There’s an old saying, especially among bears or those who short stocks: I “wasn’t wrong, I was just early.” Well, we all know that being too “early” can put you out of business. The flip side of this is taking profits too early.
In the first case, you’ll be left sitting in a dive bar telling no one who cares about your great “call.” The latter you get to spend time with friends and family enjoying life with nary a word about the trade or market.
On November 4, Options360 established a ROKU (ROKU) iron condor, following the streaming company’s earnings release the prior afternoon. We initially collected $1.95credit on a $5 width between the put spread strikes (270/275) and call spread (320/325) strikes. The position was set to expire today, November 12.
So, I closed half on Monday at $1.50 debit for a small profit. On Wednesday, I followed up with a recommendation to close the balance for an $0.80 debit. A few members questioned my logic. The email below is a good example. As a side note, it also highlights one of the Options360 features that I’m most proud of; members have direct access to me and I usually respond within 10 minutes.
“Steve, Why give away 80¢ on the ROKU trade? I may be wrong, but it looks like ROKU will stay nicely above 275.” -Mark
Before I get to my response — which came 11 minutes after I received the email — explaining why I would close a position early and “give away $0.80,” let me step back a bit to set the stage of how we got into the position, how it was managed and why I opted to close it down even though it was tracking for a solid profit.
I established the iron condor after ROKU dropped up to 15% in the aftermarket, which I thought was an overreaction to what looked like a pretty solid report, and I thought an iron condor looked attractive.
The Options360 Alert on 11/4 read in part; “ROKU reported earnings last night which were actually pretty good by most metrics such as revenue jumping 50%, the number of subs increased by 27%, hours watched was up21% and average revenue per user (ARPU) jumped 49%. But, wait for it…. supply chain issues resulted in fewer players (both as separate devices and those built into the TV) being sold. This last issue should be resolved in the coming months.
A potentially darker cloud hanging over ROKU is it needs to renew deals with Amazon to keep access to Prime and with Alphabet with regards to YouTube. At the moment the sides are not coming together. But the resolution (or not) isn’t due for another 6-8 months.
Rather, I think stock after initially sinking as much as 9% to the $282 a low of in the aftermarket, Stock tried to stabilize this morning with a run back to $300.
I think it settles into a range over the next week.”
Okay. Fast forward to the stock price action which informs my position management decisions. Keep in mind that our key level is a short put with the 275 strike price.
After an initial rebound back above $298, the stock quickly turned back lower, and by the next day, it had tested the $275 level. I made a quick adjustment by rolling down the call side from 320/325 to the 295/300 call spread, collecting a net credit of $0.50, bringing a total net credit to $2.40. Meaning, our risk/reward was now near 1:1 in that I collected $2.40 and the spread could only go to $5 should ROKU drop below $270 per share.
Back to the question of “why would I give $0.80 away” by closing early, even as the stock was holding above $275?
My answer, with some expanded explanation, was as follows:
- I’m not giving away money. I’m trying to secure a profit. We already picked up a very small gain by closing half yesterday. Now, I’m looking to lock in a true-and-reasonable gain.
2. The price action in ROKU has been sloppy. The pops above $280 get sold off quickly. On the other hand, the support at $275 has been tested a few times and just lays there. The more support is tested, the more it eats away at said support.
3. A break of $275 today, tomorrow, or Friday will send the spread to intrinsic value (if below $270 that means $5 debit) which would be a $260 loss.
4. I don’t like trying to squeeze out the last bit of a premium during the final days before expiration. This is true as to whether the options are way-out-of-the-money and seem surely set to expire worthless or, as in this case with ROKU, if stock is on the bubble hovering on each side of the short strike.
In the case of a short leg of a spread, I’ll always close if the value drops below $0.10 as the risk/reward becomes too asymmetric.
- Maintain realistic expectations. ROKU closing for $0.80 provides a return of 40% on initial risk. That’s a very good target return for iron condors or credit spreads. Especially those that have not behaved and are threatening the short strike.
The calculus is that I’m forgoing another $80 of profit, but risking a $260 loss. Not something I want to do heading into the last three days until expiration.
So how did this play out?
We missed getting filled at $0.80 on Wednesday by a nickel! This morning, ROKU broke below $270, forcing me to close the position around $2.50 to prevent it from ending fully in-the-money and incurring a maximum loss.
The upshot is; risk management comes first. I won’t second-guess the initial trade. But, it would be stupid and stubborn of me to not have made adjustments, such as the roll down and partial close, once I saw ROKU was struggling to hold above the $280 level.
Do I wish I had closed it even earlier when it was showing a 28% profit? Sure. But, I’ll live with scraping out a 14% profit from a trade where I was basically wrong. Getting out early was the right move.