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Last week, we discussed using our judgement to decide whether we should stay in a credit spread. In our mock trade of Activision (ATVI), the stock broke through our mental stop at $21. However, each time the stock makes a run early in the session, it ends up losing a lot of this advance by the close. Nonetheless, if this were a real trade, I would most likely have gotten out when the stock reached $22. However, one aspect of a credit spread is the ability to roll the play forward to the next month.

When rolling forward, we normally wait until the week of expiration and then figure the cost of the roll. There are a couple of things we need to see in order to roll a credit spread. First, we must still have a directional bias for the stock. In our ATVI trade, this means that we must still feel the stock is going to fall below $20 by January expiration. Since ATVI is still trading between the strikes of our credit spread, we are going to hold on to this play and look to roll if the stock is at a similar point come expiration.

Below is the week to week data for our bear call credit spread:

11/12/02
ATVI Bear Call Spread
ATVI @ 19.97
Buy 10 Dec 22.50 Calls @ 1.00
Sell 10 Dec 20 Calls @ 2.00
Net Credit = 1.00 or $1,000
Max Risk = $1,500
Breakeven = $21

11/19/02
ATVI Bear Call Spread
ATVI @ 18.77
10 Dec 22.50 Calls @ 0.35 (bid)
10 Dec 20 Calls @ 1.20 (ask)
Net Credit = 1.00 or $1,000
Profit/loss = 0.15 or $150
Max Risk = $1,500
Breakeven = $21

11/26/02
ATVI Bear Call Spread
ATVI @ 20.39
10 Dec 22.50 Calls @ 0.55 (bid)
10 Dec 20 Calls @ 1.55 (ask)
Net Credit = 1.00 or $1,000
Profit/loss = 0.00 or $0
Max Risk = $1,500
Breakeven = $21

12/03/02
ATVI Bear Call Spread
ATVI @ 20.90
10 Dec 22.50 Calls @ 0.50 (bid)
10 Dec 20 Calls @ 1.70 (ask)
Net Credit = 1.00 or $1,000
Profit/loss = 0.20 or $200
Max Risk = $1,500
Breakeven = $21

Though we are going to wait to roll this play if needed until expiration week, let’s go over a few rules in rolling a credit spread.

Our credit spread can be at three junctures come expiration: 
1)  Both legs of the option are in-the-money
         -If this is the case, then we would want to just close the trade and take our losses. This is because rolling forward just creates more risk.
2)  Sold leg is in-the-money
         -If we can roll the spread forward for a credit, breakeven or a slight debit, this may be the thing to do. However, we must feel the stock is going to roll over by the next month’s expiration. 
3)  Both legs are out-of-the-money
         -This is what we want when trading a credit spread and requires no action. If both legs are OTM, then we keep the entire credit.

As always, it is a good idea to put the data into a risk graph to see the adjusted trade graphically. As we always teach, don’t chase a bad trade. If you made a mistake and there is more risk to roll, just get out of the trade and move onto a better one.

When figuring the cost to roll, first figure the cost to close the current month. Then, figure the credit that would be received to open the trade for the following month. At this point, add the initial credit and the new credit and subtract the price to close the current month. If the cost to roll is more than 0.20, then is probably isn’t a good idea to roll forward.

As option traders, we have to get used to losing. It is going to happen, but the profitable trader cuts his losses shorts and doesn’t let the loss affect them. The object of any long-term trading account is to have more money down the road then you do now. This may mean more losses than wins, but as long as the wins are larger than the losses, we can still see profits.


Jody Osborne
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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