Lesson Overview

Big Picture Options Trading Adjustment Strategy

Before we get into adjustment details and techniques, I think it's important to walk through the big picture concepts on making trade adjustments as an options trader. The reality is that it focused much more on "stopping the bleeding" than it does on "making more money."

More Discussion

Was This Helpful? Add Comments/Questions

  • Yep you can use some very wide stop losses if you need to. Based on the backtesting we’ve done on this 3X or 4X your initial credit is a good starting point. Honestly though the backtesting numbers suggest that as long as you can adjust for a credit, roll when needed for a credit, that maintaining the position and waiting for the market to normalize is the best course of action. But, this does mean you could have some big losers here and here on the way. My feeling on this is that I’d rather maintain a position in an ETF whenever possible and use the wide stop losses with regular stocks.

  • shan naidu

    Hi Kirk:
    I learnt some thing today. Adjust put side when market is going up and call side when it is going down. This is very important to me because I add more positions when it is going down. Thank you

  • We can roll out the challenged side and do show examples of that in the next video in this series. The key like you said is that you HAVE to take a credit to roll it.

  • Sure I think there is always a point at which rolling for infinite times doesn’t make sense but using your /CL example it’s already back to near $50 now so would you have continued to roll, taking in a credit each time which reduces the break-even point lower and lower it’s not completely out of the question that you could have had a smaller loss by rolling than not – again not saying you should have done it it all cases but that it still might have worked better than just taking the biggest loss possible.

  • Yep and at that point you want to be careful of not going too far inverted.

  • You can’t unfortunately since it will think of it as 2 separate trades. That said I just put them both into groups in my account position on the main page so I can watch them together.

  • Though I don’t suggest you roll infinitly, you could in theory since there will always be another 30 day contract (or monthly expiration) in the future.

  • Troy

    Hey Kirk – at the 13:40 mark, when the market is moving up, you said to leave the losing call alone and don’t touch it. I assume we are closing it out (so we don’t get assigned), especially heading when it’s ITM going into the the week of expiration. Is that correct, or am I off?

    • Yes correct we do close it the week of expiration we just don’t adjust it.

Show Video Transcript +

In this video, I want to talk through some big picture options trading adjustment strategy. So, as we have previously talked about, adjusting and hedging options trades is an important skill to learn and develop. Though, not as important as trade entry, it can help reduce risk and "save" positions that go bad.

So in today's video I want to first walk through the big picture concepts on making trade adjustments before we start to get into specifics, and we will start getting into the specific techniques and strategies that we use to adjust trades as you get through track #3, but it is important that you watch this video because you have to understand why we are doing what we are doing and kind of what the overall goal is.

So, here is how we lay out kind of the big picture strategy when we think about trade adjustments, and it comes down to five things that we have narrowed down.
1) Never increase position size or risk.
2) We have to stop the bleeding and then save the patient.
3) We need to look at the single trade adjustment versus the adjustment on the portfolio side, and that's impact.
4) We always want to be taking in credit, that way we have wider breakeven points.
5) We have to keep it systematic.

So, the first thing we talk about is never increase your position size risk. Now hopefully this goes without saying, but throwing more fuel on the fire and hoping it will turn around never works.

I'm sure if you've gone this far into our training and you've made trades before in the past, you're just getting started with trading, you realize that you have to be willing to accept a full loser sometimes in this game because sometimes things never turn around.

In our opinion, that means that you know right off the bat that you might have a losing trade every time you enter a position, so you have to be willing to accept that loss, manage your position size accordingly on trade entry, and not throw more fuel on the fire.

Don't add money and throw bad money after bad money. If your trade is not going well and is not working out, why do you think in the world that adding more money to it will help it? It just never, never works, okay? And in the rare cases where maybe it does work, it is the exception to the rule.

Number two is that you have to stop the bleeding before saving the patient. This is a concept that I talk about a lot in coaching with people and a lot of our elite members on weekly strategy calls, but the whole concept of making a trade adjustment is first to reduce risk.

