Options 101: Turning Potential Losing Trades Into Winners

In the game of trading (and investing), we inevitably experience losses. "Options 101" says managing those losses is important toward trading success and moving forward.

At times, it makes sense to just let a losing trade go -- book the loss and move on. It's a painstaking exercise, but one we must often perform in order to clear the deck and our minds. I have even paid the broker to get a loser off my screen, just so I don't have to look at it everyday.

In this sense, I view removing a loss as a win. From a psychological perspective, I no longer have to think about that losing trade, how much it has to gain to get even or become a winner. When the odds are extremely low, only hope enters the equation, and hope is not a strategy.

However, what if that trade is not much of a loss? What if the technicals, price action and volume confirm the stock will move in your direction soon? How can you mitigate the loss or even create a winner? Well, it's not easy to repair these trades, but it is certainly not impossible with some delicate touch.

When I find myself in a long call situation with a bit of a loss but believe there is a strong possibility for a win, I'll immediately look toward taking more time. Now, that would require more capital from the same strike price, so what I may do is take the strike up higher, and then add a layer of protection by selling an upside call -- creating a vertical spread. The net will often be less capital expended, more time to let the trade work and the potential to roll the short strike more than once.

This strategy can work with puts as well.

If there is a situation where a long call just gets hammered in a few days because the stock is tanking, we might look to repair this total trade by selling put spreads. I would look to capture enough premium to cover the long trading loss, taking a bit more time as well.

Say we bought calls at $3 and now the options are selling at $1.85. I would look to sell put spreads for at least $3, and if the stock rebounds we'll collect on both ends. Realize, though, the put spread sale requires posting margin.

In the end, we must recognize losses are part of the game. How we respond tells us if we can continue to stay in the game.

Bob Lang is a frequent contributor to Real Money and co-portfolio manager of Trifecta Stocks.