Writing options is not without risk. You open the option position because you have certain expectation on the stock. What if all goes wrong?
Towards the end of august, I got more relaxed with options. I had sold already a few puts and calls and considered I was now ready to take on more positions to get even more experience. In this post, I will walk you through an option position that went wrong and what it did to me.
Gaining some more experience in option writing was on my mind. I therefore decided to write a put option on Coca Cola (KO). At that time, I considered KO a stock I would not mind to own at the price of 40 USD. I had read a lot about the stock on DGI blogs and considered 40 a cheap price to pick up a wide moat stock.
Hence on sept 17, I wrote the 40 put for Sept 20 2015. The stock was trading around 41,2 at that time and I was able to collect a premium of 30,55.
Then the markets digested the China news in a bad way on aug 24. As a result, the markets took a major hit and my KO option was in the money, and stayed in the money for quite some time. The stock did not go above 39 and expiration week was coming soon. This meant I would have to pay 40USD for a stock that now trades at 38 something…!!!
I felt bad, really bad… But why…? I was happy to buy the stock at a price of 40 USD. If I stayed loyal to my original plan, I would need put the money on the table and get the stock at 40. If I believe that nothing has changed with KO and its fundamental business, I could do just that. Now that the moment approached to act like I promised, I chickened out. This is not something I expected to happen. A good lessons learned.
So, I decided to take the other exit possibility: I decided to roll the option.
What is rolling an option?
Rolling a put option means that you buy back the put options that you have originally written. as a result, you have no more open position. But You have locked in a loss. You paid more for the buy-back than you received for selling initially. You then go and sell another option, with another expiration day and possibly strike price and get hopefully some more premium.
This is what I did.
I bought back the original put for 202 USD, and thus locking in a loss of approx 170 USD.
At the same time, I sold a new put option. For this one, I got 229 USD. This means I now have received after costs 60 USD credit for this option. Top Deal
What are the characteristics of this new option?
I now only need to pay 39 USD if the option gets exercised. this is a full dollar less than the option I had on before. It means I get to keep 100 USD extra: Top Deal
Maturity date: January 2016
In order to lower the strike that much and still collect a premium, I needed to roll 4 months. This was with hindsight a bad idea.
This is a bad idea for 2 reasons
1- options with that much days till expiration have almost no time decay. If nothing changes, then your options almost does not loose any value in a day.
2- If the stocks goes back in the right direction, the price of the option does not change that much at all
How it ended
The markets started to recover after Yellen decided not to raise the interest rates for now. Ko started to recover and went to 40, 41, 41,5. I started to look at the option premium and it went slow down. The highest KO went the slower it went down.
on 8 October, the option went below 60USD. From this time onwards, If KO does not go any lower, I would start tomato money again.
Due to some circumstances, the option was written at a broker I decided no longer to use. I used this opportunity to close the position and empty my account.
Key take aways
Make sure you really, really want to own the stock
If you roll an option, do not roll it out to far in time
What are the lessons you have learned from option positions going bad?