READ THIS! If You Want to Be Serious About Options Trading

The risk of options trading I have traded options professionally for more than 25 years. This chosen profession has been a wonderful choice for me as I can think of no other profession where every day you can answer the question, “Did you have a good day today?” with such objective clarity.

The secret to such longevity in trading derivatives is very serious, however. This secret – very simply – is to mitigate risks and eliminate uncertainties whenever and wherever possible.

I have seen way too many retail traders do the exact opposite of this with disastrous results. They try to make a quick couple of bucks on expiring options rather than follow the discipline serious traders do around expiration. Professional traders eliminate risks! I am embarrassed to say that many of our customers add additional risks for the potential reward of pennies. This is insane!

Last Friday (New Year's Eve), quarterly options in the SPDR S&P 500 ETF (SPY) expired at the end of the day. In the last 20 minutes, traders actually sold to open the 126/127 bear call spread for two cents! The risk/reward for this play is even worse than giving 50-to-1 odds on a $1 call spread!

This is due to the fact that the 127 calls are really out of play with so little time to go before they expire. So this really amounts to just selling the 126 calls naked for two cents. The seller of these options additionally took pin risk into their portfolio for a measly two-cent credit!

The SPY closed the session at $125.75 but the options and futures continued to trade for 15 more minutes on the exchanges. During this time, SPY stock rallied thru the 126 level all the way up to $126.20 before settling at 3:15 CT at a price of a price of $126.05.

This price action caused many of the 126 calls to be exercised, causing assignments to the short call positions! Likewise, many 126 strike puts were NOT exercised. This resulted in customers being surprised with short shares in the SPY Monday morning. The market gapped higher Monday, resulting in Reg-T margin calls and large losses in these short stock positions.

It is important to realize that with the expiration of the options, this is no longer a short call spread but a resultant short stock position that has unlimited risk to a market move higher. All this risk for only a limited potential return of two cents!

As foolish as it is to open a spread with a maximum potential gain of only two cents, it is equally foolish for the traders who did not cover their short option exposure before expiration. They too were leaving all that uncertainty and risk in their portfolios. To me, not covering a short is the same as shorting it anew.

With the proliferation of weekly options, expiration is now an every-Friday occurrence.

The lesson learned here is professional traders take risk OFF the sheets at expiration. Consider closing short expiring options before they have a chance to turn into stock positions that are unwanted and uncertain. As George remind us several weeks ago, the long holder of options controls the decisions around exercising. Short option holders are at their mercy.

Photo Credit: renaissancechambara

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