When Is It Smarter To Roll or Cut Losses On Options

I recently received a question on options trading.

"Do you ever adjust (i.e. rolling, turning your spread into iron condor, etc.)? Or do you just cut them right away?"

Now - I will first address the portion on turning your spread into an iron condor.

The answer is that I will never turn my spread into an advanced option strategy such as a iron condor, iron butterfly, etc.

The reason is simple.

Complexity is the enemy of execution. The more complicated it is, the more likely we tend to freeze in action.

Essentially, my approach is simply to K.I.S.S (Keep it Simple and Sweet).

With that said, let's dive into whether we should (1) cut our losses or (2) roll out option.

I share the benefits of each, and at the end of the article - I share my preferred approach.

The Advantage of Rolling A Trade

Rolling an option trade refers to closing your existing trade and extending the expiry date.

Let's give an example of one of the trades I did.

As you can see above, I have opened Bear Call Spread at an expiry date of 21 Jul 23.

There was only 7 days of expiry left. However, the position was in a negative.

As with all trades, it takes time to be right.

The beauty of option is that - we can extend our time expiry by closing this position and re-opening a new position with an extended expiry.

Let me dissect this trade.

In the third and forth row, you can see that I am closing my original option trade (i.e. expiry at 21 Jul 23).

In the first and second row, I reopen the trade with the exact same strikes with the next expiry date of 18 Aug 23.

In the process of doing this, I was actually paid $25 per option trade.

So let's summarise:

- I extended my option trade for a month, so that I get more time to be right.
- I get paid $25 for doing so.

This is the benefit of rolling an option - giving yourself more time to be right. However, there is catch.

The Unseen Truth Behind Rolling

What I presented in the above - is an example of rolling an option trade.

However, it is not always the case where you want to roll an option. There are some rules which you might want to follow:

1. Thesis Remained Unchanged

You can see that the benefit of rolling, is that you give yourself more time to be right. However, this also means that the original intention is why you entered the trade in the first place must be unchanged.

For example, I first entered the IBM trade as a bearish trade.

If I wanted to roll the trade, then I have to make sure that my thesis that IBM remains bearish is unchanged. This means that by re-looking at the resistance levels, I have to formulate my thesis that IBM stock price will still go down or at least only moves sideways.

2. You Must Roll For A Credit

When we choose to extend the expiry of our option trade, it is a compulsory to roll for a credit.

This is because, if we are rolling a trade at a debit (i.e. paying money) - we are introducing more risk to the trade, which defeats the purpose of rolling the trade in the first place.

Unfortunately, it is not always the case we are able to roll a trade for a credit. In some cases, if the share price have moved sharply against you - you would not be able to roll for a credit.

3. Take Note of Earnings

When you extend your option trade, there is a chance you might be taking your trade through earnings.

As explained in the Option Cash Flow Mastery Course, earnings seasons are periods where stock price can abruptly move. This can result in your trade moving against you.

Therefore, all of three criteria have to be met - before I consider rolling an option trade further to extend expiry.

The K.I.S.S Strategy Of Closing An Option Trade

It is quite rare that I manage to fit the three criteria for rolling an option trade.

Therefore - we come to the other option, which is to Keep It Simple and Sweet.

Simply to close the trade entirely, with a maximum loss based on a 4:1 rule. Based on statistics, we will still make money in the long run when following this rule.

The benefit of doing this is to have well established rules to cutting losses, so that you can recover your option buying power and move on to the next trade.

Conclusion

There are opportunities for rolling an option trade - but more often than not, it is quite rare for it to fit my criteria for rolling.

I tend to keep things simple, but simple makes it easy for execution.

This is why, I prefer to close my trades sharply and move on to the next trade.