You've entered a new option trade with a high probability of success - but you also know that a 70% chance of success doesn't mean it's a sure thing. As soon as your order fills the stock starts to move against your position - just your luck right? And each subsequent day the stock continues to trend closer and closer to your strike prices, threatening your position. At this point, you're starting to get pretty emotional about the whole thing and don't know what to do or how to adjust it.
When do you pull the trigger and make an adjustment? Do you do it now or is it too soon? If you wait, what if you miss an opportunity? How much time is left until expiration? Are you taking in enough of a credit to reduce the overall risk? Is it worth it to even adjust at all right now?
Believe me; I get it, and I know that these are just some of the questions circling in your head when presented with this situation. That's why in today's podcast episode I'm going to take you through three specific triggers you can implement right now to help you start making smarter, more unemotional option trade adjustments when a stock starts moving against you. You'll also hear why I favor trigger #1 over the others as it's a more mechanical and systematic.
Setting Up Adjustment Triggers
How do you know when to adjust positions?
- There are many different ways to adjust positions.
- Need to lay the groundwork to set triggers in advance in your trading platform.
- This allows for unemotional trade adjustments.
- Creates a framework and process to give clear guidelines on how and when to adjust positions.
1. As a trader, most of your attention should be on the trade entry.
- Most of the emphasis — your focus, research, and analysis — should be allocated to the trade entry.
- Example: using the right strategy, setting it up for a high probability of success, checking the position size.
- It is more important to get the trade entry right than it will ever be to get trade adjustments right.
- A bad entry will not be saved or turned around through adjustments.
2. Adjustments are 100% focused on reducing risk first, not increasing profits.
- The goal of the adjustment is to lose less money.
- A successful adjustment is one that cuts the overall loss of the trade.
Three Main Adjustment Triggers
1. The Doubling of Risk Rule.
- Initial trade set up: a short strangle — a short call and a short put out of the money — at 70% probability of success, each side placed the 15 Delta.
- Only make an adjustment if one side has risk that doubles.
- Example: If the probability of losing doubles from 15% to 30% on either side, consider making an adjustment.
- Set up a trigger to alert you when the risk has doubled, to then allow you to consider making an adjustment.
- Once the adjustment is made and the probabilities have been reset, use the same doubling of risk rule in case the stock continues to perform against you, using 60% as the second trigger.
- This strategy allows you to make unemotional adjustments to reduce risk.
Why use the Doubling of Risk Rule?
- The Delta is not subjective just to stock price movement. It is a substitute for the probability of losing.
- When Delta is the adjustment trigger, it naturally factors in time decay, time until expiration, volatility, etc.
- These extrinsic factors can help ensure that you do not over adjust too early, or under adjust too late.
- Creates a level playing field across all different types of stocks and all different types of ETFs.
- For these reasons, the Doubling Risk Rule is the most favorable strategy.
2. The Breach of the Short Strike.
- Simply make an adjustment any time the short strike gets breached.
- Example: if the stock is trading for $100, you sold $105 calls and the $95 puts to create a strangle. Any time the $105 calls or $95 puts are breached and the stock goes beyond those levels, then make an adjustment.
- This strategy is based more off of the stock price than other factors.
- Naturally, it could cause adjustments that are not needed.
3. A Breach of the Long Strike.
- Example: a stock is trading for $100, you sell the $105, $110 credit call spread. Only adjust the trade if it goes against the long strike, really far out of the money.
- This strategy is less favorable because it takes a while to adjust the position.
- With this, you are basically waiting for the trade to be dead, and by that point, there may not be enough premium or credit to take it in when you make the adjustment.
- Even if using any of these three strategies, need to evaluate if it is still worth it to make the adjustment.
- Example: If adjusting the trade brings in an extra $5 of premium, is it most-like not worth it to adjust it and move in one side of the trade just to get an extra $5 before commissions.
- Is it worth taking more risk for the potential credit?
- As a barrier, need to take in at least $20-$30 credit.
- If trading spreads, take in at least $15-$18 as a bare minimum, at least enough to cover the premium in the position.
Iron Condor and Credit Spread Trades in Retirement Accounts
- If you reach the adjustment triggers, you ideally want to move the whole spread -- do not want to take on any more risk.
- Close the further out spread, sell the complete new spread a little bit closer in.
- This creates more work to close one side and reopen the other, but this helps to reduce risk.
- If you just move on the short strike, you will leave the long strike and widen out the spread which increases the margin requirement.
At The Money Strategies; Straddles or Iron Butterflies
- Can adjust the positions, but want to go slower and practice more patience with adjustments.
- Leave the position on to go for a longer time period.
- Since it is already at the money, need to manage the position early and avoid having it go inverted.
- Best to close the trade out early and manage it early on, which will increase profitability dramatically.
- If you do have to go inverted, try not to go inverted by more than the credit you have taken in.
- Sold an at the money straddle at $100 — the short $100 call, the short $100 put.
- If you go inverted, move up the put to the $105.
- This $105 is now higher than the short call at $100.
