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When we roll an option for credit, we improve our break-even price. Does that mean that we can eventually close an ITM position for a profit, if we roll enough times?

  • For example, I sell a put in a $10 stock for $1.
  • The stock drops to $9, so I roll out the next month, collecting another $.50.
  • I've now collected $.50 more than the intrinsic value of the option.

As the extrinsic value evaporates, it should be possible to close the position for a profit, even though it's still in the money. (assuming the price doesn't change) Is this correct?

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The short answer is yes, if the stock is above $8.50 at expiration, you will have a profit, ignoring commission costs ($10 less the net premium received for your option transactions).

Where this falls apart is that you are not going to get much, if any, time premium for a horizontal roll of a $10 put if the stock is at $9 unless you go out many months. Because of that low extrinsic premium, you'll have no additional downside protection if the stock keeps falling and no way to lower cost basis via rolling. You may also be subject to early assignment, even more so if there is a pending dividend along the way.

My advice to you would to avoid selling short puts unless it's a stock that you are willing to own at the lower price (strike price sold less premium received). A short option has an asymmetric pay off (you get a small reward but you bear most of the risk). A spread would be the way to improve the R/R ratio.

  • Good explanation, thank you. Considering the trade has gone against me, breaking even would be an acceptable outcome. – alekop Jun 7 '18 at 20:48
  • I thought dividend risk was only an issue for short ITM calls, not puts. – alekop Jun 7 '18 at 20:49
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    If there is excessive selling of ITM calls due to a pending dividend and it drives price below parity, it enables Discount Arbitrage. The dividend is an indirect cause. It's the call selling that leads to early assignment and this could happen at any time during the life of the option. This discount arbitrage is why call owners often exercise in order to avoid the haircut they'd take if they sold the discounted option to close. A Dividend Arbitrage is possible if a put's time premium is less than the amount of the dividend. There is no possible Dividend Arbitrage available with calls. – Bob Baerker Jun 7 '18 at 21:47

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