Once you’ve entered a short call vertical trade—or any trade for that matter—you need to know how to manage it and exit effectively when the time comes. This requires traders to be patient and disciplined. Given the ups and downs that are likely to occur, this can be easier said than done, which is why it’s important to plan ahead. That way, when emotions run high, you’ll know what to do.
First, let’s talk about exiting when the trade goes well—this happens when both options are out of the money near expiration.
In this case, consider closing the trade when the bid price of the short call is $0.05 or less. At this point, you’ve gained just about all of the time value out of the short option, and the risk of giving back gains is greater than the opportunity to increase them. Therefore, it’s best to close the trade and take the profit.
Next, let’s talk about exiting when the trade doesn’t go as well—this happens when one or both of the options go in the money prior to expiration. If only the short option is in the money, first consider the value of the long option. If it still has a fair amount of value, consider closing both sides of the trade—the value gained from the long option could offset the loss incurred on the short option.
If the OTM option doesn’t have any value left, you might be better off closing the short option and letting the long option expire worthless. There’s a slim chance that there’ll be a big price move, making the long option profitable, so you might as well keep it open just in case.
If both options are in the money, you have a couple options. First, you can let the trade go to expiration. You’ll have a loss, but the long call caps it at the maximum loss. On expiration, the short trade will be assigned and the long call will be automatically exercised to meet the obligation from the short call. It’s a process known as same-day substitution.
However, this route includes additional fees associated with exercise and assignment. If you don’t want to deal with these fees, you may want to close both sides of the trade several days before expiration.
These are important considerations. It’s always helpful to remember that, depending on how you manage the trade, you may end up owning the shares of the underlying or exiting the trade too early.