The best time to plan your exit is before you’ve entered.
You can exit an options strategy at any point before expiration, and you may have more than one alternative. But the exit strategy you choose and your timing in putting it into effect might mean the difference between a profit and a loss, a small profit and a bigger one, or a small loss and a bigger one.
Smart investing means establishing how you’ll exit if your option is in-the-money, at-the-money, or out-of-the-money — before you open the trade.
Since you can close out your position, or buy back an option you sold, as an options writer you’re almost never forced to fulfill an obligation to buy or sell the underlying instrument — assuming you close out before expiration. Keep in mind, though, that in-the-money stock options are often exercised before expiration. If you write an option, closing out is the only way to make sure you won’t be assigned.
Depending on the option’s premium when you want to buy it back, you might pay less than you received, making a net profit. But you might also have to pay more than you received, taking a net loss. If that loss is less than what you would have faced was the option exercised, closing out might be the best exit. You should also keep in mind the tax consequences of selling or acquiring stock through the exercise of an option, since it might affect your capital gains or losses for the year.
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If you’re an options holder, you’ll have more flexibility when deciding how to exit, since you have the choice not to exercise. You might still close out your position by selling the option, rather than exercising it. If the option’s premium has gone up since you bought it, closing out would mean making a profit. If the option’s premium has decreased, closing out would mean cutting your losses and offsetting at least part of what you paid.
Exiting Call Option
CHOICES FOR OPTIONs HOLDERS
If you’re long an option, the price you paid in premium might reduce your gains. For example, if you hold an XYZ 90 call that cost you $200, you’ll have to factor in the $2 per share you spent on the option when deciding how and when to exit:
In-the-money
If the stock price is above $92
- Your option is in-the-money. You can exercise and buy shares for $90. You can then retain the stock or possibly sell it on the market for more than $92, offsetting the $200 you spent, and still making a profit.
- You can possibly sell the option for more than the $200 you paid for it, making a profit. Investors who purchase options for leverage often choose this exit strategy.
At-the-money
If the stock price is between $90 and $92
- The option is in-the-money—or at-the-money, if the stock is exactly $90 — but exercising it and then selling the shares won’t provide enough profit to offset the cost of the premium. If you want to own the XYZ shares, exercising it allows you to purchase them, and you might gain back your $200 in the future, if the stock rises.
- You can sell the option, hoping to earn back some of the premium you paid.
- You can let the option expire, losing $200. This may be the most costly exit, in this case.
Out-of-the-money
If the stock price is less than $90
- The option is out-of-the-money, and exercising it would mean purchasing shares at more than their market value. You’d lose money on top of what you spent on the premium.
- If there is any time value left, you can sell the option to partially offset what you paid for it.
Exiting Put Option
CHOICES FOR OPTIONs WRITERS
If you’re short an option, the premium you received will add to your gain or reduce your loss. For example, if you wrote an XYZ 90 put that earned you $200, you can factor in the $2 per share you received for the option:
In-the-money
If the stock price is below $88
- The option is in-the-money, and will most likely be exercised, which means you’ll have to buy 100 shares for more than their market price, taking a loss.
- You might buy the option back before it is exercised, paying more for it than you received, and taking a loss.
At-the-money
If the stock price is between $88 and $90
- The option is in-the-money—or at-the-money if the stock price is exactly $90—and might be exercised at the discretion of the put holder. You’ll have to buy the shares at $90, but the premium reduces your net price paid to $88 a share, so you could still sell them on the market for a small profit.
- You could buy the option back, and you may or may not have to pay as much as you received for it.
- The option could expire unexercised if it is at-the-money, in which case the $200 would remain your profit.
Out-of-the-money
If the stock price is above $90
- The option is out-of-the-money, and most likely will not be exercised. You keep the $200 as your profit.
Option Exit Strategies And Timing by Inna Rosputnia
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