Quite often, I’ve seen people hold onto their short option premium too long.  In other words, they have wanted to get every possible penny from their short vertical spread or their single leg short option.  In a previous post (Mindset of a Credit Spread), I described my personal rule about how I like to exit a short option position when I get about 80% of the potential credit.  I explain my reasons there.  Today, my goal is to help convince you to exit short leveraged premium positions BEFORE expiration and NOT try to let them simply expire worthless.

First, let me clarify that I’m referring to leveraged positions, and not cash-secured puts.  If you are selling a cash-secured put, and want to own the stock anyway, this article does not apply to you.  This article is addressing the traders that consider holding short vertical spreads until expiration.

In most things in life, decisions come down to greed and fear.  If you are too fearful, you will miss out on opportunities.  If you are too greedy, you can stay in trades for too long and turn winning trades into losing trades.  That is what we are going to address.

There are 3 main reasons I believe in closing out short spreads before expiration. 

1.  If you would not take on the trade at this level originally, why are you in it now?  For example, if you sell a short put spread for $1 with $5 between strike prices, you are risking $4 for a $1 credit.  If you can get out of the short spread for .05, it makes sense to me.  The reason is that very few people would ever get into a short spread for .05 and risk $4.95.  At that point (for me a long time before this point) you should be out.
2. Weekend risk is a real thing.  Let’s say that your underlying expires between your short and long strike prices.  Yes, it may have been very far OTM on Thursday, but if it is between strike prices at the close on Friday, it is the same thing as simply being short a put.  The reason is that you can be assigned on the weekend.  At that point, the protective leg of the put spread is expired and can offer you no help.  It is the same thing as being unhedged.  A lot of brokers won’t allow you to go into expiration and will close you out as they see fit (however, don’t count on it).  Most people don’t realize this at first and can be very exposed.  Don’t let it happen to you.  Get out before it happens.
3. The final reason is that most of the time, there is a better way to make money.  Let’s say that you are a week away from expiration and you can exit your short spread for .05.  If that is the case, then you can very likely make more than .05 for that time frame when you sell a spread for the following week, month, etc.  If you don’t feel comfortable doing that, then it makes even less sense to hold onto your current spread for the .05.

Once again, I like my 20% rule described in a previous post but having an exit plan is extremely important.

If you would like more information on what I like to do for my own investments or for my clients, email me at mtosaw@rcmfs.com.