The beauty of option trading is that if the stock moves against you, you can still come out as a winner if you have the patience and the capital to defend your position.
Let's look at a scenario where you sold a January $50 put option and collected $1.00 premium ($100 cash). The stock at the time of transaction was at $65 but for some reason it moved down significantly.
If you held this position till expiry then you would lose money.
How to calculate how much you would lose?
In our case the breakeven point is $50.00 - $1.00 = $49.00. So if the stock stops at $48 at expiration then you lost $1.00, which is equivalent to $100 cash.
Losing $100 cash is not the end of the world but you are in this game to make money so let's take a look at what we could do to defend our position.
Scenario 1: you expect the price to bounce back and you have about 21 days or less till expiry
In this instance you would buy back your January position at a loss and sell a February put option. What this does is that it pushes your paper loss out by a month giving you more time to be right.
Ideally you should select a lower strike price (e.g. $48 instead of $50).
Aim to get additional credits, however I would not be super strict about it as if you collected $1.00 for your January $50 put but the February $48 put pays $0.20 less than what you can close your January position for then your total net credit will drop from $1.00 to $0.80 but on the other hand your risk reduces significantly (you move from $50 to $48).
How to calculate your breakeven in this scenario?
Simply add the total amount of credits together and deduct it from your February strike price.
When to close the trade for profit?
Fresh traders often fall into the mistake of miscalculating their profits. Let's assume that you want to take 50% profit, which would be at $0.50 on the original (January) trade. In other words, you would close the position when the put option that you sold is only worth $0.50. But in our example the stock moved against us so our option's value goes up instead of going down, which is why we rolled to February. Would it make sense for us to close the February position at 50% (or at $1.10)? First you collected $1.00, then you spent $2.00, then you collected $2.20 so your net credit is $1.20 (1-2+2.2=1.2). If you close at 50% then you will make $0.10 (or $10 cash). I leave it up to you to determine if you would be happy with that.
Scenario 2: you expect the price to bounce back and you have more than 21 days till expiry
In this instance you need to assess if you expect the price to bounce back within days. If you are not convinced about it then you should roll your put position down and finance the cost of it by selling call option.
Once again, you should aim to get additional credits, but you must find the right balance between reducing your risk, your buying power and your premium position.
On the diagram below we can see that the share price went down to $49.2 so to defend our position we can but back our January $50 put and sell the January $49 put. This will cost us $0.80 (-2+1.2=-0.8) so to finance the deal, we can sell a January $53 call option for $1.00. So our premium position will be $1.20 (1-2+1.2+1).
If we want to reduce our risk further then we could roll to the $48 January put instead of the $49. You may get $0.50 credit instead of $1.20 so your net credit position will drop from $1.20 to $0.50 (1-2+0.5+1), however you reduce your risk substantially by moving your strike from the original $50 down to $48.
On the call side, however, you have to be mindful of a potential bounce back (increase of stock price) as if that happens then very quickly you will be sweating over the call side instead of the put side. In our example, a bounce back is actually quite likely considering that the price was at $65 when we jumped into this trade.
How to calculate your breakeven in this scenario?
Because you now have a strangle (sold a put and a call), you have two break even points.
If you moved to the $49 put then your total credit is $1.20 so your break even point on the put side is $47.80 (49-1.2) while on the call side it's $54.20 (53+1.2).
If you moved to the $48 put then your total credit is $0.50 so your break even point on the put side is $47.50 (48-0.5) while on the call side it's $53.50 (53+0.5).
When to close the trade for profit?
Similarly to the first scenario, you have to make sure that you take the total net credit position into consideration when you calculate the level where you want to close the position. For example, if you roll to the $48 then your net credit is $0.50 so if you decide to close the deal at 30% profit and you only look at your original premium position ($1.00) then you would close the position at $0.70, which would mean that you would lose money on the deal.
Key takeaways
When you roll, try to get additional credit
Reduce your risk as much as possible
Understand the impact on your buying power
Take the broader market conditions into consideration