Posted by As it should be, the main trade management focus of “The Monthly Income Machine” is on properly handling the occasional position going the wrong way.
But we should also consider the pleasant matter of what to do with the winners – allow them to expire worthless so that we realize the entire trade profit, or exit before expiration and take less than the maximum profit.
The Monthly Income Machine does not provide a “rule” for this because it is essentially a comfort-decision for each investor. Often, our conservative investor community views it this way: (1) should I wait for expiration day and maximize my absolute profit, or (2) should I take a partial profit early and remove all risk of a late-in-the-cycle adverse move?
Factors That May Favor Early Exit
1. Greatly Increase Return on Investment (ROI)
If sufficient time remains before expiration to establish a new trade (I want at least 6 trading days), closing out an existing trade pre-expiration frees up margin for an additional trade and therefore another potential premium. Thus the premium earnings on the same “investment” dollars can be much greater.
Caveat: If we are dealing with an iron condor, exiting from one of the two spreads, and establishing another spread in its place, can produce another premium, but it will require additional margin if the new spread is not related to the condor. Remember: the big attraction of an Iron Condor is that the bear call spread and the bull put spread in the same underlying with the same expiration date are backed by a single margin requirement (at an option-friendly brokerage).
If you have an AAPL iron condor and exit from the bull put spread and replace it with an IBM spread, the original single AAPL margin would still be required for the remaining AAPL bear call spread, and an additional one would be needed for the IBM.
If you replace the AAPL put spread with an AAPL put spread of different strike prices, in the same expiration month, you still have an Iron Condor. The margin requirement does not change and ROI because of the extra spread will therefore increase substantially if the replacement spread works out.
2. Expire Worthless with High Likelihood
When I consider an early closeout from a spread that appears very likely to expire worthless, I only do so if I will realize at least 75% of my premium. Otherwise, I will let it expire and hope to realize the entire 100%.
3. Incentives from Brokerages
Some brokerages substantially reduce the commission on closing out an option position trading at or below five cents.
Bottom Line
The latter makes sense if:
- There is enough time remaining before expiration to profit from an additional spread.
- The additional commission cost is relatively small.
- Your account is housed with an options friendly broker.
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Lee Finberg
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Note: We can – and do – guarantee your satisfaction with “The Monthly Income Machine” detailed how-to blueprint for conservative income investors. No one, however, can guarantee market profits. For a full description of the risks associated with such investments, see Disclaimers.
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This is very helpful. When the market is moving significantly higher I’ve rolled up put spreads with the same expiration to capture additional premium. This provides simple rules that make a lot of sense and I’ll use this at my next opportunity. Thanks Lee!