better to hold the option for two more months, with the best case scenario being an additional profit of $20?

I would advise buying this kind of option back for the reasons listed below:


  1. You take over 97% of your potential profit from the trade and eliminate your exposure in the position. At this point there is little to gain from this position ($20) and everything to lose. Chances are overwhelming that this option will expire worthless but why take the risk for 60 more days if there is little or nothing to gain?
  2. You free up valuable margin for repositioning. Chances are this position does not have much of a margin requirement at this point, but it is probably still pulling a few hundred dollars. By freeing this margin and eliminating the risk exposure, you can redeploy funds in other markets, or sell more options in the same market, as you now have no additional exposure there.
  3. You book a winning trade. By taking profits early, you take the trade off the books. It is one less trade you have to monitor, one less line you have to look at each week. You free your mind and capital to pursue other opportunities.

For the most part, we do recommend early buybacks when they are viable. Options decay at different speeds depending on the movement in the underlying and time until expiration. Some may be bought back 5 months early; some may be bought back 2 weeks early, some you may have to hold through expiration.

In investor portfolios that we manage, buybacks are typically considered when the option premium has decayed down to 10% or below of its original sale price. If you have made 90% or more of the potential profit on the trade, you should consider booking it.


James Cordier is author of McGraw-Hill’s The Complete Guide to Option Selling (3rd Edition, 2014). He is also founder and head trader at OptionSellers.com, an investment firm specializing exclusively in writing commodities options for high net worth investors. James’ market comments are published by several international financial publications and news services including The Wall Street Journal, Reuters World News, Forbes, Bloomberg Television News and CNBC. Michael Gross is co-author of The Complete Guide to Option Selling and director of research at OptionSellers.com.

If you would like information about managed option selling accounts directly with Mr.Cordier, Mr.Gross and OptionSellers.com, you may request a free investor information pack at www.OptionSellers.com/InfoPack. You may also request a complimentary consultation by calling 800-346-1949 (813-472-5760 from outside the US).


Price Chart Courtesy of CQG, Inc.


***The information in this article has been carefully compiled from sources believed to be reliable, but it’s accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss, and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.

  1. Michael,

    My understanding for the choice to go 6-12 months on selling options is to capitalize on taking in more premium, to take in more money to have greater absolute upside. It also establishes a bigger margin of safety and allows more time for the news frenzy to run its course. Though, one can’t necessarily benefit as much from decay, as one would with shorter dated options. That being said, what’s your take on 2-4 month options?
    One drawback to selling longer dated options, is the longer period of time to wait if one decides to go to expiration, if one opts to go that route.

    In summary, (at least for stock equity options) what time frame (in conjunction with decay) would you say works best.

    Thanks in advance,
    Bruce

    • Michael Gross Says:
      February 19, 2018 at 2:30 pm

      Dear Bruce,

      A commercial pilot once told me that if something goes wrong in the air, you want it to go wrong when you’re at high altitude, not close to the ground. Why? Because it gives you more time and space to recover. I’d say that is the perfect analogy for selling long dated, deep out of the money options. You’ll find that many of these options can decay close to zero months before expiration – making them excellent buyback candidates. There is nothing wrong with selling options with 2-4 months time. However, those options will have to be sold closer to the money – meaning your risk of going in the money goes higher.

      I speak of course, only in reference to commodities options. Stock options are a different ballgame and do not offer high enough premiums to practice this strategy effectively.

      Regards,
      Michael Gross

  2. Dear OptionSellers team,

    Thank you for this article. Do you always close position only if premium will be more than 90 %? What if you sold 120 days options and it lost 70% of its premium? Does it reasonable to close position or we should still wait for at least a 90 % decay? Have you any extra rules for similar situations? For example If our option lost 50% of Its premium on the next day by black swan event?

