The Buyback: Taking Your Option Selling Profits Early
Hi, this is Michael Gross, Director of Research at OptionSellers.com here with your bi-monthly Video Option Selling Lesson. The subject of this week’s lesson is The Buyback. Before we talk about the buyback, I don’t want to mention that if you find today’s lesson interesting or some of our other video lessons interesting, they’re all covered thoroughly in our new Third Edition of The Complete Guide to Option Selling. It’s out through McGraw Hill. You can get it at a 40% discount off cover price if you go to our website at www.OptionSellers.com/book.
Today’s lesson, The Buyback, in particular what we’re going to be talking about today is taking profits on your options that are successful. You can also buyback options as a risk management strategy, that’s the subject of another lesson, in fact, it is up on our blog or video lesson page if you’d like to see that one. Today, we’re going to talk about as it relates to taking profits. A lot of people wonder when they’re selling options, “If I sell the option and it goes my way, do I have to wait all the way till expiration until I get my profits?” The answer is no, of course not. You can buy options back at any time. In fact, buying options that have decayed where there’s a lot of time left on them can be an excellent strategy. Let’s do an example. Here.
So, a recent market we talked about, if you watch our market updates and our market articles and the newsletter, etc., we talked about selling natural gas calls. Let’s just assume here’s our natural gas chart. For example, 60 days ago you sold natural gas calls. Here’s your call and there’s your strike price. This is what the market’s doing and the market has continued to go down, for example. So, here we are, 60 days later. Now, you sold an option with 120 days on it, let’s say. 60 days in, the market has done nothing but go down. Now, your option has decayed substantially at this point, okay? Let’s say it has decayed by 90%. You sold the option for $1,000, now it’s worth $100. The option still has 60 days until it expires. Now, the question for you is do you want to wait around another 60 days when all you can make is $100? Well, if it’s me, my answer is no. I don’t want to wait 60 more days, I’ve already made 90% of what I can possibly make on this trade because all I can make is the premium, $1,000, and I’ve already made $900 of that. Why stick around another 60 days and take that risk just to make $100? So, most of the time, if makes sense to buy these options back if they have decayed. Our typical guideline is if the thing has decayed by 90% and there’s more than 30 days on it you might as well buy it back. In this case, you buy the option back at $100, it cost you $100 to do it, but you make a $900 profit on the trade.
What benefits does this give to you as the option seller? One, you take 90% of your profit but, more importantly, you eliminate the risk. Again, as we mentioned, why stick around those extra 60 days just to make 10% more? That’s benefit number one, probably the biggest one. Number two, you free up valuable margin from repositioning. When you’re in the trade, it’s pulling margin. Even when the option has decayed somewhat it can still be pulling some significant margin. When you eliminate it, you free that margin up to go and do a different trade where you’re getting higher premiums, repositioning, that’s more efficient deployment of your capital, another big reason why buybacks are a good idea. The third reason, it’s more psychological in nature, you book a winning trade. Psychologically, that can be a boost to you as an individual trader. When you’re managing portfolios professionally, that’s not as big a deal, but when you’re trading at home often times emotions do come into it. Booking a winner can give you that confidence to go on and reposition in other markets. If you are managing risk on your own portfolio, the buyback and valuable strategy, it’s something we use quite a bit of when we’re managing portfolios. Obviously, if we’re managing your portfolio it’s something we’re going to be employing quite a bit.
I hope you’ve enjoyed this week’s lesson. Again, if you’d like to learn more about these type of strategies, you can now get The Complete Guide to Option Selling: Third Edition at our website at www.optionsellers.com/book. You get it at a 40% discount off the cover price. If you’d like to talk to us about account, we do offer free consultations. You can call us at 800-346-1949 to schedule your consultation. Of course, if you’re calling from overseas you can call us at 813-472-5760. Have a great month of option selling and we’ll talk to you in two weeks. I’m Michael Gross with OptionSellers.com.