Profiting On Options While Lowering Risk

July 30, 2015

This is a weekly column focusing on ETF options by Scott Nations, a proprietary trader and financial engineer with about 20 years of experience in options.

It’s a nice problem for an institutional option trader to have: You executed a trade just six days ago and it’s already a big winner. But what do you do now? Do you press your advantage or simply take the money and run?

One trader, faced with that question in a bearish option trade on the iShares Russell 2000 ETF (IWM | A-88), decided to press his advantage so that he can still profit, but also managed to nearly eliminate the risk from the trade.

IWM has had a pretty tough run; it’s lost more than 4 percent during the last 30 days and traded below $120 on Tuesday, the first time it’s done so since March.

IWM tried to stage a rebound during the middle of July, but once it started to roll over again, one institutional option trader placed a bearish bet on July 22 by buying the September $123 strike puts. The volume that day was more than 12,000 option contracts, so we have a rough idea of the size of the original trade, and it’s likely they paid about $2.50 per option.

Since then, IWM has fallen by $3.28, and the value of these puts has nearly doubled. If our trader thought the bottom was in for IWM, he might simply sell his options and pocket his profit. But our trader doesn’t think the bottom is in for IWM, so he decided to roll his long position in the $123 strike puts down to the $118 strike, maintaining bearish exposure to IWM, and pocketed about $2.18 per share in the process.

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