One of the most common questions I am asked about options trading is: What do I do before the option expires?
That’s a good question! I get lots of questions from traders making their first trades.
And that’s great. I’m glad they’re asking questions.
Because it’s easy — and lucrative — to learn to trade options.
With a little introduction, you can double your money on trades as well.
Now, the mechanics of trading options and stocks are similar. But options can still intimidate or confuse the newbie.
If you’re shouting amen to that, let me help you break down some of those barriers starting today.
A Common (And Important!) Question About Options Trading
David H. wrote in last week (modified for clarity):
“If you have an option trade due to expire several months from now, and to date it has moved in your favor, what happens to the option between now and expiration? Must all option trades be held all the way until expiration or can you close at the current price?”
An option is a trading vehicle tied to a stock’s price. Investors can use options to hedge — or protect — a position in shares of a stock. Traders can also use options to speculate on the price of a stock.
I use options to speculate.
And I help my subscribers do that to earn triple-digit gains in weeks at a time. (Want to know more? I welcome you to join us in Apex Profit Alert, my options trading research service.)
So let’s dive into David’s question.
You bought an option, and you know the trade is winding down. You have to do something before it expires.
But you don’t know what to do … much less when to do it.
It’s actually an easy answer.
But to know why that’s an easy answer, it helps to know what’s going on when an option trade is winding down.
Options include elements such as strike prices, time decay, expiration and more.
Phrasing is also different. You can “buy to open” or “sell to open” an option trade. Selling to open is also known as writing an option.
Don’t worry about memorizing it all right away. It shouldn’t scare you off.
Start with the essentials…
There Are Only Two Types of Options
Option traders — a buyer and a seller — place orders with their brokers the same way they would for a stock trade. Same as with stocks, you can sell an option or buy one. Brokers link the buyers and sellers up on an options exchange.
The two types of options are “calls” and “puts.”
The textbook definition of these options goes something like this…
A call option gives the buyer the right, but not the obligation, to buy shares of an underlying stock at an agreed-upon price at an agreed-upon date in the future.
A put option gives the buyer the right to sell shares at an agreed-upon price on an agreed-upon date.
The “agreed-upon price” is called the strike price.
The “agreed-upon date” is called the expiration date.
To answer today’s question, let’s focus on the expiration date.
Close Your Trade Before Expiration
An options contract expires at a predetermined, or agreed-upon date in the future.
Two things can happen when an option expires.
If the option price is $0 — it has no value — the option will expire worthless.
In this case, the seller of the option keeps the money earned from the sale, and the buyer loses the money paid to buy the option.
If the option has value, the option will be exercised.
When a call option is exercised, for example, the option holder must buy shares of the stock at the strike price. Conversely, when a put option is exercised, the holder must sell shares at that cost.
Don’t get hung up on those details if they feel complicated.
Just know that traders who use options to speculate do not plan to let an option be exercised. Traders usually close the option before expiration.
They usually have one of two reasons when they close the trade:
- To secure a gain on the trade.
- To minimize a loss on the trade.
Closing an option trade is the same as closing a stock trade.
If you bought the option, you would “sell it to close.” If you sold the option, you would “buy it to close.” This is the same no matter whether you’re trading a call or a put.
In summary, you are not locked into an options trade until expiration. You can secure a gain or cut a loss any time you want. Just close the trade at the current price.
In fact, options buyers often want to close trades as soon as possible to avoid the deleterious effects of time decay.
Time decay means the option will continue to lose some of its value the closer it gets to expiration.
This is why Chad Shoop and I always recommend you consider closing our bonus options trading ideas if your trade has fallen to a 50% loss or greater.
I’ll talk about time decay and risk management in another update.
Stay tuned. And keep sending in your questions! We aren’t able to respond to individual emails, but we do read them all. You can reach out at WinningInvestor@BanyanHill.com.
Editor, Apex Profit Alert
P.S. As I said, when you buy a put option, it becomes more valuable as the stock it covers falls. My colleague Chad Shoop often shows you how to buy put options for profit. These trades can be used as great hedges in your portfolio — protecting you in the event of a downturn. You can check out his latest bonus options trade for Winning Investor Daily readers here.