The background

On this site, we strive to teach you the fundamentals of options trading – managing risk, sizing your positions properly, staying disciplined.  These fundamentals help you generate steady and consistent profits by setting you up with a repeatable system that helps you make money.

But we all know that part of trading options is to expect the unexpected.  Sometimes, things go against you.  But things can also go your way.  This short article will show you one example of how.

The scenario

It was expiration day, about halfway through the day.  I only had a few minutes to take a look at the market and decide if I wanted to trade that day before heading out.  Normally, I’d stay away from this.  I like to trade expiring options only when I can monitor the trade all the way to expiration.

But this time, things were different.  Volatility was extremely low.  It was the last trading day of the year, and I knew none of the major players were going to push the market too far in one direction.  On top of that, options premiums were uncharacteristically high, especially for that time of year.  So, I decided to take advantage of the situation by selling an at-the-money iron butterfly on that week’s expiring VXX options.

I knew that since I wouldn’t be able to monitor the trade through to expiration, I had to limit my risk, so I kept the number of options that I sold down to a minimum.  I put in a market order to sell an iron butterfly on 5 contracts of the VXX at 34/35/36, with the current price hovering just above 35.  That trade brought in a 37 cent profit on a risk of 63 cents per contract, for a total return possibility of 57%.  At the time, it seemed like a great trade – I could make profit if the VXX didn’t deviate by more than 37 cents from its current price level in only a few hours.  I clicked “Submit,” watched the order get filled, and then left my computer.

This was bad.

Why?

Normally, I only trade index options, which means that if I’m ever assigned an option, I merely pay cash in the amount of the difference.  I don’t need to hold it overnight, much less over the weekend, which eliminates significant uncertainty and risk.

What I failed to remember, though, is that the VXX is an ETF, not an index fund, which means that if I were assigned, I’d have to actually buy or short sell shares of the fund.  So what I should have done was to enter a stop limit order for the trade, getting me out of it if the trade started going against me.

Surprisingly enough, in this case, it  was actually beneficial that I didn’t do that.

Assignment and sale

Later that night, I returned home to find that the market did what it always does.  In the last 10 minutes of trading there had been some significant selling, which pushed the VXX up to 35.53, out of my profit zone.  Worse off, I was assigned a short sale of all of the calls that I sold on the VXX.  Having to hold this short position over both the weekend and the New Year’s holiday was not a comforting thought.

At that point, I could only hope that the market wouldn’t tank when the new year came, causing the VXX to spike, and leaving me with even more losses than I originally planned for.  Having been assigned a short position, I was now responsible for hundreds of shares of the VXX, and without the downside protection that options provide, I could have very easily taken a significant hit.  Of course, there was also the possibility that the VXX would tank, leaving me with unexpected profits, but at the time, the possibility of the VXX rising was a much more real, and worrisome, possibility.

Fortunately for me, the best case scenario actually came true.  When the market opened on January 2, it opened significantly positive, which caused the VXX to tank, allowing me to buy back the short shares at a profit.

Somehow, my lack of properly managing my trade turned into added profit.

Post mortem

This is one of the reasons I love options.  Not only do you get extreme flexibility, but you also get surprising opportunities to make unexpected profits.

I should be careful to say that this is not how you should deal with your trades.  If you don’t want to deal with assigned options, always enter a stop limit order.  The market could have very easily gone the other way and I would have incurred losses I didn’t plan for.  But when I got the opportunity to buy back my shares for a profit, I jumped on it.

One other option I had available was to sell puts against the shares that I had.  The idea is similar to selling covered calls on shares you already own.  It’s an income generation strategy that could work very well.  I chose not to do this, due to the large number of shares I was assigned and the uncertainty with upcoming market performance, but I did want to note that the possibility was there.

This time, the market was my friend, but I’ve made enemies with it far too many times to expect this on a consistent basis.  Next time, I’ll set a stop limit… either that, or I’ll just avoid non-index options entirely.