Rolling a put option that went wrong and what I learned from it.

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…!!!

Manage an option trade
Manage an option trade

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?

Strike: 39:

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?

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6 thoughts on “Rolling a put option that went wrong and what I learned from it.

  1. Ciao Atl,
    Sorry to bother but as I wrote in a previous blogpost I am trying to learn more about options. What I do not understand is this:

    1. If I sell a put to buy a stock a at a lower price, a stock that I do not mind owning, let’s say KO @ 40, if the option is ITM @39 when it expires, you will be assigned the stock at 40, money will be taken from the account and you keep the premium. If you bought the stock at 40 instead of the option to start with and the price goes down to 39 you would have the full loss and no premium, correct?

    2. I do not understand very well (probably because I lack practice) the whole story of the “value” of an option. What is your concern of its value if you want to have the stock anyways? Yes one could say that there is little point to buy something for an higher value if you can get it lower, but the point wasn’t to own the stock at that price?

    If the option is ITM at a much lower price than the strike, together with the obligation of buying the stocks are there other charges involved?

    ciao ciao

    Stal

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  2. Hey Stalflare,

    Let me try to help you. It is a pleasure

    1- Point one is correct. When you sell a put option, you get a premium and it is yours, no matter if the stock is in the money or not. By selling the put option, you can indeed buy the stock at a lower price (strike – option premium). So, you have a lower cost basis compared to buying the stock directly

    2- The way that I use options is for income. I do not try to own the stock. This means that I will sell and option and try to buy it back a few weeks later for less money. In my case, the value of an option is thus important.
    If you write the option and do actually want to won the stock, than you should indeed not care about the option price/value.
    A random example: You want to buy KO at 40. In stead, you sell a put option 45 days out in time and get a premium of 0.40 cents. If the stock now drop to 39, that value of the option will increase to 1.2 or so.
    For me, this is bad, I need to pay more than I received. I will decide to roll, see the story above.

    If the put was written in order to actually buy the stock, than, you do not care. At expiration, you will get assigned the stock and pay 40. Remember, you got 0.4 premium, so you now own the stock at 39.6. You off course need to think also about the case where KO drops to 35. You then still need to pay 40 at expiration.

    If you get assigned stock, it then depends on your broker what costs you have. I any case, in Belgium, I have pay the TOB tax and the regular trading fee. Some brokers charge an additional fee for the assignment as well. You need to ask the full details to your broker.

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    1. Ciao Atl,

      Thanks for the explanation, now it’s a bit more clear. Of course if you are into the trading options business then the price is paramount, but in that case I would not trade them on stocks but rather on indexes or ETFs as they have a lower volatility (a stock can get sold just on rumours and loose 20% in a day, an ETF no). But that aside now the important part is to understand my bank how it behaves, we also have all sorts of taxes, so I need to be careful…

      In my case the rationale is that if KO was at 40 TODAY I would buy it, netting a loss in 1 month if it was at 35. Mind you I still wouldn’t sell so it’s paper losses as I was to keep it for the long haul. With options I have a chance to make moves at interesting prices if the market falls, or keep the premium if the market stays the same or rises… At least this is how I want to start with them… 😛

      Thanks a lot for the help!

      ciaociao

      Stal

      Like

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