As a dedicated income investor, my primary goal is to own quality companies for the long haul. However, I occasionally venture into mid-cap growth stocks, which come with higher risks but also the potential for significant appreciation beyond just income generation. Patience is indeed a virtue and a requirement in these situations. If your strategy is purely trading options for income, this approach might not apply to you. Nevertheless, I strongly recommend allocating a portion of your income to invest in solid companies and ETFs to build a more robust portfolio.
Remembering the Rationale Behind the Trade
The first step in managing a distressed options position is to recall why you made the trade in the first place. If you selected a strong company and its fundamentals remain intact, consider the possibility of assignment. This means taking ownership of the underlying stock at the strike price, which could be beneficial if you still believe in the company’s long-term prospects. If something has fundamentally changed with the company, conduct a thorough analysis to determine if it’s still a viable investment.
Utilizing Protection to Manage Risk and Cost Basis
Implementing protective strategies not only reduces risk but can also lower your cost basis for the stock, giving you more flexibility in managing your positions. Here are some strategies to consider:
- Close for a Loss: Sometimes, the best move is to cut your losses early. This can prevent further decline and free up capital for better opportunities.
- Roll for a Better Position: Rolling the option involves closing the current position and opening a new one with a different strike price or expiration date. This can improve your position by widening the spread and potentially allowing the stock more time to recover.
- Full Assignment with Sale of Put Protection: This involves taking ownership of the stock (assignment) while simultaneously selling a protective put option. The primary reasons for selling the put are to generate additional income and reduce the effective cost basis of your newly acquired stock, thereby providing a cushion against further losses.
- Full Assignment then Put Assignment: After taking ownership of the stock, you put the shares to the owner of the purchased put. This way you will be at max loss. This will happen automatically on expiration if the outer leg is in the money.
- Full Assignment + Partial Sale and Sale of Put Protection: Take ownership of the stock, sell a portion to lock in some gains or limit losses, and sell a protective put on the remaining shares. This usually happens when you do not have enough cash in your account to cover the share assignment.
Maintaining Emotional Discipline
A critical aspect of managing troubled options positions is keeping emotions at bay. Emotional decisions can cloud judgment and lead to suboptimal outcomes. Always approach these situations with a clear, rational mindset. Assess the data, review your strategy, and make decisions based on sound analysis rather than fear or hope.
Conclusion
Dealing with disasters when selling options requires a strategic, level-headed approach. As a long-term income investor, focusing on owning quality companies and maintaining patience can often help navigate turbulent times. Remember why you made each trade, utilize protective strategies to manage risk and cost basis, and keep emotions out of your decision-making process. By following these guidelines, you can effectively manage your options positions and continue to build a resilient and profitable portfolio.
For a deeper dive into these strategies, including real-world examples, watch the accompanying video where I share my experiences and insights on handling distressed options positions.
Thanks for joining me on my journey!
Uncle Jim