See, everyone has the misconception that when you make a trade adjustment, it's to increase potential profits or to turn the trade around and make an adjustment so that it turns it automatically from a loser into a winner.

And while that is obviously the goal, the goal is obviously to turn a bad trade into a good trade, a loser into a winner, the first thing you have to realize about trade adjustments is that your number one priority, first and foremost, reduces risk and reduce the loss.

So that's the first thing, that's why the concept of making adjustments for most people is a little bit backward, they think about profit first. It is no different than if a doctor is operating on a patient that comes into the emergency room.

If they are bleeding from all different angles and they are losing blood, the first thing the doctor has to do before they save the patient stops the bleeding. That is the same thing you have to do with trading; you have to stop the bleeding first.

You have to reduce risk, reduce the potential loss, then worry about potentially turning the trade around and making a profit on it.

The next thing, number three that we talk about is a single trade versus portfolio impact. So the question you really should be asking is, are the single trade adjustment that you are planning on making good for the individual position and the overall portfolio?

So, for example, if you are going to be rolling up a short put, which is a bullish type of adjustment because you're moving the pud strike from say 45 up to a 50 strike, but your portfolio already has too many bullish positions, to begin with, do we really need to be making that type of adjustment?

Again, it might be good for the individual trade, but it might be bad actually for the overall portfolio. It might put you in a position where now you're insanely bullish or uber bullish, whereas maybe you can afford not to adjust that position and leave it there because it's better for the overall portfolio.

So, in our opinion, obviously we will talk about this a little bit more in other videos, but we think you should never sacrifice a single trade for the sake of the overall portfolio, meaning that sometimes you have to let a trade go unadjusted and a loser, because adjusting it and focusing just on that one individual trade, would be detrimental to the profitability of the other positions.
I will give you a clear example of this. If you have, let's say a couple of positions on, your overall portfolio right now could make, let's say $5,000 for the month.

But one position is going bad, and you're so concerned about being wrong and being a "bad trader" because you didn't get the direction right or you didn't have volatility right.

You're so concerned with that one trade that you make an adjustment to that trade and now your portfolio overall, after making an adjustment to that one trade, now can only make let's say $1,000 for the entire month if everything goes right.

So sure you might win on that one individual trade and now you feel good because you're right and you're a great trader and all this other stuff, and you feel really motivated because you made an adjustment to that trade, but the impact on that one adjustment and how it impacted the rest of your portfolio actually reduced your overall profitability by $4,000.

So, I think you have to be concerned as you start becoming a little bit more professional in this business, start becoming a little more advanced in how you manage your portfolio and trades, you have to think about the single trade adjustment versus the portfolio.

This also means that if you have a trade adjustment that say is a bullish adjustment as we talked about in the last line, rolling up a put, if you have that type of adjustment and your portfolio needs to be more bullish, then that works out in both cases, right?

That's a good type of adjustment to make because you needed to adjust that individual position to make it a little bit more bullish and your overall portfolio needed to be a little bit more bullish, so that's a great type of adjustment.

Okay, so again, it's not that there are black and white clear barriers here, it's just understanding how a single trade impacts the overall portfolio and sometimes it's better to lose on a trade not adjusted, take a full loss, whatever the case is, because you'll still be profitable overall on everything else.

The fourth thing that we talk about is always take in a net credit. Now, this hopefully should go as kind of a no-brainer here, but as option sellers, we should be focused on always taking in a net credit when making adjustments.

This widens our breakeven point, it reduces our maximum risk in the trade, and it increases our potential chance of success. If we widen our breakeven points on a trade, kind of after the trade has moved against us, we have a better chance that we could see the stock land inside of a profitable zone.

To use a very simple iron condor example, just to prove this point, there's no case where I think that you should be paying to make an adjustment, meaning that it would cost money or a net debit as an option seller. You should always be taking in a net credit.

So let's say that you did this original $5 wide iron condor, and this is what an iron condor payoff diagram looks like, you can see that if you took in a credit of $100, your maximum risk in this case, since it's a $5 wide spread, would be $400.

