Proper position management is one of the keys to profitable trading. Unlike stock traders, who really need to consider only price when deciding to buy or sell, an option trader needs to weigh additional elements such as time and volatility.
A good option trader should think two and three moves ahead of the market and prepare specific responses to various possible scenarios.
It's frequently overlooked that sometimes the best strategy is to do nothing. There is nothing wrong with standing pat and letting a thesis plays out, or if you are wrong, taking a loss and moving along to the next opportunity.
Don't let options tempt you into trying to salvage a bad position or get too greedy on a good one. You don't want to keep making adjustments until you find yourself in a pretzel-like position that's difficult and costly to untangle.
With this in mind, I thought it would be useful to review some recently suggested strategies and answer the recurring reader questions of "What do you do now?"
Handling Research's Motion
Let's start with
last month's suggestion to buy the January $80 straddle in
Research In Motion
. At the time, the stock was trading at $81.50 and the straddle could be purchased for a net debit of $18.80, giving the position break-even points of $98.80 and $61.20 per share.
The January options were being used on the expectation that a court ruling on a patent-infringement lawsuit would be handed down before the January expiration, would provide a catalyst for price movement, and keep implied volatilities relatively high. That would help offset some of the time decay of the straddle's value.
So far there has been no court decision, and yet the implied volatility has fallen from around 65% to 58% for the January at-the-monies, so my assumption that implied volatilities would stay pumped was wrong. Fortunately, the underlying price action, in which the stock ran to an intraday high of $94.87 on Dec. 6, has more than offset both time decay and the decrease in volatility.
As I suggested in the article, "should Research In Motion trade above $90 you might consider selling some December $90 calls to capture some premium and reduce the straddle's cost." I would stick with that game plan. As of today, with RIM at $90 in recent trading, the December $90 call can be sold for $3.20 per contract. This creates a diagonal calendar spread and reduces the cost of the original straddle to $15.60, bringing the break-even points down to $95.60 and $64.40 per share.
Be aware that if the stock closes above $90 on the Dec. 17 expiration, you probably will be assigned on the short calls and the upside potential will be limited. But the position will remain open and can profit from a decline in Research In Motion's share price.
Another alternative would be to simply sell out half of the January $80 calls, which are currently trading around $14. This would reduce the position's cost by 61%: For example, if you owned 10 straddles for a total cost of $18,800 and sold five of the calls for $7,000, the new total risk is $11,800. That gives you break-even points of $91.80 and $68.20, and you still maintain unlimited profit potential on both the upside and the downside profit. If you think the position is just no good anymore and are afraid to own premium heading into the slow holiday season, the straddle can be sold at $17.70, which would result in a $1 loss.
Getting More on Sirius
More recently, I suggested
a strategy for trying to reap some premium on
options. On Tuesday, when the stock was trading at $8.50, I suggested selling the January $10 calls at 90 cents and buying stock on 3:1 basis -- sell three calls, buy 100 shares.
The idea was to take advantage of the fact that implied volatility had hit 110%, and the stock was likely to settle back down. Now, with Sirius at $7.20 in recent trading Thursday, the January $10 calls are worth about 30 cents, and the position is showing a profit of about 60 cents per 3:1.
If you don't want to simply close out the position for a profit, some possible adjustments might include reducing and rolling the calls down to the $7.50 strike. This can be done by buying back the three January $10 calls and selling just two of the January $7.50 calls for 80 cents each for a net credit of 70 cents.
This accomplishes several things. First, it brings the position back toward delta neutral. This is important because you should never let a premium or volatility play become a pure bet on price direction. The roll down also allows you to take in some more of the rich premium; the options still carry an implied volatility in the 95% range. It also reduces the number of naked calls, or the position's upside risk exposure. Just be aware that the position still carries unlimited risk and becomes outright short once Sirius shares rise above the $9.10 break-even point.
Like all options positions, there is no single right answer. Readers should make adjustments according to their viewpoint and risk tolerance. I look forward to hearing other suggestions and the feedback, but I will be away for some R&R until Dec. 14 so I won't be responding to emails for the next few days.
Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to