When closing an secondary (or tertiary) option leg it needs to cover the original rolled put for the trade to be profitable. Reading that sentence over again, it probably makes absolutely zero sense to some, and seem painfully obvious to others. Either way, I learned this lesson the other week, and it was not readily apparent to me so maybe it isn’t to others.
Rolling Out of an In the Money or Near the Money Put
I have been selling naked puts to create additional income to invest in dividend paying stocks. My goal is to sell naked puts with a large cushion between the current price and the strike price so that the stock is never assigned to me.
As with all great plans it just doesn’t work out all the time and my cushion erodes and I am left with two main options:
- Take assignment of the stock
- Roll the Stock
This post obviously has to do with the latter. When you roll a put you are buying back the contract (buy to close) and sell another (sell to open) with an expiration date that is further in the future than the original contract – your goal should be to be doing this for a net credit. Put another way:
- Sell the original naked put – income. The trade turns bad so you
- Buy to close that contract at a loss and sell another one to open for additional income.
- Buy to close that second contract at some point
An Example of Rolling a Put Where I lost Money
I think the options world opens up for most people when using an example, so what is better than my real life example that cost me money:
- I sold a naked put on SWHC (which later became AOBC) with a strike price of $22 (made a few dollars)
- My cushion eroded and I had an in the money options contract (i.e. AOBC was under $22)
- I rolled the contract – which means I bought to close (at a large loss) and then sold to open another contract – this contract provided me with a small profit.
- I then closed the new contract for a small gain
What I didn’t realize at the time is that when I bought to close the new contract (last bullet point) that the small gains made throughout the process did not equal the large loss I incurred on the original contract. Again, this may seem intuitive for some traders, it was not for me and I paid for it (quite literally).
When Closing a Rolled Put What do I need to Do in the Future?
When dealing with a rolled put situation I am going to have to keep track of the original loss so that I can later know how much I need to make on the second contract for it to be a profitable trade.