If you made an adjustment to take in a $50 net credit, let's say you rolled up the put spread side or rolled down the call spread side, whatever the case is, but you made an adjustment to take in $50 of net credit to add to the trade, so that goes on top of your $100 credit that you originally have.

Well, now your maximum risk gets reduced down to $350. So now you've cut your maximum loss from $400 to $350, that's a smart adjustment. Now in this case, maybe the trade still goes against you, and you still lose, but now you lose $350 versus losing $400.

The alternative to this would be to pay $50 in a net debit. So for some reason, if you wanted to pay to adjust this trade, which we never suggest doing, then you've increased your risk in this position up to $450 because you've used $50 of your $100 credit and now you're left with only $50 of potential profit.

So, we never suggest paying to make an adjustment. You should always be taking in a net credit. Now, this also means that we'll never move the side of the trade that the market is testing or challenging or moving against, you'll hear all kinds of terminology around this.

We never want to dig ourselves into a deeper hole. What this means is that if the market is moving up, don't roll up your call side. That is a common thing that people like to do; they like to roll up and out. We never suggest rolling up and out.

If the market is moving down, don't roll down your put spread side. Don't roll down and out your put spreads. So if we look at just a simple example this year with GLD today, so GLD at the time that we are doing this video has had some pretty large moves, okay, pretty large moves.

So let's say that back here in October you went ahead and sold a strangle around where the market was trading, so maybe you sold the 117/118 calls, maybe the 108/107 puts, okay?

If the market is moving down against your position, what most people do is they take this side of the trade, which this is your put spread side or your put option side, they take that side, and they move that side down a little bit further and try to give themselves more room.

That is the completely wrong way of going about it because then you dig yourselves into a deeper hole. Because think about what would happen if you rolled down this side. So first, if you enter the trade and the stock starts moving against you immediately, you are losing a ton of money on this side of the trade.

So you are already losing a ton of money because the stock is moving against you. When you close that position, you're going to close that position and bank that loss, okay? So you're going to immediately lose that amount of money on that side of the trade.

Then when you reopen this new position, you're going to take in less money or less overall credit then it costs to close the put at the higher price. It only makes sense, right? The puts at a higher price or higher strike price are going to be worth more than your new put options that you want to sell down below the market.

But now again, let's continue the thought process and now let's say that three days later GLD continues to fall and just continues to fall and continues to fall, well now you've basically put yourself in a position where you are digger yourself a deeper and deeper hole by rolling down this puts spread and some people continue to do it.

Maybe they do it one more time, and they keep rolling it down. You just keep on banking losses every single time that happens and its never a good way to go. In our opinion, you put your line in the sand someplace.

If the market goes against you, in this case, and now you have these two strikes, this is your call spread side, and this is your puts spread side. If the market starts moving against you, you move down this side of the trade.

You move down your call spread side, and you take a profit on this side because you're closing out this call as the market is moving away from you.

So those are going to be worth more money and you roll it down to something closer where the market is trading for a higher credit, because, again, these calls that are closer to the money are going to be worth a higher credit.

That higher credit naturally moves your breakeven point down a little bit further on the puts spread side. So you naturally get that type of exposure, it's just the way that you go about it has to be a little bit different.

So you have to move down your call side when the market is moving down. When the market is up, you have to move up your put side. So let's go through another example here on the reverse.

So let's say back in January of this year you went ahead and sold a call spread, or a call/shore call, doesn't matter about 109/110, and then you sold one down below the market. So you did a very neutral trade, doesn't matter if its an iron condor or strangle, whatever. These are your call spread sides, your call that you sold, and this is your put option that you sold down below the market.

Now again, the same concept makes sense here is that if the market starts moving against you, what most people do is they move this call strike, say maybe it was at 110, they move this call strike up and out, to say 112, so now their new call strike is at 112.

But again, if the market moved against you immediately, this call is now losing money, it's losing a lot of money as the market moves against us. So by closing this out, we bank a loss. We guarantee that we lost on that trade and we re-establish it at a new level with less money.

