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More Thoughts for the Short Put Spread Trader Facing Bad Odds

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Mark Wolfinger adds his two cents to Brian Overby's counsel in a recent Options Guy post

I wanted to chime in a few additional thoughts on Brian Overby's post  A Short Put Spread That's Soured On You. What Can You Do? As Brian observes, this is a bad situation for this trader - but hopefully a teachable moment that'll save him future losses like this by replicating the mistake.

Below is the original question, so you can get the context. I'd also definitely recommend reading Brian's blog post in response:

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Hi Brian: I have a trade for which I would like to get your advice. I sold an AA Oct 16-15 put spread for around 55 cents credit. Now AA is trading at 11.21 and that spread ask price is 1.05 with mid around 95 cents. Should I sell one more lot just in case if AA rallies to 12.5 and I can get out of it, or should I roll over to Jan? Waiting for your suggestions...

 

The very first problem is that you feel that you are limited to the choices mentioned.


The second, and major, problem is that you have allowed the stock to fall too far before considering what to do next. Rolling down and out, as mentioned by Brian (below) could be a decent play - but not this time. By the time you reached out with this question, it was far too late in the game. Risk management requires that you stay on top of your trade and not close your eyes and hope for the best.


This trade is, unfortunately, a loser. I would strongly suggest in this scenario that you do nothing. Wait. Perhaps the stock will rally, but the likely result is that expiration will arrive and you will be required to exit the trade by paying $1. Keep in mind that you can still lose more money if that doesn't happen. It is nearly always less expensive to pay $1 to exit the trade than to undergo the exercise and assignment process. Again, speaking from the point when this trader emailed Brian, it was soon to do that at that point, because miracles do happen, but do not expect to do anything with this trade other than to pay $1 and lose $45 per spread. That's rough, but it's the likeliest outcome.


Brian is correct. You should have had a plan. You should have executed that plan. You should have done something other than pray. This loss was luckily not too costly, and I hope it is a lesson learned for you. The most important part of the trade is not making the trade. It is managing your risk intelligently throughout. 


   

Regards,


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