It’s no secret…
…options are wasting assets… and on the expiration date, contracts expire worthless or in-the-money.
The closer an option approaches expiration the faster it seems the time decay accelerates.
What landmines lie in wait during options expiration?
Do you know how to steer clear?
If not, don’t worry, because I’m about to hook you up.
I use three keys that prepare me for reigning in profits and shrinking losses. And I’m going to share them with you today.
Not too long ago, I traded options that expired that same week for a big win.
Two triple-digit return monsters—these were alerted in real-time to subscribers of my WMM service.
There is a special way to deal with options right before they are set to expire… and when executed correctly… the profits are absolutely explosive.
1) Evaluate your standing
Not all trades are created equal. Trades that you’ve held for a long time can be big winners, major losers, or anywhere in between.
I like to separate my trades into two major groups: long and short trades.
These groups need to be treated differently. Short trades may require no action. But long trades almost always require some action.
Short trades I break down into 3 categories:
- Trades likely to expire worthless
- Positions that are near the strikes
- Short trades that have moved against me
The first group I simply check in with a couple of times a day just to make sure nothing’s changed.
I look at positions near strikes as if they are new trades. That means I consider:
- Probability of success and failure
- Additional profit to be gained
- Current profit or loss
- Additional losses possible
I want to close out trades that have moved against me as early as possible. Option spreads don’t lose the full amount until expiration. Even closing the trades a day early can save you as much as 20%.
Long trades come in one of two forms: winning or losing.
In both cases, you really want to take profits as early as possible. This lets you maximize the extrinsic value remaining in the price. Extrinsic value completely disappears at expiration.
So unless you have a really compelling reason to believe the stock will move further in your favor…get out while the going’s good.
2) Calculate your odds
Let me walk you through an example.
I sold a call option spread in stock ABC that expires in three days. The stock currently trades at $283.50. Last month I sold the $290/$292.5 call spread for $1.10.
Below is the option chain for the stock.
If I sold the same spread right now, I’d get $12.45-$11.40 = $1.02.
I’ve only made $0.08 for holding it an entire month…not great. My additional profit potential is $1.02.
Now, let’s look at the odds the stock finishes out-of-the-money by expiration (Prob OTM). Looking at the $290 strike price, I see the odds are 59.24%.
Let’s think about the expected value (the amount I’ll make based on the probabilities). I have a ~60% chance of making $1.02. However, I could lose an additional $292.50-$290.00-$1.08 = $1.42
Note: I get to keep the $1.10 I made.
This means my expected value would be:
Expected value = (59.24% x $1.02) – (40.76% x $1.42) = $0.025
With a positive expected value, I want to stay in this trade. My math says that if I made this same decision over and over, I’d make $0.025 for every $1.00 I risk.
You also need to consider the chart technical as well. If the stock is in a major uptrend, your chance of winning drops from 59.24%.
3) Decide whether to close or exercise losing trades
Out-of-the-money options will always expire worthless. In-the-money options can be exercised/assigned or closed. Which you choose comes down to a matter of costs.
For traders with smaller positions, you have some math to consider. Most brokerages charge $15-$20 to exercise (clear out) in-the-money spreads. This can be per side (meaning you pay double that).
When you get near expiration, you may not be able to close your spread at fair value (the difference between the strike prices). Often, you’ll have to close at $1.05-$1.10 on a $1.00 spread or higher.
Depending on the number of contracts you have, you need to decide what’s best for you. Here’s an example.
- I own 5 vertical spreads that I can close at $1.05 on a $1.00 strike spread
- My broker $0.75 per option contract to close a trade.
- Otherwise, they’ll charge me $15 per side to exercise the options
- Option 1 – I close the trade – ($0.75 x 5) + ($0.05 x 500) = $25.00
- Option 2 – I let the broker do it – $15.00 x 2 = $30.00
Here I would choose to close the trade.
Each situation requires you to do your own math. Generally, if you have a flat exercise fee, you’re better off using that. You can attempt to walk your options up by increments of $0.01 from fair value if you can get better commissions.