SHORT PUT DEFENSE
You put on an FXI 43 short put in the June cycle, betting on a trade deal coming through, and ... oops ... it didn't, and your short put is now deep in the money.
What do you do now? Fortunately, there are several paths you can undertake to defend the position and/or reduce the cost basis in any shares you might be assigned either randomly or at expiration.
(a) Roll Out for Duration. Rolling out "as is" (i.e., from the June 43 to the July 43) will bring in additional credit (.21), reduce the net delta of the position (from to 67.72 to 64.54), as well as decrease your cost basis in any stock you might be assigned. Because there is still extrinsic left in the 43 (about .72), it's usually best to wait until the majority of the extrinsic has decayed out before rolling.* Some broker platforms display this conveniently; others, you'll have to manually calculate it. Here, the strike price (43) minus the value of the option (2.45) = 40.55. The stock is currently trading at 41.27, so the extrinsic left in the option is 41.27 - 40.55 or .72.
(b) Roll Out for Duration and Strike Improvement. The current value of the 43 short put is 2.45. In order to strike improve (e.g., to 42), you're going to have to roll to a 42 strike in an expiry in which the price of the 42 short put exceeds 2.45; the first expiry in which this occurs is quite far out in time -- November, where the 42 strike is currently priced at 2.87.** Rolling from the June 43 to the November 42 brings in an additional credit of .42, improves your break even/cost basis, and reduces your net delta from 67.72 to 51.77. The downside is that this extends duration dramatically from 37 days until expiration to 185 days.
(c) Wait, Take Assignment if Price Finishes Below 43, and Proceed to Sell Calls Against at Or Above Your Cost Basis. Sometimes, this is, in fact, the play you want to do from the get-go. For whatever reason, you want in on the stock (e.g., dividends), and you're totally comfortable with taking on shares at that point. In fact, time could very well be of the essence in taking on shares if you want to be in the stock as of the next date of record for purposes of collecting the dividend. In those cases where that was not the play or you'd prefer reducing cost basis further before taking on shares, you're going want to take one of the other paths available to you, if only because -- particularly on margin -- being in shares isn't buying power efficient over being in an options position.
(d) Add by Selling More Puts or Strangles. I generally do not opt for the former unless I'm keen on generating a longer term position in the underlying since it adds long delta to an already long delta position, which can amplify P and L draw down if there is continuation. On occasion, however, I will short strangle a deep in the money short put, with the goal being to more quickly reduce cost basis in it so that I can conceivably exit the trade more quickly. For example, selling the June 39/43 would reduce cost basis in the 43 short put position by an additional .98 and reduce net delta slightly. Naturally, if there is downside continuation, this trade could potentially leave you in the same boat as you were with just the 43 short put alone, only now with a two-lot at the 39 and 43 strikes.
(e) Sell Calls Against in the Current Cycle. Generally, this is the choice I make where I'm not keen on taking on shares at that point in time, where I want to reduce cost basis further before taking on shares, and where I want to maximize the rate of theta/extrinsic in the options, which is speediest and/or accelerates as the option approaches expiry. There also is an advantage to staying in the puts over taking on stock, since shorts puts generally have extrinsic in them to decay out; stock does not, so you get a little extra cost basis reduction on the put side even when they are monied.
When you do this is somewhat subjective, but I generally opt for selling 20-30 delta calls against when the delta in the short put is in the 70-80 delta range. For example, I would sell the 27 delta 43 call against the 43 put in the June cycle for a .43 credit, resulting in a June 43 short straddle. This has the effect of reducing my cost basis in any shares I might be assigned on the 43 short put by another .43, improves my break even by a like amount, and reduces net delta in the position from 67.72 to 40.27. The downside to doing this is it injects call side risk into a setup that did not previously have any, and you'll now have to manage the short straddle going forward as opposed to managing the simplicity of the short put. Naturally, if there is little time left until expiry of the short puts (<21 days), you'll probably want to roll them out "as is" for a credit first and then proceed to sell the 20-30 calls against in the same expiry.
In all cases, you will want to keep track of credits collected and your cost basis in the position. This is the only way you'll know what your scratch point is and/or when you can profitably bail on the trade.
* -- I generally roll at 21 days until expiry and don't wait for all of the extrinsic to bleed out with an in-the-money short. Generally speaking, assignment risk increases as extrinsic value an in-the-money option converges on zero, which is generally on the back side of the cycle.
