When do I close a short option position?

I think this first piece of advice I received on the floor is truer today than ever.

I received this question during a covered call strategy webinar presented to our customers this week.  Many of our customers employ short option trades, either covered calls or cash secured puts.  They are confident on the risk and rewards of the strategies and the initial trade set up, but where I believe many of them make mistakes is in the closing of the position.  Way too many retail investors simply hold their short positions all the way until expiration especially when the option they have sold is out of the money.

Once you have a trade established, ignoring adding to existing positions, your choice is to either hold that position or close that position.  When I think about whether to close or hold any position (but especially short option trades) I use the one of the most important bits of wisdom I learned my first month on the floor 30 years ago.

A very successful trader preached to me, “If you don’t close an open position today, it is the same as if you opened it today.”

This is an incredibly simple concept and yet totally missed by many retail traders.  Most retail traders focus on the price they initially sold the option.  Let me make one thing extremely clear.  The market does not care what price you bought or sold to open any position, stock or option.  If you sell a covered call at $1.50 and now that short call is offered at 10 cents, if you don’t CLOSE that open short call at 10 cents it is the EXACT same as if you are choosing to SELL that call TODAY at only 10 cents.

Therefore determining when to close a position is really basic.  If you wouldn’t sell it today at the current market price, then CLOSE the position.  That’s it.  End of discussion.  Whether this is a short call or short put the most additional income you are going to make from that short option is only 10 cents.  Many traders wait until it expires worthless, basically tying up margin and buying power for very little return.  A better use of your investing margin may be to close that “teeny” and roll into a new option that is more attractive to be short, with more decay and more potential reward.    Steve Claussen