We’ve reached yet another options expiration week, which can sometimes cause many traders to freak out as they worry about positions that are still lingering in their portfolio. And with the deadline for expiration quickly approaching it's no wonder why many people are incorrectly managing trades with the fears of assignment knocking on their doorstep. Either rushing to close position that shouldn't be closed or waiting too long to act and putting them at risk of a massive "gamma move" in the underlying option's price.
Typically by the time we reach expiration week we've closed positions that hit our profit target and adjusted positions that have gone against us. But as we near the third Friday of every month, we have to come face to face with the realization that some trades just haven't worked out as we might have hoped. In today's episode, I want to help you create a checklist for deciding which positions to close or roll during options expiration week. In particular, I want to walk you through my thought process on which trades I focus on closing first and how I ultimately decide if a position should be rolled to the next expiration month.
Expiration Week Trading Tips
- Inside of expiration week, most of the assignment that happens is towards the latter end of the week because there is still some extrinsic value or volatility value left in these contracts.
- Even though you might have a position in the money, slightly or very far in the money, it does not necessarily mean that you will be assigned solely because it is expiration week.
- As you enter expiration week, do not rush or panic. There is plenty of time and opportunity to adjust, manage, close, roll, or make the appropriate decision for your positions.
6 Step Expiration Week Checklist:
Step 1: Is your trade profitable?
- If the answer is yes, the best course of action is to take it off the trade.
- Most trades are short-premium, option-sellers.
- Most of the time you should have an automatic closing order — if you sold an iron condor you would be closing it out at 50% of the credit that you received.
- When you get to expiration week and the order has not been executed, it means you have not reached your 50% profit target yet.
- However, if they are still profitable, even marginally, take the trade off and move on to the next one.
*If your trades are not profitable, continue on to step number 2.
Step 2: How bad is the position?
- If the trade is not profitable you have to analyze how much money you are losing in that position.
- Is the trade really close to profitability, or is it way off?
- If the trade is way off, close the position or let it expire.
- The further in the money the position is, especially with short premium trades, the more at-risk of assignment you are going to be because you have less extrinsic value.
*If you are close to profitability, move onto step number 3.
Step 3: Can you adjust the trade now to dramatically reduce the risk?
- Can you do something to adjust the position in the current month that will dramatically reduce the risk for this month?
- The key is that you have to be able to dramatically reduce risk, and increase your potential for success. However, this often does not happen.
*If you cannot reduce the risk, continue to step number 4.
Step 4: What does your portfolio need for the next month?
- This is where traders often times fail.
- Before making the decision to roll or close the contract, you have to look at your portfolio next month.
- Most broker platforms gives you the ability to analyze your portfolio and specifically target different expiration dates.
- Looking ahead to next month can help make the decision of whether or not you want to roll any of your existing positions to the next month.
Next month's portfolio is bearish with a lot of call credit spreads and you generally want to see the market go down the next month. It might be a good idea to roll some put credit spreads that are marginal, right now, to the next month to help give some balance. Put credit spreads are generally a bullish strategy, and if next month's portfolio has a lot of bearish strategies already rolling the contracts (if possible), might give the portfolio a little bit more balance next month.
Step 5: Can you roll the current position for a credit to reduce risk?
- If you have a short premium trade, can you roll that trade for a credit?
- If you can roll the trade for a credit, you are getting paid to extend the trading timeline and then you get more time for the market to turn around and become favorable.
- If you cannot roll for a credit and it will cost you a debit to roll, you should not do it.
- You do not want to pay for more time, because when you pay for more time you guarantee a greater loss for the next month if it does not turn around, which is not worth the risk.
- Instead, re-set the probabilities and the trade if you cannot roll for a credit to start with a clean slate next month.
- If you do want to continue the position and can roll for a credit, consider what you portfolio needs and then roll it out.
*If you cannot roll for a credit or adjust the position, continue to step number 6.
Step 6: Close out your strategy as strategically as you can.
- Look at each individual leg that you have and find the most strategic way that you can close out of the position so that you either:
- Minimize the loss/risk
- Leave a little bit of value that is left that you can squeeze out of the remaining position.
- Remove short options that are in the money first; these short options are always at risk of assignment first.
- Then look to get out of any long positions that still have some value left in them — if you have a long spread that was part of an iron condor that has some value left in it, try to get some of the value by selling the option back into the market.
- Next, leave on any legs that are out of the money and short that could decay a little bit more in value.
- If you have an iron condor and one side of it is really being challenged, only close the one side that is being challenged or threatened and leave the other side on to decay and expire worthless if it is out of the money and far away. That side may have value left, so do not close that side.
*Strategically look at your positions and try to pick which ones you want to exit, individually.
1. You have to be aware of the gamma risk in expiration week.
- This is the concept that pricing in options will move very quickly as the stock moves the week of expiration.
You have to be aware of this gamma risk, or this acceleration in pricing movement during the week of expiration. If your options contract that is 90 days out, it will not move much with the price of the stock because there is a lot of volatility and time decay built in. However, an option contract that is 3 days from expiration has no volatility priced in and no time decay priced in anymore. It will move based on the value of the stock; as the stock goes up, the contract goes up and will move rapidly.
As you get into expiration you could be in a situation where a 10 cent move in a stock could create the difference between a $500 profit and a $500 loss; it can happen that fast in some positions. So Therefore, make your decisions quickly during the first part of the week as to positions you want to take off that are profitable. Do not gamble with positions that are on the fence. Make a decision, work down the checklist, and get those trades off or out to the next month.
2. You have to be less aggressive in adjusting risk-defined positions.
- When you have a risk-defined position, you can be less aggressive during the week of expiration because you have contracts on both sides, so it will not move around as much as the undefined risk positions.
- Focus on the positions that could hurt you the most, that needs to be managed and given the most attention early and then work your way backward from there.