Buying Back Options
When we talk about trading options, we want to find the best way to maximize our profits from a trade. Today, I’m going to talk about buying back options, specifically a call option.
In this article, I’m going to show you how to execute this to lock in profits, and why this is such a powerful strategy, especially when used while trading The Wheel Strategy.
Before we get started, let’s just review how to trade with The Wheel Strategy. There are three key steps to it:
- First, we sell put options to collect premium
- Second, we may or may not get assigned while selling put options
- Third, if we do get assigned, we sell call options to collect even more premium!
That’s right, The Wheel Strategy is all about collecting premiums on these options contracts. Today, I’m going to show you a very recent example of a trade that I personally made last week. Let’s get to it!
Macy’s Stock Example with the PowerX Optimizer
I won’t go into too much detail here because I want this to be a quick article. When you sell an option, you collect a premium from that upfront. The trade can go for or against you by the expiration date, but the bottom line is you always collect that premium.
Here is a screenshot of Macy’s stock (NYSE:M) in the PowerX Optimizer tool that I use for trading. This is a look at Macy’s stock chart:
You’ll quickly notice that Macy’s has formed a bit of a bottom here around $16.50 to $17.00. This is exactly where the PowerX Optimizer suggested that I sell a put option contract on Macy’s to collect premium. So that’s exactly what I did! Here’s a look at the calculator:
Okay, so now we can see that when I traded this last week, Macy’s was trading at around $17.50. I could sell this put option with three days left to expiration on August 12th. With three days left on the contract, I would get $0.15 for this trade.
According to my calculator, I should sell 71 call option contracts based on my account size. In doing this, I would receive $1,065 in premium. Let’s just talk about what that means and the concept of premium per day, because this is super important.
Premium Per Day
Okay, so with Macy’s, we are selling the $17.00 put for a premium of $0.15. Let’s do that quick math. The calculator says I can trade 71 contracts, multiplied by $15.00 ($0.15 x 100) which equals $1,065. If we divided this by the four days to expiration of the contract, it means I am making $266.25 per day.
So I made this trade on Tuesday, so that’s $266.25, and then the same for Wednesday, Thursday, and Friday. This is the idea of trading these options like this. But now, let’s take a look at the reality of the trade and what actually happened.
Okay, so we sold the options and made the premium upfront. Now the market is rallying, which is good because that means the premium is worth less. Let’s take a look back at the chart for Macy’s stock.
This blue bar was the current price of Macy’s stock. As you can see, Macy’s was having a good day and was up by $5.70 or 8.0%. That’s quite a lot for a stock like Macy’s. For us, this means that the put option loses its value quickly.
After this major surge, the premium of that put option will likely fall to something like $0.02. In fact, let’s actually bring it up and see what it is currently worth.
Okay, so let me open up my trading platform and see what the Bid-Ask spread is. Currently, the Bid is $0.03 and the Ask is $0.04. Let’s just assume that the call option would be worth $0.02 because that’s what I’m trying to show you guys.
Buying Back Options
So the idea of this is to buy back Macy’s here for $0.02, because it is rallying higher. In this situation, we have two options: we can do nothing and let the options expire worthless and keep the premium, or we can buy back those options contracts.
When we are doing nothing, if the stock stays above the strike price of $17.00, we would collect an additional $142. How did I get to that number? So $0.02 for the premium multiplied by 100 shares for an option contract, multiplied by 71 contracts. If I’m not doing anything, I receive an additional $142.
Now, let’s talk about buying back the option. I was planning to make $266.25 per day.
If I buy back the option at $0.02 this would be about 90% of the maximum profits that could be made from this trade. As most of you know, this is what I am always aiming for. So let’s see how much I would get here:
Instead of $1,065, I would buy the option back. So I have the original $0.15 premium minus the $0.02, which means my new net premium is $0.13. Multiply this by 71 contracts and my new profit is $923.
So if I close this trade on that day, which is a Wednesday, I would make $923. This is great because I was planning to make $266 today and tomorrow. But who knows where Macy’s stock will go? If I can lock in $923 today, instead of $500 something tomorrow, then I’m way ahead of the game. This also has some advantages.
The most important advantage is that now I cannot get assigned. Even if Macy’s tanks over the next few days and moves below the strike price of $17.00, I’m already out of the trade. There’s no way I can get assigned shares because I’ve already closed it.
At the same time, I am freeing up buying power in my account. If I were assigned and had to buy the stock, I would have to invest up to $120,000 of my buying power.
If tomorrow the market moves lower and I’m buying the options back today, I could sell it again. In fact, take a look at my scanner again and we can see that next week’s Macy’s $17.00 put option has a premium of $0.19.
The One Exception to the Rule
That all sounds great, doesn’t it? Well, I do have an exception to this rule. That exception is on the last trading day to expiration, if the option is far out of the money, I won’t buy it back. What do I mean by this? The last trading day to expire is on Friday when the option expires.
So back to the Macy’s trade, I collected 80% of the premium and might as well keep it all. This way, I won’t get assigned and I’ll free up my buying power as well.
With the markets being so volatile as of late, there are actually great opportunities for trades. This is why I want to have the buying power because my scanner has been lighting up!
Now, for this example, I used a put option, but the same applies to call options. It might even make more sense to roll call options forward, but I won’t go into that strategy now. Take a look at this video to learn how and when to roll forward a call option.
I hope you’ve found this article on buying back options helpful!
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