One of the hardest things to do as an investor is to control your emotions when making investment decisions. It is even more difficult for option traders because all options have an expiry date. Plus option prices are very volatile which can be difficult to ignore.
My dollar cost average using an option strategy for buying 200 shares of Royal Caribbean has been an emotional roller coaster ride. I took a position on Oct 11 with the intention of either making 11.2% return in 38 days or owning 200 shares at an average price of $68.84 per share. The chart below illustrates the price movement over the past 16 days.
I get nervous when a stock price falls 3.5 % two days before earnings are released. I seriously thought about buying back the call & put options and selling my shares for a loss. However, the whole point of this strategy was to own 200 shares of Royal Caribbean. Nothing really has changed, under normal conditions I would have bought 100 shares at $72.22 on Oct 11 and bought another 100 shares at $68.00 for an average price of $70.11 per share.
My option strategy, up until Oct 27 has reduced my paper loss to $68.84 – $68.00 = $0.84 divided by $68.84 or 1.2% compared to $70.11 – $68.00 = $2.11 divide by $70.11 or 3%. The next day, RCL released their earnings that surprised on the upside. See the chart below:
Now I am faced with more challenging set of opportunities.
- Do I buy back the Nov 18 call & put options which brings my cost base down to $69.92 and I hopefully sell my 100 shares on Monday for $74.40 ( 6.4% return)
- Do nothing for the next 22 days and hope that the shares don’t fall back below $72.50 and make 11.2%
- Do I roll my options forward by buying back the Nov 18 options and sell the Dec 16 $72.50 call for $4.10 and Dec 16 $72.50 put for $2.20?
- Do I get greedy? Buy back the Nov 18 options and sell the Dec 16 $75 calls for $2.64 and the puts for $3.30?
Analysing the risk / reward of rolling my options to Dec.
Scenario (1): What happens if the shares of Royal Caribbean are trading below $72.50 on Dec 16?
Under choice # 3, call option expires and I buy 100 shares at $72.50 bring down my purchase price per share to $66.20 for the 100 addition shares plus 69.92
Under choice # 4, I still buy 100 shares at $72.50 bring down the purchase price per share to $66.56
Scenario (2): What happens if the shares of Royal Caribbean are trading above $72.50 but below $75.00 on Dec 16?
Under choice # 3, I sell my 200 shares for $$14,500 – $6,620.00 – $6,992.00 = profit of $888.00 or 6.72%
Under choice # 4, I will own 100 shares at $69.06 plus my 100 shares at $69.92
Scenario (3): What happens if the shares of Royal Caribbean are trading above $75.00 on Dec 16?
Under choice # 3, nothing changes, I still make $888.00 or 6.72%
Under choice # 4, buying back the Nov 18 options, I reduced my cost base on the 100 shares to $69.92 – the Dec 16 put option of $3.30 – call option for $2.64 = $63.98 per share. I will be force to sell at $75.00 for a profit of $11.02 or 17.2%
Two factors that I am weighting are the Fed is considering raising interest rates in December combine with tax loss selling could spark a market correction. Now, Choice # 3 is out of the question, less change of being profitable than choice # 2, 6.72% in 48 days compared to 11.2% in 20 days.
Now, I still have until Nov 18 to decide if I want to change the perimeters of my original trade. However, I do run the risk that the purchaser of the Nov 72.50 call option will force me to sell my 100 shares before Nov 18th if the stock price continues to the upside.
What choice would you make if you were in my shoes?
Remember this old saying “Bulls & Bears make money and Pigs get slaughtered.”