The Life Cycle of Trading Options
by John Lansing 04/04/09
WHAT HAPPENS WHEN IT'S TIME TO HIT THE EXITS?
So, let's say you've bought an option and are wondering what to do with it, and when. What you can do depends whether the trade is working in your favor.
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When you buy an option, the purchase price is non-refundable and you can only make a return on your option by closing the option trade before its expiration date or exercising the option (i.e., buying stock at the strike price if it's a call, or selling stock at the strike price if it's a put).
Failure to act before expiration date means that an in-the-money option is exercised for you (unless you instruct your broker beforehand to directly close the position) and an out-of-the-money option expires worthless and you lose everything you invested.
Some have lost money even when their option was profitable because they failed to act before the expiration date or didn't take advantage of the opportunity to exercise their option. Some stockbrokers will now automatically exercise your option on your behalf and purchase the underlying stock (again, unless you tell them otherwise), provided there is a profit in it for you.
This differs from the stock, though you may fail to sell a stock at its most profitable moment, it can still have some inherent value. Out-of-the-money options lose their value at expiration date.
Even if your stock is moving in the wrong direction, it is possible to recoup some of your losses by closing your option trade prior to its expiration date. However, just as options allow you to make an investment for just pennies on the dollar, closing a trade that didn't work out in your favor also reflects a payout of only pennies on the dollar as well.
Either way, whether you win big or not at all, trading options can be an inexpensive activity that ensures that you don't lose big!
John Lansing is the editor of Parabolic Options. To learn more about John, read his bio here.
