I got a question from a long-time reader–Wilson M.–today, that I thought was a good one. I’m sure a lot of people have wondered the same thing, so I asked Wilson if it would be okay to post our conversation on the IOI Blog. He graciously assented, so here it is. Hope this exchange helps you as well:

Original Question

Hi Erik,
Do you have any rules that you follow on when to close out a put write position early?  I had a position in TDC and SYMC that were set to expire at the end of the week.  Both were trading within 2-5% of their respective strike prices.  I closed out of SYMC early and it looks like I could have just let it expire worthless, while with TDC I held on and they preannounced and the stock plummeted.  Argh!

Erik’s Answer
Hi Wilson,
Thanks for the mail and sorry about the TDC?I feel your pain on that as similar things have happened to me in the past too?
There are a couple things that I usually look at.
  1. Option liquidity and bid-ask spread. If the spread is too large, I usually just assume I?ll have to own the stock eventually, so do a lot of valuation work up front. Doing that, I feel more confident about keeping the thing open until expiration and don?t mind owning the underlying.
  2. Perceived probability for negative news. For liquid options, I don?t mind trading out ahead of time if I start to see more signs that there could be something negative to valuation on the horizon. I did this with Western Union WU a few years ago, because I started to get worried that the Morningstar analyst was not being realistic in his assumptions for the possibility of a slow-down in European and North American migrant worker populations (one key driver to WU?s business model).
  3. Unrealized profit. If I find that I am worrying about negative new on a stock in which I have a position in a liquid option, and on which, if the option expires OTM, I?ll only make an additional $0.05 or something on premium of $1.75, for example, my fear usually overwhelms my greed and I?ll leave the extra $0.05 on the table and close out.

Remember that in the case of TDC, you can write covered calls on top of your new stock position that will help you to keep lowering your effective buy price. Just make sure that the strike price at which you write your covered calls is above your original effective buy price, otherwise you run the risk of locking in a loss on your investment.
Western Union Stock Price
Source: Yahoo! Finance
Thanks again for the question–this is a good one that I think a lot of people wonder about some time or another.
All the best,