Exiting Options Trades Automatically
Exiting options trades automatically once they reach predefined profit targets is one of the most important concepts you can master as a new or experienced trader. When we close trades early we increase our overall win rate dramatically as we'll show in this video.
In this video, we are gonna talk about Exiting Options trades Automatically.
So as we discussed in the last video, trade entry is an important aspect of successful trading. And probably more important obviously then making adjustments to trades. Now in our opinion, all of your "analysis" or "thought" should go into placing smarter trades from the start.
And that's really where we focus all of our attention here at Option Alpha. Therefore, the easiest part of trading actually should be the exit. It shouldn't be complicated, and it needs to be automated as much as possible to help remove your emotions.
That's the way that we believe; you should be trading. Meaning a lot of your thought process your analysis entering the right trade, once your in the right trade, the exiting part should be pretty much automated and not emotional as much as possible.
So here at Option Alpha, we favor placing a "GTC" or good to cancel the closing order immediately following each and every new position that you enter. Again, we have outlined the specific profit targets in a simple PDF guide that we have right here in the membership area.
I just kinda want to cover some of these right now, so that you can understand how this works, so this is what you will see as you download the PDF guide, again its completely free, you can you know take it with you its kinda like your check list for how you should be using automatic exits and stop losses etc.
And you can see here for Bullish Trades, lets say we were doing a Bullish call debit spread, okay we want to take that trade off at 50 percent of max profit. So that means that if we enter that trade lets say for one dollar, and we can make a dollar on the trade, then we want to take that trade off once the trade increases in value to a dollar fifty.
So, we entered it for a dollar; we can make a dollar or lose a dollar. That means max potential profit is a dollar. We want to take that trade off once the value goes up half of that max potential profit, or up to a dollar fifty, and again we will go through some examples here.
So you can understand that. And again what we usually try to do here is make sure that we are maximizing both the number of wins that we have that's why we are trying to do this and the potential money that we make.
You can see some trades. Obviously we are gonna be a little bit more aggressive in howl we take profits to put like broken wing butterfly ah we are gonna be a little bit more aggressive, wait a little bit longer for a bigger profit. If we do a custom naked put or something like that or a single naked option we'll again wait for that 50 percent profit target.
If we are doing things like calendars and diagonal spreads we are actually going to take profits a little sooner because those trades don't have as good of a success rate on the outside meaning when you enter a calendar spread or a diagonal spread, you don't have the really really high probability of success that you have with credit spread or an iron cons or something like that.
So you want to take those profits off just a little bit earlier. Again, we have also got guidelines on Neutral Trades. So most of the neutral trading that we do, we take profits at 50 percent of max profit. Except for things like straddles and iron butterflies.
Your going to be a little bit more aggressive when you enter a straddle or an iron butterfly your gonna take in a bigger credit. Therefore you can afford to take it off a little bit quicker. Meaning at a very short or very quick profit target of 25 percent.
So, again this can help you and guide you as to where you need to exit these trades. And again this is based on a lot of data and research.
So, we also have Bearish Trades again I won't go through this one, but very similar to the Bullish Trades. But pretty much any strategy that you want to trade, we've got guidelines on how you should be exiting those trades.
So the question becomes why we would want to exit trades early? I mean we've kinda covered it, but again the two biggest reasons why we would wanna exit trades early are to One increase our win rate and profits.
And number two reduces our trade duration and exposure. So when we exit a trade early, that means that we are locking in a gain for sure, on a trade that could have gone the other way, right?
So if you have a trade and it goes in your direction early in the cycle or maybe right after you enter the trade. Why not take that trade off, bank the profit and prevent an opportunity to hold onto the trade where it could turn around at the end of the expiration cycle and go against you?
So once you do that you will see that you will increase your win rate and it will increase your overall profits. So even though you will be taking less money on each trade, then you enter for credit you'll have a much higher profit at the end of the day because your win rate is going to be dramatically higher.
And again we will prove this concept with what we do here at Option Alpha. The second part of this is, of course, is it reduces trade duration and exposure. So if we enter a trade say 45 days out but close it after 10 days.
We only had money exposed for 10 days. We didn't have money exposed for 45 days. Now does this always happen where we get to close out trade 10 days early? Or 10 days into the cycle? No. Sometimes we do have to wait and hold the trades all the way to the expiration.