    Thank you

    • Michael Gross Says:
      February 15, 2018 at 3:17 pm

      Dear Nikolay,

      There is no absolute “right” or “wrong” way to buyback options. There are times where we will buyback at more or less than 90%. A change in fundamentals, something happening in the market that makes us uncomfortable, et, the options carrying value right up to expiration (in which case its best to simply let it expire.) However, as a general rule, sticking to 90% has proved to be an efficient strategy.

      Regards,
      Michael

  3. Hi guys! The material you present is the easiest to understand thus far. Plus the straight forward explanations is exactly what drew me in and I’ve bought the book. I’ve done options trading for about 4 years (all long positions and even opened a TDA account under my LLC; I do Web Design as freelance as well) along with being in Grad School. Now, I’m not a HNW individual, I did recently receive a substantial inheritance and looking to make it grow. Originally, long positions made sense and admittedly did chase the high but I would always feel there was a better way (especially after blowing an account in the very beginning and learning from it). After reading your book, back testing and paper trading, I feel 200% comfortable about short positions.

    Long story short, just wanted some quick insight into weeklys. I’m not looking to be a billionaire as of yesterday but want to generate some more consistent income that’ll allow me to also reinvest in other ways. How do you feel about Short (naked or spread) on weekly expirations? My thinking is to find a strike sufficient deep enough out of the money, choose a reasonable strategy (naked or spread), keep all other aspects of risk management in place and ride it to expiration. The weekly would be at least 4-10 days prior to expiration and I’ve noticed I can collect premium anywhere from $800-$2k per trade. Do you think it would be a good idea for a smaller account?

    • Michael Gross Says:
      April 25, 2017 at 2:52 pm

      Dear Howard,

      Thank you for your email.

      While there are different ways to sell options and be successful, we prefer not to sell short term options. While you will get fast time decay, you must sell perilously close to the money. One hiccup and your option could be well into the money – exactly the place we want to avoid. Of course, we, and our clients, are mostly long term investors.

      Its your money and you may do with it what you wish. However, this type of trading is often responsible for the “1 step forward, 2 steps back” that novice option sellers often complain of. I realize the potential for quick and easy profit is tempting. But selling close to the money options runs the risk of a sudden and substantial loss. I would not recommend it unless to a very experienced, actively managing and well capitalized trader. I certainly would not suggest it for a “smaller” account.

      I don’t mean to rain on your picnic but do hope that you will continue to learn to sell options. There are other, much more reliable and lower risk ways to take premium out of the markets.

      Regards,
      Michael Gross

    • Howard,

      If you can honestly answer this question you’ll also have your answer to whether your plan is a good idea for ANY account, let alone a smaller account:

      Is it reasonable to expect to consistently earn $800 – $2,000 in a period ranging from 4-10 days by selling option premium? Before answering, consider the fact that, for the most part, option premium is based on time value and volatility in out of the money options. Now, you’re talking about time value of only 4-10 days worth of time until expiration… because of this, there simply isn’t much time.

      IF an option is volatile enough to provide you $800 – $2,000 for only 4-10 days of time, that means it is ridiculously volatile. Do you really think that you’re going to be able to come out on the right side of that enough to be profitable in the long run?

      Be careful…

      • Michael Gross Says:
        February 15, 2018 at 3:21 pm

        Chris,

        No. Absolutely not. We would NEVER sell options with a 4-10 day time range. That is a high risk, volatile way to trade. Most of the options we sell are 6-12 months out in time.

        Regards,
        Michael Gross

  4. Good..

  5. OptionSellers – Michael Gross,

    The video on how to take profit in Option Selling using buybacks was Very good. I also have the 3rd Edition of the Option Selling book and it is the best. I will be joining OptionSellers soon. I currently have options futures accounts with OptionsXpress and thinkorswim and I like to be diversified. Will be calling OptionSellers soon.

    • Michael Gross Says:
      April 12, 2017 at 2:12 pm

      Joseph,

      Thank you for the feedback! We’ll look forward to talking with you.

      Regards,
      Michael

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