This week, which would be “Week Ending 7/6/18,” I have no trades to report results on. This does not mean I didn’t have a good week because I did. I didn’t have any trades come to an end where I locked in profit, but my account went up nicely. Hopefully I’ll be reporting that I put some of the gains in my mattress within the next week or two. The market moved nicely this week and I had some nice gains with some of my stock holdings. The big one would be Netflix (NFLX), but my stocks in my “Gift Account” also went up a bit. Stay tuned to see how my NFLX and RH play out.
I received a few questions this week asking about my use of “Buy to Close.” Since I don’t have a “Results Week Ending 7/6/18” report to post, and explaining my use of “Buy to Close” to individual readers could get lengthy, I decided to write a post for all to read.
It’s no secret that I’m an options Seller and not an options buyer. Option seller receive a premium in exchange for assuming the obligation to deliver stock at an agreed upon price, the Strike Price.
An option buyer pays a premium to have the right, not the obligation, to buy stock at an agreed upon price, the Strike Price.
When you sell an option it’s is a Short Position. When you buy an option it’s a Long Position. With a Short Position, whether it’s with stocks or options, you “sell” to get into the position. If you Short a stock you sell the stock before you buy the stock. If you are Long a stock you buy the stock then sell the stock to make a profit. The same thing with an option. If you Short an option you do a “Sell to Open.” If you go Long with an option you “Buy to Open.” With an option when you do a “Sell to Open” or Buy to Open” you are opening a position. With my strategy I sell options, so I always do “Sell to Open.”
The reason for this post, and the question is, when do I do a “Buy to Close?” Let’s get into it.
Reason #1: I like to sell 1 week options. This is very short term but that’s what I like! I have an unwritten rule that if I sell an option on a Monday, to expire Friday, and because of stock price fluctuation, I can get out of that position with half of my premium locked in, I’ll do a “Buy to Close.” Let’s make a scenario to explain this unwritten rule.
On Monday I buy 1000 shares of XYZ Corp at $75 per shares. I also sell an option to sell these shares with the Strike Price of $77. I receive a $1 premium for $1000. I made this trade because I felt by the end of the week that XYZ Corp would be selling at $77 or $78 per shares. I did this Covered Call to make a $1000 premium plus make 2 points on the stock for another $2000. Let’s say after I made the trade XYZ Corp’s price fluctuated and when it was down the premium dropped to 50¢. To get into this option I did a “Sell to Open” which brought me in $1000. Now that the premium is at 50¢ I can do a “Buy to Close” to close the position. On the sale I locked in $1000 and with my “Buy to Close” I spent $500 to end the deal. The question is why would I do this? Why don’t I just hold the position for the remainder of the week and keep the entire $1000? #1 I like to lock in money, PERIOD! #2, with the stock fluctuating, locking in the $500 and closing the deal I will possible have another opportunity to sell the Call again for the $1 premium for another $1000. If not, I’m still hoping the stock will go up and possible it will go up above my Strike Price and I’ll realize more gain on the stock. I won’t be capped at the $77 Strike.
Reason #2: In the same scenario, I buy the stock at $75 and sell the $77 Call. I feel the stock can go to $77 or $78 before Friday. However, on Tuesday good news comes out and the stock start moving up fast. I feel like I’m losing out on money because now I think the stock is gonna go well into the 80’s. With the stock at $76.50, and the premium at $2 I decide to do a “Buy to Close.” Now, I brought in a $1000 premium but it cost me $2000 to get out of the deal. Why would I do this and take a $1000 loss? I would only do this if I now thought the stock was gonna blow through my Strike Price and go up to $85. By doing the “Buy to Close” I got out of the obligation to deliver the stock at $77 and now I’ll get the all the stock gain if it goes up to $85, like I feel it will.
Reason #3: Same stock scenario. I buy the stock at $75 and sell the $77 Call. the stock goes up to $76 and bad news comes out. I feel XYZ Corp will now go down. I sell the stock and go Naked on the Call because I feel the stock will now go to $70. While it’s going down the premium on my Naked Call is now at 35¢. If there’s still a few days left to expiration I might do a “Buy to Close” for the $350 (35¢ premium), free up the cash, lock in $650, and move on.
When doing a “Buy to Close” your vision of where the stock may go has changed. Whether it’s a temporary vision change or a permanent vision change, I might do a “Buy to Close” to lock in money or put myself into a better position to make more money. This is what I call an adjustment trade. I can give you a ton of scenarios of when I might do a “Buy to Close” but it’s always to get myself into a better situation locking in money or to make more money.
Any questions on this do not hesitate to reach out.
Steve
The Options Coach