How Fast Can Options Winners Run?

The options trading pits were a drop-off center for eccentric people – ones who have fallen into remote, half-mad furrows of life and simply given up trying to be normal or couth.  Trading freed them from ordinary standards of behavior.

My pit was profoundly cramped – a ravine of tall, cranky people, lurching toward one another in curious stances, as though they had all been frozen in the act of collapse.  There was an ancient broker from this pit – a gentle, controlled sort, never rowdy or quarrelsome, and never sober.  Every morning, like an orator on a barricade he would disclaim to us, “Learn to cut your losses and let your profits run.” It took me years to comprehend what abysses of wisdom the old man was imparting to us.

For years you have thought about that first winning options trade – it’s the thing you knew would happen to you sooner or later; and it is all so prosaically different.  You thought profitability would be quite straightforward, but it is extraordinarily complicated.

Once a trade is made, regardless of the decision-making process, risk and money management begin.  We all have been informed countless of times that the key to trading success is to “let winners run, and cut the losers.”

Believe me this is far easier said than done - it is psychologically difficult for even the best of us to hold on to a winning position as we are tempted by strange combinations of fear and greed - vices inherent of our human nature.  Rolling positions allow the trader to hold positions longer while constantly taking profits – it wiles the internal vice of fear and greed into a virtue of wisdom.  Here is an example of how it works:

Imagine you bought the SPDR S&P 500 ETF (SPY) January 205 calls for $3, and you are profitable.  Now what?  You think the market will continue higher.  Should you take a quick profit and be satisfied, or do you take a portion of those profits “off the table” and go for more?

Well, there is rarely a good reason for taking a quick profit but, if you really think that SPY is going much higher, ask yourself why would you cash in here and then be sitting on the sidelines as SPY continued to rally!  Perhaps it would be better to take some profits “off the table”, yet maintain your long conviction?

A trader with this view (and mentality) should roll his position using vertical call spreads.  As SPY trades higher and the long call position becomes increasingly more profitable, the trader would sell call spreads, “rolling” his long call position to a higher strike, and collecting money every time he sold a spread.  Below, is a hypothetical example of a roll trade with a long put option position.

Example: Rolling down a (profitable) long put

• XYZ = $111:  Trader buys 10 January 110 puts @ $7.50.  Net cost = $7,500
• XYZ = 105.00:  Trader still bearish, but wants to take some profit.  He sells the January 100 /110 put spread ten times @ $5.00, collecting $5,000.  (I.e. trader would sell 10 January 110 puts and buy 10 January 100 puts – leaving him net long 10 January 100 puts).
• Trader is now long 10 January 100 puts.
• XYZ = 95.00:  Trader still bearish, but wants to take additional profit.  He sells the January 90 / 100 put spread @ $5.00, collecting $5,000. (I.e. trader sells 10 January 100 puts and buys 10 January 90 puts – leaving him net long 10 January 90 puts).
• Trader is now long the October 90 puts, and has $2,500 “in the bank”.
• XYZ = 85.00:  Trader is satisfied that XYZ has reached his downside target, and sells his 10 January 90 puts @ $9.00, collecting $9,000 for a total profit of $11,500.

These are very hypothetical prices and examples, but this is exactly the way participants roll positions.  If the trader had simply held the original position, he definitely would have made more money, but would he have held the position?  The point of rolling is that it gives you greater staying power by putting you in a more powerful psychological position.  Taking profits off the table raises the trader’s comfort level and allows him to stay with a trade much longer.

To roll a call position, one would sell vertical call spreads.  To roll vertical call spreads, one would sell call butterflies.  To roll a put position (see above) one would sell vertical put spreads.  To roll a put spread, one would sell put butterflies.