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The ULTIMATE Guide to Navigating Down Positions When Selling Options
One of the most common questions I receive is: "What do I do if the stock I get assigned goes down in value?"
I wrote this article to explain clearly and in detail the exact process I follow to ensure we exit positions without a loss. In 18 months of publicly placing trades, we have yet to take a realized loss on any position using the strategy I am about to detail below.
Before we get too far ahead of ourselves, no matter which step below you have to implement, it is important to document each week's premium collection, starting with the week your cash-secured put is assigned. Add all premiums together for a running total. This will be valuable to keep track of and necessary in step 3.
Setting the Scene
You've been selling cash-secured puts and doing well for a few weeks. Then it happens—you get assigned shares, and they go down in value. Now what? I like to reference an old elementary mathematics phrase: this is my order of operations.
Step 1: Sell 1-Week Calls Above or at the Strike Price Assigned
This step is well-known but crucial. When assigned shares via cash-secured puts, you have two options:
The second option has a higher potential ceiling but less guaranteed cash flow. Both strategies work, and it is a personal preference whether you price in appreciation or maximize cash flow.
Step 2: Extend the Duration of Your Contracts
Move to this step when step 1 is no longer viable—when premiums collected at or above your assigned price are no longer impactful. This means there is no longer demand for premiums at your assigned price because the stock has dropped.
Stretch the duration of your contracts from 1-week to multi-week contracts, ideally 2-6 weeks. Keep your strike price at or above your assigned price. Extending the duration increases the likelihood that the stock will recover to your purchase range, maintaining demand for premiums at your strike price. Although your weekly ROI may be less, it ensures you continue collecting premium to reduce your cost basis. Repeat this step until the stock recovers, the stock is called away, or it is no longer viable to collect premium.
Step 3: Use Math to Determine Your Break-Even Price and Adjust Strike Prices Accordingly
This step emphasizes the importance of tracking premiums. This step is great for expediting your way out of a position WITHOUT taking a loss. Let's do some math:
Suppose you were assigned a cash-secured put for a stock at $100 per share. Since each contract is an agreement to purchase 100 shares this means you spend $10,000 on the stock. For our example, let’s say the stock drops to $90. This means you have an unrealized loss of $1,000. But wait! We need to factor in our premiums collected. For our example, let’s say we collected a total of $700 in premiums.
Since you have collected $700 in premiums, you only need to make up $300 to break even.
The makes your break-even price $93 per share.
Sell 1-week contracts at $93 per share and continue adding premiums to your total. For every $100 collected, lower your selling price by $1 to reach break-even more quickly. Keep this in mind, we sell options to MAKE MONEY not to breakeven. This step should only be used when you feel like you've exhausted steps 1 and 2 and you are just ready to start fresh.
Step 4: Step 3 but with Longer Contract Durations
This step mirrors step 3 but extends contract durations to 2-6 weeks if there is no demand for 1-week contracts at your adjusted break-even price. This is useful when stocks have more drastic downsides. For instance, if the stock is at $80, you purchased at $100, and your break-even is $93, you might need to go 6 weeks out to get a reasonable premium. This step helps keep premium flowing and further reduces your break-even price. The hope for these long contracts is that in the interim the stock price recovers a bit and allows you to take a shorter contract next time around. If we stick to quality stocks (as we should) the stock price will eventually recover giving you exit opportunities.
Step 5: Undercutting Your Break-Even Price to Sell for a Potential Loss
This is the last resort—a "roll of the dice." You set up a covered call that, if exercised, would result in a loss. The risk is selling for a loss if exercised; the reward is collecting good premium if unassigned, thus reducing your break-even price. For example, if the stock is at $80, you purchased at $100, and your break-even is $93, entering a 1-week covered call at $82 for a $200 premium reduces your break-even from $93 to $91. Use this step only if you are okay with the potential loss.
That's it! That is the order of operations. Stay on each step until you are forced to move to the next one. These steps work perfectly when paired with the strategy we implement inside of OPG – selling options on high-quality businesses at fair or undervalued prices. You can't apply these steps to bad stocks—it won't work. Trust the system and exercise patience. I've watched hundreds of you go through various levels of these steps over the past 18 months. I love seeing the light bulb come on and the confidence in both the steps and system increase with each successful cycle. And as always, if/when you have questions feel free to reach out! I am here to help!
Happy Trading!
— Caleb
