No matter what your trade, when things go well you generally have a problem: When’s the right time to close out?
If you exit a position too early you can lose out on valuable gains. Hold on too long, though, and the market can turn around and take your gains away.
It becomes even more complicated when it comes to options contracts, where you have a defined end date alongside the chance to close out early if things are looking good.
“I frequently get questions asking how I decide whether to continue riding with a winning short put position or to close it out early," Real Money Columnist Paul Price wrote recently.
The key, Price suggests, is to consider a few competing needs.
Three Questions
First, if you close out now, what will you use that capital for? Do you have another, more worthwhile, investment that you want to make right now?
Second, what are your risks of holding on? Are you hoping to maximize gains or are you trying to shield yourself from potential losses?
Finally, what kind of up-front costs are involved? For example, if you’re holding an options contract position, will you be paying or saving contract closing costs to exist this position?
Looking at your investment through this lens allows you to quantify the risks and rewards that you’re trying to chase, which can help you avoid making an emotional decision based on fear or greed.
Case in Point
In a recent example, Price looked at Citizens Financial Group (CFG).
Price wrote that he sold June 17, 2022 expiration date puts near CFG's mid-December low. "I received $10.34 per share net of fees for standing ready to own CFG at $39.66 if exercised."
At the time of writing, with "CFG up about $10 since trade inception, those same puts could be closed out for about $2.10 per share. Buying to close would extinguish all risk while capturing almost 80% of the maximum possible profit (if the puts go on to expire worthless)."
Price wrote that "[u]nless you feel strongly that CFG is likely to dip back to under $50 the choice becomes...
· Do you want to close early for that nice gain, freeing up the buying power for other things?
· Would you rather save the $210 per contract cost to close hoping to never have to buy back at all?
If you close out early, "paying $210 to remove a potential $5,000 outlay means laying out 4.2% of the strike price. With about 0.345-year to go that annualizes at 12.17%.”
That’s how Price would look at this trade. Is a 12.17 percent payment worth ending risk and freeing up capital?
In this case, Price says, "I'd call this one a pick 'em selection based on 43 years of experience. There is no clear better choice, unless you can clearly picture whether CFG will decline to under $50 by June 17."
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