Moving the Goalposts—Difficult but Effective

There’s one last general defensive tactic to examine. Opportunities to apply it are somewhat scarce, and it embodies a little more risk than we’d usually prefer to accept. However, when we observe a situation where a market has moved against our position in a written option and other defenses are unavailable or undesirable, this defense is highly effective in reducing a loss or in returning our trade to profitability over time.

Suppose we’ve written an option and the market moves adversely. Suppose also that we don’t want either to roll the short option out or to flip it into the next month. There are a number of situations in which we might prefer not to adopt an extended defense. The next month in our chosen market might involve some large weather risk, as in summer coffee or grains.

Equally, we might be aware that the next month is historically much more auspicious for buying options than for writing them, as, for example, if we had written August CME/IMM currency options and it became necessary to defend the position. Moving the goalposts is a good way to reduce the immediate threat to our trade, regain most or all of any paper loss we might have,and possibly return to profitability . . . and all within the same time frame as our original trade.

There are two ways to apply this tactic, which I call respectively “the single” and “the double.” The single move-the-goalpost defense consists of repurchasing the options we originally wrote, and for each repurchase writing two or sometimes three options whose striking price is further away from the current market price, but having the same expiration date.

The double defense consists of repurchasing the options we wrote and then writing two OOM strangles (see Chapter 9) for each option repurchased, again with the same expiration.The operational preconditions for moving the goalposts, as far as I understand them, are:

1. Other defenses aren’t suitable to our current position and situation, or their preconditions cannot be met, or they are undesirable for marketspecific reasons.

2. The IVs of the options in this market at this time are not at the low or the high end of their 6-month range.

3. In the single version of the defense, we must be able to replace the premium we repurchase by writing no more than three options further awayfrom the market. In the double version, we must be able to replace the premium repurchased by writing no more than 2 OOM put-call pairs (strangles), and we must make the width of the strangle (the striking price of the call minus the striking price of the put) as wide as possible.

4. We do not, ever, extend when we defend. We only move the goalposts in the same expiration month as the original option we wrote.

5. We prefer that the time remaining until expiration be short, but, in extremis,moving the goalposts is acceptable as a defense in a longer-term trade. In a longer-term defense, we will strongly prefer the single defense to the double.

A good example of a move-the-goalposts defense occurred in one of my accounts in April–May 2001. On April 16, for what seemed like very good reasons at the time (cough . . . an optical illusion that I was too nearsighted to see through), I wrote several June coffee put-call pairs (ticker: KCM) that were to expire on May 11. I chose the KCM 55.00 puts and 67.50 calls, with July coffee (against which the June options offset) trading at 60.15, and received 110 points gross for each put-call pair.

Coffee, although a longstanding bear market at the time, had indicated that, heading into summer and hence the usual possibility of weather dramatics, it had stopped going lower for a while at least.That indication was proven out pretty quickly. Two weeks later, July coffee touched 65.00 cents and closed just under that, at 64.45.

When it opened above 65.00 the next day, it was clearly time to defend, given that there were 101⁄2 calendar days and 81⁄2 trading days left until the options expired.I had zero intention of rolling the June calls into July or any other month. One freeze event in coffee equals three strikes and out, possibly out forever.

Nor did I want to flip the calls into July puts, because in most years,when Brazilian coffee doesn’t freeze, it moves well lower from mid-May onward.The market was within one striking price of the calls I’d written, so no hedge defense was possible. The IVs of the market weren’t suitable for a time spread defense.

This, my friend, was a dandy spot to try to move the goalposts. The “double” version looked particularly attractive.I repurchased the 67.50 calls for 210 points apiece (very ugly!) and wrote in their stead the 72.50 calls for 80 points and the 62.50 puts for 55.This move was opportune, because the option premiums were such that I didn’t even need to write two put-call pairs for each repurchased call.