We take in less credit to re-establish it at a new level. What's to say that the stock can't keep moving against you, so the stock just keeps moving against you and moving against you, right? Now you just continue to compound this loss and keep rolling up your call spread side.

That's what most people do, they just keeping rolling this up. You can see that in the case of GLD, this huge move that gold recently had could have created a lot of compounding losses that somebody would have had in this case.

In our opinion, what you should be doing is if you have this call spread here, where this sure call, and you have the puts down below the market, somewhere around here, if the market moves up you don't touch this call. You leave it there.

It's a loser, so you don't want to compound your losses by closing and rolling and closing and rolling and closing and rolling. What we want to do instead is roll up our put side to something closer to where the market is.

So by doing that we guarantee a profit on this put because the market is moving away from this short put, so that thing is going to lose value very quickly, become profitable. We close it out, guarantee a profit on that individual side, then we roll to something closer for a higher net credit.

That net credit then moves the breakeven points out a little bit further on the call side, and then we can roll up the put side again and again, and we can go inverted if we need to. We just keep moving the side of the trade that the market is moving away from or not challenging and not testing.

It's a hard concept to understand but hopefully, that was a good description here with GLD and GLD is a good case study right now as to why you don't want to roll the side of the trade that the market is moving against.

So the last thing, number five, is that you have to keep things systematic. We always think about keeping things systematic with if-then statements. This is starting to kind of pre-plan out or pre-think out your adjustments into the future.

There's no doubt that losing trades make you emotional. Period. End of story. Me too, everybody. I mean if you aren't emotional losing money then you maybe aren't even human, right? So there's no doubt that it makes you emotional, but to control your reaction, you need to develop a way to keep adjustments as systematic and robotic as possible.

Now again, we're going to be going through this step by step and showing you some tools and tricks on how you can keep it systematic, how you can create different trigger points and guideposts for when you should make adjustments.

We will be covering that in other videos, but the concept is real, critical. You have to make sure you know exactly what you are going to be doing in the future. I always think that with making trade adjustments it should never be something that is rushed into.

You should be thinking in advance, hey, if this goes against me, what do I do? Then I need to look at making x adjustment or look at rolling up or rolling down x side of the trade.

So just as a quick little bonus tip, please analyze your trades. This is something that I harp on a lot with our pro and elite members, is that most people don't analyze their trades before they make adjustments.

So use your broker's platform or portfolio analyzer or an analysis tab software section, whatever you need to, to look at the simulated adjustment before you place the order. See what the impact is going to be in the position. See where your new breakeven points are.

Look back at the charts. Does that relate to where you think the stock might go or could go? You know, like look at some of these things. Take your time and think through your analysis. There's no need to rush into making an adjustment.

Like I said before, I think you should be thinking about an adjustment. You'll see that trades are starting to go against you and before they are completely against you, you'll have ample time to think through the adjustment process.

So take your time with it because, again, if you enter the trade correctly and your order entry is sound, which we have hopefully coached you through here at Option Alpha, making sound order entry. Then making adjustments is just going to help tweak your returns and increase your returns just a little bit more.

It cannot save bad entries from the beginning, right? So there's no need to rush into making adjustments. Make sure that you take your time and make the right adjustment. Please analyze your trades; it's going to help you out tremendously.

So thank you so much for checking out this video. Hopefully, it was helpful. If you have any comments or feedback, I'd love to hear it in the comments section right below. If you enjoyed this video, if you loved it, please consider sharing this online. Help to spread the word with what we are trying to do here at Option Alpha. Until next time, happy trading.

eBook Download

The "Ultimate" Options Guide

Ultimate Options Strategy Guide

The step-by-step guide on how to set up each of the top 18+ options strategies we trade to generate monthly income. Read the whole strategy guide in less than 30 mins and have it forever to reference.

Download PDF

Join More Than 47,345 Members

Membership is always free & you can upgrade anytime to unlock our live trades.