- When you go inverted, the minimum that the spread can be bought back for is the width of the inverted strikes, the $5.
- Be cognizant of the total credit taken in, and make sure not to go inverted by more than that credit.
Free Options Trading Courses:
- Options Basics [20 Videos]: Whether you're a completely new trader or an experienced trader, you'll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options.
- Finding & Placing Trades [26 Videos]: Successful options trading is 100% dependent on your ability to find and enter trades that give you an "edge" in the market. This module helps teach you how to scan properly for and select the best strategies to execute smarter option trades each day.
- Pricing & Volatility [12 Videos]: This module includes lessons on mastering implied volatility and premium pricing for specific strategies. We'll also look at IV relativeness and percentiles which help you determine the best strategy to use for each and every possible market setup.
- Neutral Options Strategies [7 Videos]: The beauty of options is that you can trade the market within a neutral range either up or down. You'll learn to love sideways and range bound markets because of the opportunity to build non-directional strategies that profit if the stock goes up, down or nowhere at all.
- Bullish Options Strategies [12 Videos]: Naturally everyone wants to make money when the market is heading higher. In this module, we'll show you how to create specific strategies that profit from up trending markets including low IV strategies like calendars, diagonals, covered calls and direction debit spreads.
- Options Expiration & Assignment [11 Videos]: Our goal is to make sure you understand the logistics of how each process works and the parties involved. If you don’t feel confident in the expiration processes or have questions that you just can't seem to get answered, then this section will help you.
- Portfolio Management [16 Videos]: When I say "portfolio management" some people automatically assume you need a Masters from MIT to understand the concept and strategies - that is NOT the case. And in this module, you'll see why managing your risk trading options is actually quite simple.
- Trade Adjustments/Hedges [15 Videos]: In this popular module, we'll give you concrete examples of how you can hedge different options strategies to both reduce potential losses and give yourself an opportunity to profit if things turn around. Plus, we'll help you create an alert system to save time and make it more automatic.
- Professional Trading [14 Videos]: Honestly, this module isn't just for professional traders; it's for anyone who wants to have eventually options replace some (or all) of their monthly income. Because the reality is that mindset is everything if you truly want to earn a living trading options.
PDF Guides & Checklists:
- The Ultimate Options Strategy Guide [90 Pages]: Our most popular PDF workbook with detailed options strategy pages categorized by market direction. Read the whole guide in less than 15 mins and have it forever to reference.
- Earnings Trading Guide [33 Pages]: The ultimate guide to earnings trades including the top things to look for when playing these one-day volatility events, expected move calculations, best strategies to use, adjustments, etc.
- Implied Volatility (IV) Percentile Rank [3 Pages]: A cool, simple visual tool to help you understand how we should be trading based on the current IV rank of any particular stock and the best strategies for each blocked section of IV.
- Guide to Trade Size & Allocation [8 Pages]: Helping you figure out exactly how to calculate new position size as well as how much you should be allocating to your each position based on your overall portfolio balance.
- When to Exit/Manage Trades [7 Pages]: Broken down by option strategy we'll give you concrete guidelines on the best exit points and prices for each trade type to maximize your win rate and profits long-term.
- 7-Step Trade Entry Checklist [10 Pages]: Our top 7 things you should be double-checking before you enter your next trading. This quick checklist will help keep you out of harms way by making sure you make smarter entries.
Real-Money, LIVE Trading:
- IWM Iron Butterfly (Closing Trade): Exiting this IWM iron butterfly options trade gave us a $1,100+ profit after pinning the stock price one day before expiration at the peak of our spread.
- CMG Iron Condor (Opening Trade): I just recorded my live trading platform (and real money account) as I walked through the process of entering a new iron condor trade in CMG stock. Inside you'll see me analyze, price and fill the trade in real-time.
- APC Strangle (Closing Trade): Took about $150 out of this small APC strangle trade even after the stock moved completely against our short call strikes this month. But as always, implied volatility always trumps direction and because IV went down, the value of this spread dropped more-so than the impact of the directional move higher.
- IYR Call Credit Spread (Adjusting Trade): This adjustment is good for 2 reasons. First, it reduces the overall risk in the trade if IYR continues to move higher. Second, it still leaves room for the stock to fall back down into our new profit window.
- XHB Straddle (Closing Trade): We were able to bank a $120 profit early in the March expiration cycle for our XHB straddle with the stock trading right in the middle of our expected range.
- AAPL Call Calendar (Opening Trade): Look behind the scenes as I use our new watchlist software to filter quickly and find this AAPL call calendar spread trade during overall low implied volatility in the market.
- COF Strangle (Adjusting Trade): Here I recorded my live trading screen (and real money account) showing you the entire thought process we used to make an adjustment to my current short strangle in COF to reduce risk.
- GDX Strangle (Opening Trade): With gold's high IV we are getting into a new strangle with a 70% chance of success and a decent credit for selling option premium.
- IBB Iron Condor (Closing Trade): Today we're exiting an iron condor we traded in IBB for a $142 profit. Inside you'll see me analyze the exit price and fill the trade in real-time.
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