But most of the time we are not in trades more than 30 days. In fact right now as it kinda sets at the time I'm doing this video our average trade duration across all of our trades is about 27 days. That means less than 30 days that we have money invested in the market.
Most of our trades are placed anywhere between 45 and 60 days out. So we are closing trades at about half the time right now, and again that reduces our exposure and the amount of money we have at risk in the market.
So, for example, lets assume on the next chart, just to kinda prove this point here about why you should be closing out trades early. That you sold the same 43 calls and 40 puts to create a strangle 3 months in a row.
This is Strangle not strange. So you created a strangle 3 months in a row back to back to back. Okay. Now, this is a chart I believe of aal at the time that we are doing this video it doesn't matter, but it proves the concept.
So again lets assume that the 43 calls are here this is your line in the sand or your breaking print on the 43 calls. And then you sold the 40 puts down here below the market as well. Okay. Now each of these red lines on the chart here is expiration dates.
So for just the sake of arguments here we will assume that you entered a trade at the beginning of expiration and it was just a one month trade which means that it expires the next expiration month, and then you entered another trade here at the next expiration, you entered another trade here the next expiration etc. etc. etc. etc. okay.
So we will just assume that you keep entering this same 43 40 strangle back to back to back. Now if you entered the trade here at the ex-point you have a lot of opportunities, because again you want they stoke to trade inside of your range.
You got a lot of opportunities to close out this trade early in the cycle. Yes there was a lot of movement, but likely as you got through that initial cycle you saw some time decay, maybe a drop in volatility, whatever the case is, but you saw the value of the options probably go down because the stoke more or less trades sideways for about 20 days.
Now if you had taken profits early you would have been out of trade somewhere here, maybe 20 days in or so you would have taken profits early been out of the trade. If you waited for all the way till expiration tried to kind of milk every last penny out of this trade, you might have been a stick in a situation where the stoke broke out above your strike prices.
Okay. It came back in on the last day of expiration, but it closed outside of your strike prices the last day of expiration. Okay. So this proves the concept that at least in this first month you had a lot of opportunities early on int he expiration cycle to take money off the table.
Probably multiple times you could have taken money off the table. Had you waited and been maybe a little bit greedy trying to get every last penny out of it you would of either been faced with two scenarios where the stock would haver gone against you and maybe would have used the stop-loss order or something and it would sort of hit you out of the trade and not had profit.
Lets assume that the next month comes, and the stock opens lower, but you continue to make that same trade, so you place the trade on this date, and again it probably took a couple of days this time for the trade to come into a profitable range.
Notice that the next expiration cycle that we are trading here so the second month, it took almost eight or nine days for the stock to come back inside of your 43 calls 40 put range, but once it did you had a couple of days you had a window of opportunity here to take money off the table again.
So early exit in this case ended up being the best opportunity to make money in this trade because had you waited until expiration which again which in this expiration cycle is this line right here.
The stock closed outside of our potential profit zone closed up around 44 dollars and would have been a losing trade, again if you had waited for all the way until expiration.
So the person who closed out the trade early in the middle of the cycle, even though they banked potentially a little bit less money then they could have made if they hadn't made a complete profit, they actually made money versus this person who did not make money by holding it all the way til expiration. Okay
So same thing, so we go to the next month, and again just proves this concept. Lets say you enter a trade on this date, so the next expiration cycle you enter a trade the first day of expiration, the first day of the new month or the calendar month.
And you can see that the stock comes into your range early, but maybe you missed an opportunity to get out of it. Okay so for whatever reason the pricing wasn't there, you didn't reach your 50 percent of profit target.
Whatever the reason is but it came into your range early but it just wasn't a good exit, or it didn't hit our profit targets that early in the cycle.
But we did get another opportunity later on in the cycle, maybe towards the back half of the expiration of the cycle, again maybe 20 days into it. We got an opportunity here where the stock closed right in the middle of our range, about 20 days into the trading month.
So we could have again closed out this trade at a profit. By this time there is probably enough time decay and volatility decay in the value of the options to take a profit off the table.
And again if you had done this and taken the profit you would have avoided a scenario where the stock closed much higher than our break-even points again creating a loss at expiration.
