Welcome to lessons for options trading for beginners. In the prior two lessons, you learned to sell both a covered call and a cash-secured put. Hopefully, you took in around $100 – $200 in premium. Not bad for an hour or so of work. You may have taken longer but going forward you will find that these kinds of trades take less and less time. Now you may be getting close to the expiration date or the ex-dividend date. When I started out, I only traded covered calls and tried to have my contracts expire. This worked well for the most part. On occasion, I did have a contract or two get assigned. However, back in 2020 before I started my journey I had several contracts be assigned. I was upset and this was one of the main reasons I decided to dig deeper and learn if I had other choices. I decided to research options trading for beginners. Boy, I was amazed at how little I understood about options. To my surprise, I had several choices and did not need to let an option in the money get assigned.
For both call and put contracts, you have similar decisions to choose from. In addition to letting the contract expire or be assigned, you can also close or roll the contract. I will discuss each below. Luckily, the choices for call and put contracts are the same.
Expiration / Assignment
What is critical with a contract when it is close to expiration, or an ex-dividend date is if its ITM “in the money” or OTM “out of the money”. A contract that is ITM simply means that the current stock price is equal to or more than the strike price. For a put, it works in a similar fashion, but the stock price would be less than the strike price.
Two quick examples will help. If you sold a covered call on KO with a strike price of $50 then anything higher than or equal to $50 is “in the money”. For a put where the strike price is $45 then if the stock price is equal to or less than $45, it is “in the money”. So, for a call you want the stock price to remain below the strike price. For a put you want it to be higher than the strike.
Here are a few examples of what to do if your stock price is near the strike price. Going to continue to use KO for the examples. Let us just say that you sold one cash-secured put at $45 and one covered call at $55. Both are expiring this Friday. Today is Wednesday. This is what I would do at each stock price and current premium to close.
- KO around $51 and the premium to close the contract costs approximately $10 for both. I would let both expire. However, I would watch the market to be sure that we do not have a major market swing. Would look one more time on Friday and if the stock price has not moved much then I would let the contract expire. If KO price is close to $55 or $45 then I would close or roll either the call or put.
- KO around $56. I would roll the call contract and let the put expire.
- KO around $44. I would roll the put contract and let the call expire.
Close Contract
If I determine that I do not want to let the contract expire or be assigned I first look to see if I can close it for less than $30. I find a good number of the contracts that are near the money are less than $30 and it makes sense to close them. To close you buy back the same contract. So, you do an order for the same contract with the expiration and strike price, but this time you buy it. I typically do market orders that way I do not have to sit there and watch the trade. For Schwab, the order type is “Buy to Close”.
Roll Contract
Typically, I roll contracts that are deep in the money. Meaning it is pricey to close them and I would suffer a loss. I have been somewhat lucky with my rolling. I did decrease my Delta or probability of expiring OTM for puts. I went from a 20 Delta to a 15 Delta. However, so far with several hundred trades, I have not experienced many losses. This could change. So be warned that you might find yourself in a pickle if you keep rolling. You could be digging a deeper hole.
One thought to keep in mind. I have had to roll more puts which in a way might be less risky. This is because I only write puts on stocks that I want to own. Also, for stocks like Apple, I feel it is easier to identify a low. Here are the guidelines I use when rolling a contract.
- I typically try to only roll out to another expiration no longer than 120 days from the current expiration. I have gone further out for positions that are deep in the money. I did this for an ARKK put. ARKK was trading around $110, and my strike was $121. I rolled it out six months to a new strike price of $107. Since the trade ARKK has gone back up to $120 and my position is now “out of the money” by a good bit. (Please note this refers to a trade I did back in 2021. Now ARKK is around $40)
- I improve on the strike price. So, for a call, I try to get a higher strike price and for a put contract a lower strike price. I have typically been able to do this. If the strike is really deep in the money then it may be very difficult to improve the price. Also, at times I will take a small loss to improve the strike.
- I always try to get more premium of at least $100 or so for the trade per contract. I have been able to get some good premium with rolling.
Here are the steps that you typically take to roll out a covered call or cash-secured put.
- I trade with Schwab so it might be different for other brokers. Go to the page that displays your existing positions. Select the option you want to work with and then click the trade option on the dropdown menu.
- If you are using Schwab the system will fill in a good bit of the trade.
- Again, if you are using Schwab select “Rollout” for the Strategy dropdown. The system will show two option trades one above the other. To roll you are closing your current position and opening a new one. So, it is really two trades in one. Here is an example again using KO.
- The above image is from the Schwab trading page. You can see for this trade I can make .37 or $37 dollars for each contract. I typically do two contracts so this would be $74 minus any broker costs. The first trade is closing the existing contract and the second one is opening the new contract.
- You can select different expirations and strike prices to determine what combination is best. Once okay with the trade you can click “Review Order” and the system will display all the details for the order.
- If you are happy with the order, then you can click the Place Order button. You also have the option to cancel or change the order.
- Once the order is placed it will show you a status page. If this is a market order, then the status will show that the two contracts were initiated. I prefer market orders because I do not want to go back and forth to see if the order has been executed and possibly change the order if the market changes.
Another important point with options trading for beginners and is not understood by most beginning traders is brokerages make it easy to roll positions. This is something I did not realize when I first started trading options. By rolling you can make more premium and buy yourself some time to have the trade go in your favor. Meaning have the strike price come back out of the money or above the stocks current price. This is also why having a trading journal is so important. I can keep track of what is going on by looking at the journal. This is especially true with determining what days I need to check the market.
Thanks for joining me in my fourth lesson. Now you have a good bit of the basics of options trading for beginners. However, the lessons are not over. Next, I will share another safe strategy, how to trade vertical credit spreads.
Thanks for tuning in!
Here is a video that I created that also shows how to manage options positions.
