There are a lot of mistakes that can be made and ways to do things better as an option trader. Trust me, I have seen it in the past with myself and with my current students. But one of the biggest things I have noticed is that traders and investors roll their short options way too soon. Patience needs to be applied and better results should follow.

Selling a call option against a stock position is commonly done by investors (covered call). 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 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 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. But 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 to hold, it may make sense to show a little patience.

Example

Recently, Valero Energy Corp. (VLO) was trading just above $100, which was minor resistance at the time. An investor was short the 100 strike call that expired in three days. She asked me if she should buy back the call and roll to a higher strike. I gave the standard answer, which is what has a better chance of happening? I meant does resistance at $100 have a better chance to hold or break? She watched the stock move lower the next couple of days and the stock closed just under $100.

Final Thoughts

Certainly, there are times 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. Closing above it 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.

John Kmiecik, Market Taker Mentoring