So as you continue to see this play out, it happened again the next month, and most stocks it happens all the time. But the reality is that you have to understand is that as a trader you can not dictate where the market goes, but you can be a little bit opportunistic in the way that you take money off the table.
So whenever the market is favorable, and reaches a profit target early, or decays in value early, you have to be diligent in taking money off the table. Now the challenge that most traders fall into is that they don't have the emotional competence to do that.
Myself included sometimes we see a trade come in into our range and we think okay now its going to you know stay in this range until expiration, I'm gonna you know to keep the entire profit that I'm really looking to get.
But the reality is that sometimes that you know, stocks make big moves, and right before expiration, they make huge moves that either turn them into full losers or maybe a winner into a loser, whatever the case is.
We have to automate this process so that when we remove ourselves as emotional traders and investors from the process so that whenever it happens in that expiration cycle or that month, we are out of the trade immediately.
Another reason why I like to do this is that then I don't have to watch and manage my positions throughout the month. So if we are keeping our position size in check or since we are keeping our potion size in check, we can hold these trades until our profit target is reached.
And that's what I like about these automatic closing orders is that I know that that order is always working for me, I don't have to constantly go in and monitor these trades to get them off.
I will just get an email alert that says the trade has been you know taken off our profit and I can go out of that trade. And I can focus on what's more important, which is finding new entries and new trades.
So again sometimes this will happen early in the cycle meaning you will get taken out for a profit early. Other times you might have to hold you know 20 25 days into the cycle or all the way until expiration.
Before something turns around. For going back to the start here you can see that if we traded another strangle, that same strangle the last month here, or the last moth the trade didn't turn out to be a profitable trade until the last four or five days of expiration.
So you had to wait a long time for this trade to come back in now this isn't saying that we obviously sell a strangle like this if the market was higher.
We would obviously adjust the strike prices, but I'm just trying to prove the concept that sometimes it takes a little bit longer for trades to come in sometimes it happens early, sometimes it happens later in the expiration cycle.
So the reality is is that its not unreasonable to increase your win rate by as much as ten percent or more by closing trades early and taking profits. Meaning a 70 percent probability trade would see 80 percent winners if profits were taken early and then trade when its closed out.
In fact, we can prove this concept because we published our performance and live stats all the time on Option Alpha and our three-course strategy just to give you a sample of this right now.
Our three-course strategy to which are strangles straddles, and credit spreads. All options selling strategy win at 84 percent 82 percent and 78 percent. Now if you think about it all of the trading that we do here at Option Alpha is placed at the 70 percent probability of success level.
So the fact that we are wining at 84 percent is just meaning that we are taking trades off you know so early, that we are actually winning at about a 14 percent higher win rate with our strangles a 12 percent higher win rate with our straddle and then 8 percent higher win rate with our credit spreads by managing these trades early and banking these profits early.
And that's again why we kind of place trades around 70 percent chance of success because we know we can win about 84 percent of the time.
If we ended up placing trades around the 80 percent chance of success level, we might end up winning about 85 or 90 percent of the time, but in our opinion its not worth giving up so much premium to go that high for an initial probability of success level.
But again this proves the concept that we are talking about here, you know when we go back and track all of our trades and publish them live, in our performance stats. We defiantly see that our win rate is much much higher than the initial probability level that we are covering.
So lets go through a couple of examples of current trades that we have on right now so that I can show you how we set up these automatic closing trades, cause I think its really important and again this is based on what we have right now at the time that I'm doing this video.
So this is about as real as we can get. I have taken off a couple of the working orders that we have, just so I can rebuild them here for you guys, and kind of work through the process.
So lets start here with some call debit spreads that we have these are directionally bullish trades. So these are where we were being a couple of nat buyers of options trying to play a couple of these ETFs a little bit higher.
So if we go back to our slides here, you can see that if we are doing a Paul debit spreads which is a Bullish Trade, we wanna take these trades off at 50 percent of max potential profit.
So now going back to our thinker some platform lets look at the first one here which is em, now em we bought for a 55 dollar debit, the width of the strikes here is a dollar, so the max potential gain that we could have for this trade is 45 dollars.
