Exercising at Expiration Follow-up: A real world example

Hi Mark,

Thanks for your suggestions on my DFS trade. In fact I should have mentioned that a majority of my option positions are OTM credit spreads and iron condors.  This is the one or two speculative positions I have at a certain point. I entered the trade back in December anticipating DFS to go up, and it did. I do admit that I committed the sin of being emotional with my position and want to make even, but in this case, I also believe in the company and I do own the stock in another account with a higher cost basis. I was in a similar situation late last year, took a loss but slept well.

1) When you opened the position, and the price you paid are immaterial

2) Your position may have been born short a put spread, but now it's a naked short put

3) You 'believe in the company'?  What does that have to do with the price of tea in China?  Is owning naked long stock (or a covered call) the way you want to play this company going forward?

4) The fact that you own more stock in another account is immaterial.  Although the fact that you are already long with downside risk ought to encourage you to take less risk in this account

The cost basis of your stock is immaterial.  Only the IRS will care about that – if you ever sell the shares.

5) It is not a 'sin' to get emotionally involved with your decisions.  That's a trait that is difficult to overcome, but it is necessary if you want to be a successful trader or investor

It is not a 'sin' to try to get back to even.  However, it is an exercise in bad judgment. You obviously plan to continue to trade.  It should not matter which stock, or which specific position, provides profits.  Your goal is to earn maximum profits with minimal risk.  You are not doing that with this position.

6) One way to break that 'get back to even' mentality is to ignore your entry price for a trade.  Write it in your journal, but do not pay any attention to that price.  Pay attention to current risk and reward.

I recognize that my stance on 'forget about break-even' is the minority view, but I stand by my belief that it's the only view that makes sense.  Consider this:  You hang onto a trade to get one more dime out of it.  You need that one more dime to break even.  While waiting for the dime, the stock moves and you lose two bucks.  Nice risk/reward.  Maximum gain is a dime, maximum loss is ???

On the questions you raised, this is what I think:

Writing covered calls the best play? By the middle of expiration week, I have a couple plans in place:

Plan A: Close the spread with nice profit.   That did not happen 

This an example of you making a trade decision based on profit or loss and not on risk/reward.  It's your money, but this is not a good idea – in my opinion.

Plan B: Short DFS stock so I am completely out of the position by Monday.   I was going to do it on Friday if Plan A didn’t work, but DFS dropped further, so I decided that was not the best time to lock in an exit price 

Again, a decision based on the fact that it would lock in a loss to exit.  This is not a good decision based on risk/reward.  You are free to trade that way, but my recommendation is to learn to think differently.

Plan C: Exercise the $15 call and let the $17.5 call expire; then exit in the near future.  I chose to write covered calls.

A viable plan.  A reasonable strategy.  However, if you chose this backup to a backup plan just to avoid taking a loss, it's no longer a viable plan. 

There is one thing that I did not think about, and that is to roll the position to a later month.  I usually view different expiration dates independently, and I did not have the work done the night before. I guess I should start looking into this possibility. 

Sure, be aware of the possibility. Plan ahead.  If you can get a price you would be happy to get to roll, then this is a good plan.  But rolling just to do something – which is what you did this time, albeit with a weekend long leg – is a bad idea. 

Rolling is not some magical trade that turns losers into winners.  It's a decision to exit one trade and enter another.

Less risky plays? This position as I explained earlier, is one of the speculative positions I have, so by design if I lose 100%, I will be fine with it (on this one, I see that with a little more time I can turn that to a profitable position). I used to speculate with vanilla long calls but I do not feel comfortable with that any more.

When this trade was made, losing 100% meant a loss of $88.  Now it represents a potential loss of more than $1,400.  Are you still willing to lose 100%?  Is this a good speculation?  Are there no other bullish plays that satisfy you?  Must you own stock?

Let me see if I have this right:  You do not feel comfortable with the risk of owning calls, but you are ok with the risk of owning stock? That's not how I measure risk.  But the nice thing about options is that there are so many alternatives that we can each take the risk we are willing to hold.

Naked long over the weekend a good idea? Acceptable, I’m comfortable with it.

Covered calls ONLY because I refuse to take loss? Part of the reason why I exercised, but I also believe in the stock itself.

Gibberish.  If you believe the stock is moving higher  – can't you find a less risky way to be long?

Once again, thanks very much.

Thanks for the question and follow-up.

F.

672


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