FAQ Section

Trade Adjustments


Do I really need to master adjustments to be successful trading options?

No. The ability to make good adjustments to losing trades is never more important than your trade entry. Ironically enough most traders assume that adjusting and hedging trades that go bad is the most important aspect but it’s not. If you start with a bad trade (the wrong strikes, wrong strategy, horrible pricing, etc.) no amount of adjusting can save you over time. Instead, you should be focusing on making small positions at a high probability of success in keeping your overall portfolio as neutral as possible. Meaning, that you don't have too many bullish or to many various trades, but a good mix of both. If you do this consistently and never made an adjustment, you would be successful long term by entering high probability trades on a consistent basis. Making adjustments will increase your returns and tweak your performance but on a very small scale compared to the necessity for entering new trades correctly.

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Should I be watching the overall position deltas or the individual option deltas when planning for an adjustment?

Both. First, when planning to adjust an individual position you should be monitoring the delta of the short strikes in that position. For example, if you sold a put credit spread you would be monitoring the short option that you sold. This is because it will give you a better understanding of your new probability of losing or winning on the trade by basing the deltas off of an individual strike price. Next, when you're looking to add new trades to your portfolio, it's also important that you consider the beta weighted deltas of all your positions collectively. If you already have too many positive deltas, then you might look to you either take some trades off that are profitable and or start adding trades that are bearish with negative delta. Using the put credit spread example above, you would hedge that trade with a bearish call credit spread which works well for the individual trade and the overall portfolio since you needed more bearish trades anyway.

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Are there any triggers for when you should start to make an adjustment?

Using a .30 delta is a good road marker to use for starting to make adjustments to short premium trades such as credit spreads, iron condors, and strangles. Because most of our trades are placed at the 1 standard deviation level (or about a .15 delta), we use .30 delta as our "trigger point” to adjust. With a short premium strategy, if the market tests one side of the position and the delta of your short option increases from .15 to .30 delta then that "triggers" you to roll up the untested side closer to the market to take in more premium. As always this is just a starting point. Some traders will use a .40 delta or .50 delta if they are willing to let the trade move a little more and want only to adjust when needed. There is no right or wrong way to go about it here; you can use whatever delta you want as a guideline for adjustments, just stay consistent in your methodology.

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What is the best way to adjust a credit spread trade that goes against you?

Your first and best adjustment to a credit spread trade is to add the opposing side of the trade once the market starts to move against you. If you have a call spread above the market and the stock starts to rally higher, you would add a put spread below the market. The key to making this type of adjustment is to keep the number of contracts the same as well as the width of the strikes. This ensures that you are not taking on additional risk and that the credit received from selling the opposing order helps reduce overall risk and widen out your break even points. I suggest starting to make adjustments on a credit spread when you're probability of losing doubles. So, if you make a one standard deviation credit spread entry with a 15% probability of losing money, then you would start to make adjustments if that short option now has a 30% probability of losing money. This is just one way to go about making adjustments, but you can see that it's all about having some set of rules or guidelines to follow and sticking with those.

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What is the best way to adjust a short straddle trade that goes against you?

Because of the undefined risk feature in a short straddle, you need to be a little more aggressive in your adjustments and management of these types of positions. Our first adjustment would likely be to roll up/down the side of the trade that the market is moving away from and collect more premium. So if the stock moves higher, you would roll up your put strike, and if the stock moves lower, you will roll down your call strike. Now, since a straddle starts with the same short call and short put strike, once you start making adjustments you’re going to create an inverted position (meaning the put strikes are higher than the call strikes). You don't want to get caught going too inverted on these short straddle trades because each time you go another $1 inverted it reduces your profit potential even after collecting a very big credit upon trade entry. At Option Alpha we suggest 1 or 2 adjustments at most and then from there let the trade go until it shows a profit. And finally, you should always look to manage and close these straddles with quicker profit targets at 25% of max profit which is much earlier than most of our other short premium strategies.

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What is the best way to adjust a short strangle trade that goes against you?