So half of that, so again 50 percent of that max potential gain, or half of that max potential gain, would be a profit of about 22 and a half dollars. So lets just round it to down 22 dollars. So what we are gonna do is we are gonna add 22 dollars to the value of the contracts that we bought.
Because that's what we wanna do, we wanna increase the value of this contract, and hopefully take it off at a 50 percent of max profit gain. So if we go here and right click on create closing order to sell back these verticals and em.
It's going to bring up this order dialog box and what were gonna do is create this contingency order that says OK basically buy these back at 72 dollars. So basically what we are gonna do is add that 22 dollars to the 55 dollars that we had originally, and we are gonna buy this back at 72 dollars.
Now remember the maximum value of this spread if it went all the way to expiration and was totally profitable is 100 dollars, that's the width of the strikes here. So we are gonna try taking it off early whenever it reaches a 72 dollar value.
And again we are just going to put that 72 dollars in here and now what we are going to change is instead of doing a day order, we are going to say GTC and what GTC means is that it's going to be good until cancel meaning this order is gonna work and it's gonna try to get this trade-off at 72 dollars, until it gets filled or we hit expiration.
And that's all we want to do. We want to let this trade work as long as humanly possible. So I went ahead and placed this order, I'm gonna hit send, and so that order will not be working in the market.
And now you can see in our order dialog box up here, that we have our closing order, it's a GTC order very similar to the sums of our other trades and orders right here, its a GTC order that's gonna get us out at 72 dollars, whenever the value goes up to that price point.
So right now the mark is at 55 which is almost what we paid for the value of the spread, but it's just gonna keep working, so as long as this order keeps working for the next basically 50 days whenever we have an opportunity to take money off the table, this order will automatically get us out I don't really have to think about this trade anymore because I know that I have already controlled my position size, I know that I am willing to lose you know a couple about 150 dollars on this trade if it doesn't work out.
But it should hopefully you know hit that profit target. So again let's look at another one here with FXI, so FIX is another call debit spread that we are trading. And you can see that we paid for FIX a dollar oh five. so we paid one oh five.
Now, this is a two dollar wide spread, so it's gonna be a little bit different. In this case, our max potential gain on this trade is 95 dollars because that's the value of this spread. The spreads gonna be worth two dollars at expiration. Meaning that we can only make 95 dollars on this trade if it were to go all the way to expiration and be profitable.
So half of that 95 dollars is 47 and a half dollars. And again we will just round down you don't have to be exact with you know 47 and a half dollars, but let's just say we want to add 47 dollars of value to this contract. So if the contact starts at one oh five, we add the 47 dollar value.
We are looking to close this trade when the value of this contract goes up to 152 alright. So what we are going to do is we are going to do the same thing we did with EM we are going to right click here, create a closing order, and we are going to say sell and now we are going to adjust this price to 152 which is our profit target on FXI and again were going to change the type of order from day order to GTC.
So I hit confirm and send, submit the order in, now in my order dialog box my working orders, you can see the two orders that I have now created here. These are gonna constantly work until they get filled or until we reach expiration and we will just keep working through that.
So let's go through a different one here, let's look at this calendar spread in SPY, So we are trading a calendar spread in SPY we are using a put calendar spread. So we've got the May 200 put, and we've got the April 200 put.
If we go back to our slides since we're doing a put calendar spread, you can see that it's a Bearish Trade, and our put calendar spread needs to be exited at a 25 percent gain of the net cost that we got to get into the trades.
So a 25% gain means we are going to take profits a little bit sooner. So once the value of the option goes up by 25%. So all we want to in this case is look at the value of the option that we paid, so this is 195, and we want to increase the value of that option by 25%.
So if we take 195 and increase it by 25%, we're looking at closing out this trade of a profit whenever the value of the spread goes up to 243. So that's again I'm rounding down here not using exact numbers. It's 243.75.
But if we want to take this trade off we are going to enter a closing order, to close out this trade when the value goes up to 243. So again its going to be very similar to those debit spreads but now you're basing it off of the current price, not the max potential gain.
So I'm going to create a closing order, I'm going to type in here 243 to enter that automatic order, and again we are going to change it to a GTC and confirm and send and submit the order.
So now that that order is working in there as well, again it's going to get us out at 243 whenever the value of that calendar in SPY goes up to that price point.