** -- You could, in fact, roll from the June 43 to the November 41.5 for a small credit.
What do you do now? Fortunately, there are several paths you can undertake to defend the position and/or reduce the cost basis in any shares you might be assigned either randomly or at expiration.
(a) Roll Out for Duration. Rolling out "as is" (i.e., from the June 43 to the July 43) will bring in additional credit (.21), reduce the net delta of the position (from to 67.72 to 64.54), as well as decrease your cost basis in any stock you might be assigned. Because there is still extrinsic left in the 43 (about .72), it's usually best to wait until the majority of the extrinsic has decayed out before rolling.* Some broker platforms display this conveniently; others, you'll have to manually calculate it. Here, the strike price (43) minus the value of the option (2.45) = 40.55. The stock is currently trading at 41.27, so the extrinsic left in the option is 41.27 - 40.55 or .72.
(b) Roll Out for Duration and Strike Improvement. The current value of the 43 short put is 2.45. In order to strike improve (e.g., to 42), you're going to have to roll to a 42 strike in an expiry in which the price of the 42 short put exceeds 2.45; the first expiry in which this occurs is quite far out in time -- November, where the 42 strike is currently priced at 2.87.** Rolling from the June 43 to the November 42 brings in an additional credit of .42, improves your break even/cost basis, and reduces your net delta from 67.72 to 51.77. The downside is that this extends duration dramatically from 37 days until expiration to 185 days.
(c) Wait, Take Assignment if Price Finishes Below 43, and Proceed to Sell Calls Against at Or Above Your Cost Basis. Sometimes, this is, in fact, the play you want to do from the get-go. For whatever reason, you want in on the stock (e.g., dividends), and you're totally comfortable with taking on shares at that point. In fact, time could very well be of the essence in taking on shares if you want to be in the stock as of the next date of record for purposes of collecting the dividend. In those cases where that was not the play or you'd prefer reducing cost basis further before taking on shares, you're going want to take one of the other paths available to you, if only because -- particularly on margin -- being in shares isn't buying power efficient over being in an options position.
(d) Add by Selling More Puts or Strangles. I generally do not opt for the former unless I'm keen on generating a longer term position in the underlying since it adds long delta to an already long delta position, which can amplify P and L draw down if there is continuation. On occasion, however, I will short strangle a deep in the money short put, with the goal being to more quickly reduce cost basis in it so that I can conceivably exit the trade more quickly. For example, selling the June 39/43 would reduce cost basis in the 43 short put position by an additional .98 and reduce net delta slightly. Naturally, if there is downside continuation, this trade could potentially leave you in the same boat as you were with just the 43 short put alone, only now with a two-lot at the 39 and 43 strikes.
(e) Sell Calls Against in the Current Cycle. Generally, this is the choice I make where I'm not keen on taking on shares at that point in time, where I want to reduce cost basis further before taking on shares, and where I want to maximize the rate of theta/extrinsic in the options, which is speediest and/or accelerates as the option approaches expiry. There also is an advantage to staying in the puts over taking on stock, since shorts puts generally have extrinsic in them to decay out; stock does not, so you get a little extra cost basis reduction on the put side even when they are monied.
When you do this is somewhat subjective, but I generally opt for selling 20-30 delta calls against when the delta in the short put is in the 70-80 delta range. For example, I would sell the 27 delta 43 call against the 43 put in the June cycle for a .43 credit, resulting in a June 43 short straddle. This has the effect of reducing my cost basis in any shares I might be assigned on the 43 short put by another .43, improves my break even by a like amount, and reduces net delta in the position from 67.72 to 40.27. The downside to doing this is it injects call side risk into a setup that did not previously have any, and you'll now have to manage the short straddle going forward as opposed to managing the simplicity of the short put. Naturally, if there is little time left until expiry of the short puts (<21 days), you'll probably want to roll them out "as is" for a credit first and then proceed to sell the 20-30 calls against in the same expiry.
In all cases, you will want to keep track of credits collected and your cost basis in the position. This is the only way you'll know what your scratch point is and/or when you can profitably bail on the trade.
* -- I generally roll at 21 days until expiry and don't wait for all of the extrinsic to bleed out with an in-the-money short. Generally speaking, assignment risk increases as extrinsic value an in-the-money option converges on zero, which is generally on the back side of the cycle.
** -- You could, in fact, roll from the June 43 to the November 41.5 for a small credit.
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