There are lots of mistakes you can make as an option trader, let alone as a human being. Let’s be honest, some just can’t be helped. But you can prevent rolling a short option too soon if you practice a little patience. Let’s take a look at what I mean by that.
Selling an option seems fairly simple if you look at it objectively. But selling premium has so many different risks and nuances that it can sometimes drive an option trader to do irrational things like managing a trade poorly. What I have witnessed in over two decades of teaching options is that many option traders don’t adhere to their trading plans when covered calls and time spreads are involved. The problem is they tend to roll the short position too soon. I have seen many option traders automatically buy back the short option as soon as the underlying has moved through the short strike. This is when patience is key.
Selling a call option against a stock position is commonly done by investors. It is called a covered call because the short call option is “covered” by shares of stock (usually 100 or more). The call option’s strike is generally sold where the investor thinks the stock will be at the short call’s expiration. The call option expires worthless, and the maximum is earned for the stock position without being called away (assigned). When a time spread is bought (calendar or diagonal), the maximum profit is also earned if the stock closes right at the short strike at the short expiration (just like a covered call) for either a call or put. Choosing which strike to sell is sometimes a challenge, but potential support and resistance can help.
Support and Resistance
Selling the short option close to a support or resistance area makes sense. The reason is that support and resistance have a better chance of holding than being broken. Using a covered call as an example, when the stock price moves through a resistance area and is trading above the short call’s strike, the first thing many option traders want to do is buy back the short option and roll to a higher strike. This works when the stock does indeed continue to move higher. But knowing support and resistance have a better chance of holding, it may make sense to show a little patience. More times than not, resistance and support do hold. So, when the underlying reverses, the option sometimes ends up having been bought back at the most expensive point. I prefer to wait until there is better confirmation of a break of resistance or support like a 2-bar close (2 consecutive bullish closes above resistance or 2 consecutive bearish closes through support).
Of course, there are many occasions when it makes sense to close out the short position and sell another strike higher or lower depending on the expected move. But it also makes sense to be patient and let the stock prove to you that it wants to break the support or resistance level. Moving above or below and closing above or below it just once does not mean it is going to break that level. Be patient and let the stock prove to you what it wants to do. As William Langland once said, “Patience is a virtue.”
Senior Options Instructor