Alright, let's look at a couple more examples here, let's look at some Iron Condors which are very similar to credit spreads. So if we look at for example Chipotle in this example, we enter the Chipotle tray which is a neutral Iron Condor, and we sold these Iron Condors for a dollar 25 each.
Now, this is a little bit different because now we are on the options selling side, so our max potential profit, since we sold this spread or this Iron Condor for a dollar 25 is the dollar 25 that we took in.
If we go back to our slides here and we go to the Neutral section, you can see that if we are doing a balanced Iron Condor or just an even Iron Condor, that we want to take money off the table or take profits whenever the value or whenever we reach 50 percent of max profit.
So again since we are selling Options the value of the Option has to go down for us to make money. So 50 percent of the 125 that we have sold means that we want to take this trade off when the value goes down to 62.50.
Okay, that's our profit target on this trade. Right now it's trading at 125 that's what we sold it for. That's the max potential gain. Half of that gain or 50 percent of that gain is six 25. So now when I go into buy back this order to close.
So right click on it and go to Buy Iron Condor to close, now it's going to create a buy order, and I want to buy it back whenever the value goes down to let's say 62 dollars essentially 62 and a half, but let's just say 62 dollars.
And again we are going to create this GTC order. So once I submit this now this is going to be working in our position activity statement, again you can see these different orders are now working for Spy, FXI, EWW.
This Chipotle order is now gonna buy this thing back whenever the value decays back down to 62 dollars. Right now it's worth about 92 and a half dollars. So we are making money on the Chipotle trade, we're making about 65 dollars on this trade.
But we need to make a little more money on this trade before we hit our profit target on this trade, meaning it's gotta work just a little bit longer before we are comfortable taking this thing off for a big profit.
Let's look at another example here with USO. Now, in this case, USO is an Iron Condor in think or swim, but if you notice, this trade in the way that we send it out to our members is an Iron Butterfly.
And the reason it's an Iron Butterfly is that the short strikes or the contracts that we sold are at the same strike price. Okay and again if you sign up for a Pro or Elite membership, we always tell you if its an Iron Butterfly or an Iron Condor. But Think or Swim doesn't have a way to distinguish that its an Iron Butterfly, they just say that its an Iron Condor.
So again if we go back to our actual position statement here, or our slides here and take a look at where we take money off the table with an Iron Butterfly.
You can see that a Neutral Trade is an Iron Butterfly takes money off the table when we have 25 percent of the max potential profit or when we have made 25 percent of max potential profit.
So we go back here and we look at USO you can see that we sold this Iron Butterfly in USO for a dollar 45. So if we take this trade off at 25 percent of that potential or making 25 percent of that max credit which is a dollar 45, we'd be looking to take the trade off at around one oh eight.
So a value of one oh eight, now you can see right now that that trade is already in our profit zone. So we could go in and close out this tray right now and remove the exposure and take profits, and that's exactly what we are going to do. I just want to do this on the video with you guys.
So you can see it's already inside of our profit zone. If we had a working order a closing order to get this thing off automatically it would have been you know submitted and filled at one oh eight, but today it's actually coming in around $99 of value so we should make about 136, $135 by closing it out and buying it back for about a dollar.
So we will submit that order, might get it filled as we are talking here on this video. But you can see that orders are working right now. We are going to buy it back at about a dollar.
It's worth about $99 right now, so we are paying a little more than market value, but since we sold the spread at 145, we should make some money on this trade as well. Okay So hopefully that's a really good example of how we can use a lot of these Contingent Orders in our favor.
Again the key here is just to remember that you have to buy back orders that you had originally sold, and if you bought options, you have to sell them to close out the trade. And that's the key. But take your time with this.
Make sure you go through our When to Exit Guide I think that's key and understanding, you know why we close out trades early. These are going to be easy to follow cheat sheets for you on Bullish, Bearish, and Neutral Trades. To make it insanely easy for you to place these automatic closing orders.
Now, remember the more times that you can automate this process the faster and faster your going to be at increasing your win rate, and increasing that potential profit, so you have long term.
So Thank You so much for checking out this video. Hopefully, it was educational for you, helped you out and understand why we close out trades early, how you can do it on your end. If you have any comments or questions, please ask them in the comment section right below.
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