OAP 167: Options Trading Profit Targets – When Should You Break The Rules?

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Oh, profit targets. The double edge sword of confusion for many traders. Take profits too early and you feel like you left money on the table. Too late and you kick yourself because the trade could have moved against you. And because we've been getting so many questions on when and why we've let positions go beyond traditional profit targets, we wanted to record today's show to talk about the top 3 market setups that would lead us to break profit-taking rules. Yes, you heard me right, and longtime members have known this for years, but we don't always take profits at 25% and 50%. Shocking? Shouldn't be because our Profit Matrix research 2 years ago laid the foundation for holding positions generally longer towards expiration.

Key Points from Today's Show:

  • Generally, there is a range where you can take potential positions off early before expiration. 
  • When you take positions off early, in many cases you increase your win rate and you increase the amount of money that you make.
  • This has been a widely held view in the industry for a long time.
  • However, generally speaking, when we hold positions closer to expiration, we make more money.
  • Keep in mind, not all market scenarios are the same.
  • When you hold your positions longer, closer to expiration, you have to give up something in exchange
  • In many cases, this means settling for a slightly lower win rate and increasing the opportunity for bigger drawdowns.
  • The strategy you choose will depend on your preferences and risk tolerance as an options trader.
  • However, oftentimes you might need to deliberately break your profit target rules because your portfolio is getting out of balance.

1. A Neutral Position

  • A neutral position means that the stock is exactly in the middle of your profit target range, without really challenging the strategy on one end or the other. 
  • If the individual position is generally neutral, then you are more likely to hold it and look for a better profit target.

Example: If you are trading EWW at $44, and you have a straddle or strangle where the position is at $44 and EWW is in the middle of your profit target range and it is not challenging on either side, you will be more likely to hold the position. 

2. When Exposure is Needed in One Direction or Another

  • If your portfolio is unbalanced one way or another, this may require you to break your profit target rules. 
  • For example, if your portfolio is bullish, then any bearish positions are going to remain on well beyond their profit taking level. 
  • You need these positions to give your portfolio more bearish exposure and remain profitable if the market goes lower. 
  • Ultimately, your portfolio balance and requirement overshadows the need to close out the individual position.
    You need to let the position stay on in your portfolio to gain all the premium you can to remain as neutral as possible.

Example: If the market is moving lower and your portfolio is bullish in tilt (need the market to move higher to make the most amount of money), if you remove all the bearish positions you create a scenario where you become even more bullish than you were before. Then, if the market continues to go lower, you don't make any profit at all. 

3. When There is a Big Early Move in the Right Direction

  • If you are trading directional positions and there is a massive early move in the right direction, then you should definitely take a higher profit target on that trade. 
  • It is now a lot less likely for the stock to come back around, so there is no reason to take the position off.
  • However, this strategy does not work as well when you have neutral positions. 
  • For a neutral position, if there is a massive drop in IV early in the expiration cycle, you should be more likely to take the profit off because you hit a profit target early and the stock hasn't moved. 
  • Breaking the profit target rules (in this scenario) only applies when you are trading directional strategies.

Option Trader Q&A w/ Alex

Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. Today's question comes from Alex:

I am currently using Thinkorswim, and when I place a trade in the order confirmation dialogue box, the buying power effect shows the width of the spreads that I'm selling. Under the monitor tab, under the position statement, the buying power effect shows the full width of the spread. How do you use this information? What is the difference between the buying power effect in the dialogue screen and how it shows up on the monitor tab?

Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.

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About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. 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 three children.