Don’t Click “Send Order” Until You Know These 3 Numbers About Your Option Trade

Option Trade Order

Right, let’s say that you have just spent hours analyzing charts and patterns, you have looked at various expiration graphs and carried out your trading checklist, so now you are now pretty convinced that your chosen options trade is an excellent choice with a high probability of success.

Perhaps you have selected a 60-day, ten Delta Iron Condor and the expiration break-evens give you a 90% chance of making money. You are feeling good about the trade, and you are just about ready to click on the “Send Order” button.

Wait! Don’t do it just yet! There are three essential numbers you need to know before you go any further!

What’s the issue?

The issue is that the Iron Condor you have chosen is based on what your profit and loss line looks like today, and that doesn’t look anything like the expiration graph. What you need to have is a plan to get yourself and your trade safely from today all the way through to expiration.

 

Iron Condor

Anything can happen between the time you place the trade and the time the options expire. If you have a plan before you go into the trade, you will always know what to do and survive to trade another day.

So before you take another step, make sure you know what these three numbers are in connection with your chosen option trade:

#1: Percentage Profit Target

 

Ultimately we all want to go into a trade to make money, but you need to have a planned Percentage Profit target before you make that trade because going into any position without a clearly defined profit objective is both risky and careless.

While there can be benefits to holding an options trade close to expiration, in many cases the Gamma risk outweighs the Theta benefits. In other words, if price makes a big move around expiration, a large open profit can quickly become a significant loss.

If you know exactly what you want to get out of the trade, you will know when to close the trade without giving away a large open profit. It is entirely possible to have two profit targets, which would come in handy if you only achieve a partly favorable trade. In such an instance, you can either opt to reduce risk or take a partial profit.

Having a profit target to aim for, before getting filled on the trade, will also help to remove the emotion from the decision to exit the trade and will help you to follow your plan logically and systematically.

Although a trading system that incorporates profit targets may well end up having less overall profitability, it’s much more likely to produce more winning trades and help you to reduce overall risk.

So, if we go back to the Iron Condor you have selected – if you enter a 60 day, ten Delta Iron Condor, a reasonable profit target should be between 40-60% of the initial credit. Once you’ve reached this point, you should exit the trade and take your money.

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#2: Adjustment Point(s)

 

Options adjustments should only ever be made to help to reduce risk or to increase the time you can hold a trade. By reducing the risk and increasing the time you can wait longer for the options to decay and hopefully exit at your chosen profit target. However, adjustments need to be made early enough in a trade to avoid disaster.

Put another way, if you just had a car crash, it’s too late to buckle your seat belt. By identifying where you will adjust the trade in advance, you won’t be caught off guard if the market makes a fast move against your position. Plan your adjustments ahead.

Adjustments are valuable with iron condors due to such trades possessing high odds as losing trades could be much greater, compared to the potential reward. It is essential therefore to plan what you would do ahead of it happening.

Potentially disastrous issues that adjustments help you to avoid include fast movements and massive trending volatility in bull markets. Since Iron Condors are more statistically-based trades rather than strategy-based and requiring a lot of thinking, you should be alert to the points where the market shows enough movement to require adjustment of the trade.

A simple Iron Condor adjustment is to roll up the side that the market is moving away from once the “tested” side of the trade reaches a 30 delta. This way you increase the overall credit on the trade and move out your break-even points.

#3: Risk Exit and Maximum Loss

While everyone knows that losing money is a real possibility when trading, none of us goes into a new trade thinking it’s going to be a loser. However, it’s important to know in advance how much you are potentially willing to lose on a trade to get your risk management into place.

The loss you can take will be relative to the size of your account, and your position sizing strategy will be imperative to reducing potential loss and the impact upon your overall portfolio. For example, a $200 loss is a 4% loss in a $5,000 account, a 2% loss in a $10,000 account, and only a 0.4% loss in a $50,000 account. Sizing your positions so that your maximum loss is only a small percentage of your account enables you to take many consecutive losses and continue trading.

This will shield you against unprecedented extreme moves in the market, better than even the most conservative investment strategy. Iron Condors can have a relatively high probability of success. If you win on 50% or more of the trades and never lose more than win, you should end up in positive territory.

Let’s Bring It All Together

Once you know those three numbers, the absolute best thing you can do is write them down. Have them handy to review during the trade to keep you honest and emotion free.

When you enter a trade with a commitment to yourself, it makes managing the trade much easier. You might not realize it, but trading would become much more comfortable, since having a predetermined plan frees up your mind to focus on more urgent needs; rather than having to second-guess every move you make.

The secondary benefit is that if things go wrong (and they will go wrong sometimes), you can still feel good about the trade if you followed the rules. As long as your trading plan includes the three numbers above, you’ll be better equipped to trade successfully over time.

Now you can click “send order” if you still want to….

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.

  • barry sherrod

    hi kirk,

    how about the actual mechanics of order entry – say on 1 point wide credit spread. When i put this in with my broker am i doing 2 trades ( ie selling a put and buying a lower put individually? or is this done as a “paired” trade? (I’m trying to get a handle on the cost end of the trading strategy).

    • You can do it as either a paired order or with single legs. I suggest paired order