Short strangles are entered with wide strikes to begin with that should give you ample room for the stock to move and still make a profit. Most of our strangles are placed with a 70% chance of success meaning that each short strike is sold around the .15 delta level. Whenever one side of the trade’s short strike increases to a .30 delta (or effectively a doubling of risk) we would prefer to roll up/down the untested side of the trade closer to where the stock is trading to take in a net credit. This would mean closing out of the short strike furtherest away and re-opening a new short option that helps widen the break-even points overall on the position. It’s also important to note that we would never move the tested side of the trade that the market is moving against as this would compound losses and risk. For example, if a stock was moving higher we would roll up the short put strikes and not move the short calls strikes.

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What is the best way to adjust a short iron condor trade that goes against you?

While there are many ways to adjust an iron condor trade we prefer that our first adjustment is to roll up the untested side of the trade when the tested short option reaches a 0.30 delta. Because we enter our iron condor trades at a one standard deviation level to begin with (or approx.15 delta) a 0.30 delta would effectively be a doubling in our probability of losing and for us that is the appropriate level we deem necessary for making our first adjustment. After this adjustment, we will let the trade go all the way to expiration win or lose and let the probabilities work themselves out. With risk defined trades like iron condors and credit spreads you are much better off not over adjusting these positions but rather keeping your position sizes small and trusting that the probabilities will work out in your favor over time.

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What is the best way to adjust a debit spread trade that goes against you?

Debit spreads are entered typically when we have a directional assumption on an underlying stock. This means that they are more often than not a 50/50 probability of profiting which is why we trade very few of them each year. That said, we do not suggest that you do much (if any) adjustments to these types of trades because you’ll end up having to increase your risk in the trade for adjustments. You're much better off to let these trades work themselves out and keep your position sizes very small given that they are not high probability trades. At Option Alpha, we use debit spreads mainly for hedging purposes against other trades and not as a general course of income generation.

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What is the best way to adjust a butterfly spread trade that goes against you?

Butterfly spreads are narrow risk to reward trades that we do not suggest you adjust but rather let them go all the way until expiration and let the probabilities work themselves out over many different occurrences. Risk management on these types of trades is best done at order entry by making small, reasonably sized trades.

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What should I look for when considering to roll a trade to the next contract month?

When considering rolling a strategy from one month to another, it's important to consider the following three points. First, did your underlying assumption for the stock’s direction remain the same or has it changed? If you were originally bullish, are you still bullish on that stock for the next month out in order to maintain the same type of position? If you are not, why would you want to hold that position for another month if you think the stock could now go the other direction? Second, you want to make sure that you are not paying to roll a spread or strategy to the next month. At Option Alpha when we are faced with the possibility of rolling a short premium strategy from one month to another, we would like to take in a credit for the roll because we are adding time to the trade. If you cannot take in a small credit or pay a very small debit then it's not worth rolling the strategy, and you are better off to close the position and reset the probabilities at new strike prices for the next month. Last, you want to make sure that whatever you ultimately choose extends the trading timeline while keeping your risk to reward the same or similar to the original trade. If you are taking on substantially more risk just for the sake of extending the trading timeline, then it's not worth doing. Take the loss in the current month and move onto other trades. Don’t force a trade when it just doesn’t work.

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What is an inverted position and what do I need to know about them?

An inverted position occurs when your short put strikes are above short call strikes. For example, with a short strangle you would typically enter the trade by selling a short call above where the stock is trading and simultaneously sell a short put strike below where the stock is trading. If you went inverted you would have the call strike below the put strike at some point. It’s important to remember that with inverted positions, the least that the strangle will trade for in the open market is the difference between the strike prices. An example would be a short $50 call and a short $55 put - the least that this position would be worth in the future is $5. So, if your total credit in the strangle after adjustments is only $4 then you would be in position that would effectively guarantee a loss of $1 at expiration. For this reason, we always suggest that you don’t go inverted by more than the overall credit in the trade to ensure you’ll still have room to generate a profit.

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