Option Adjustment Strategies
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Option Adjustment Examples
Whenever I come across good examples of an option adjustment strategies, I like to write a page about it. Theoretical examples are OK, but I find that real world examples make much better illustrations.
Admittedly, these examples are a bit of the cherry picked variety. When an option trade goes against you, you won’t always have great choices at your disposal. But still, seeing a real world example, even if it’s sort of a best-case scenario of adjusting an option trade is still a valuable exercise.
The list here is short now, but I will add to it when scenarios present themselves.
Why Such Small Trades?
One thing you may notice with these examples is the small relative size of the positions. In these examples I’m only dealing with one option at a time, even though, for example, it would be more efficient from a commission standpoint to write multiple puts a time rather than just one. There are a couple of reasons for that:
First, I want to demonstrate that you don’t need a huge portfolio to use options to your advantage. And second, by playing it conservatively not overleveraging myself upfront, I give myself greater flexibility to repair or wiggle out of a position if the trade really moves against me by having the ability to add more positions later.
A Little Leveraged Investing Background
Now for some background: As a Leveraged Investor, I write a lot of puts. Writing puts as a means of acquiring stocks at a discount to the current price is not that uncommon of a strategy for long term investors. Even Warren Buffett has publicly acknowledged that he’s employed this strategy himself (involving shares of Coca-Cola and Burlington Northern prior to his acquisition of the entire company).
As you will recall, when you write a put you are, in effect, offering to purchase 100 shares of the underlying stock at a certain price (the strike price). In exchange for this offer, you receive a cash payment (called premium).
If the stock trades below the strike price at expiration, you are obligated to purchase the shares at the agreed upon price. Your cost basis on your 100 shares equals the strike price plus commissions less the premium received.
If the stock trades at or above the strike price at expiration, the put option expires worthless and the premium you received is yours to book as 100% profit and with no further obligation on your part.
Option Adjustment Examples
Rolling Down - An example of adjusting a naked put position by rolling down.
Rolling Down and Out - An example of adjusting a naked put position by rolling down and out.
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