Sometimes things don’t work out as planned.
The move you’d anticipated doesn’t unfold quickly enough. Or the reason you entered the trade no longer stands.
It can leave you in a quandary…
Do you stay the course in the hope that things turn around? Or should you cut your losses and move on to the next trade?
Well, sometimes there’s a middle ground.
One of the great things about options is their flexibility. They can give you a second chance at a trade if the initial position doesn’t go your way.
And that’s what I want to look at today…
Cut or Roll?
Say you’re a trader who thinks the S&P 500 (SPX) has peaked and is vulnerable to a correction. So you buy a put option that will benefit when the index falls.
However, instead of reversing, SPX continues to climb.
If you think you’ve simply gotten the trade wrong, then the best path is to exit your position. Otherwise, your put option will just keep decreasing in value as SPX climbs.
Plus, time decay will work against your trade. Because options expire, they lose a bit of their value each day. That time decay accelerates the closer you get to the option’s expiration.
When direction and time are working against you, your option can quickly lose a big chunk of its value.
But what if you think you were just a little early?
Here’s what you can do if you’re truly convinced that the SPX will fall soon…
Trade Conviction
If you decide to stick with your trade, you can choose to “roll” your option.
In essence, you close out your existing position. Then you open up a new option trade that gives you more time before expiration. You can also choose a different strike price that reflects where SPX is now.
The key to rolling is that you must still have conviction in the trade’s rationale. This requires you to assess your position with brutal honesty. The last thing you want to do is double down on a loser.
Yet by rolling your trade, you have a fresh shot at capturing the gains you’re anticipating.
To see how it works, let me show you one of our recent rolls…
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A Roll in Action
The market surged off its April lows. And I became increasingly convinced that the rally was getting overstretched…
Despite 10% baseline tariffs and no real deals in place, SPX had rallied back higher than where it was trading before its tariff-based plunge. Tariffs would lead to higher inflation and hinder businesses… and the economy and markets.
So on May 2, we bought a put option on SPDR S&P 500 ETF Trust (SPY) with a $470 strike price and July 18 expiration to capture an anticipated reversal.
Check out the chart…
SPDR S&P 500 ETF Trust (SPY)
Source: eSignal
After entering the position, the Relative Strength Index (RSI) initially swung lower in our favor.
But then that down move faded out. SPY gapped higher on overhyped news of a “trade deal” with China. Yet I remained skeptical about that deal since it came without clarification or details from the Chinese side.
Plus, on the chart, the RSI was closing in on overbought territory, setting us up for a reversal.
So we rolled the trade on May 13. We sold our SPY $470 July 18 puts and bought SPY $500 August 15 puts. (We rolled the option higher and further out.)
In short, we wanted to keep our trade open, as we still believed the down move was around the corner. But we also wanted to exit our initial position before time decay ate away too much of its value.
Although it’s early days with the move, SPY recently reversed and traded lower.
If a down move hits, we could recoup the losses from the initial trade and end up with a profit overall.
So if you believe in your original analysis, you can look to roll the option. If it plays out, that can give you the best chance to profit from the move you see coming.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
P.S. Options are one of my favorite ways to play the market’s moves. They give us leverage… That’s why a 2% or 3% market move can hand us double- and triple-digit gains in a matter of days.
But options aren’t the only way to draw in big gains fast. There’s a type of asset that makes it simple to boost your profits… like making 2X the moves of major stocks and indexes – or even more.
This asset has been gaining popularity in recent years, but many people are still unaware that it even exists…
That’s why I want to tell you about it now… For the full story, simply go right here.
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