The 3 Option Adjustment Principles You Must Know Now
Losing trades are part of the game - they are going to happen and it’s a reality we must all face. And I believe what sets really great traders apart from those who are average at best is the ability to cut a loss by making smart adjustments. Adjustments that reduce risk and extend the trading timeline.
In this podcast, I’ll cover the 3 option adjustment principles you should follow if you’re considering adjusting a short premium option selling strategy like an iron condor, iron butterfly, strangle, straddle, etc. These guidelines will help make sure you’re always focusing on the most important aspect of trades adjustments which isn’t to make money, it’s to cut the size and magnitude of the loss down as much as possible.
Key Points from Today's Show:
- These adjustments are mainly used for short premium option selling positions; credit spreads, iron condors, iron butterflies, strangles, and straddles.
1. Always Take In A Credit.
- Credit reduces potential risk or expands out the breakeven points.
- If you are doing a two-sided strategy, it has to be for a bigger net credit than what you paid to adjust the other side.
- If you are paying to roll contracts or adjust a position, it does not make sense; at that point, you have to close the position and move on.
- Before you make the decision to adjust a position, make sure you are getting paid for it and reducing the risk.
If you have a $5 wide iron condor and you take in $1 of credit. If you take in a credit by adjusting that position and rolling one side closer, but you still maintain the structure, then you have gone from $1 credit to $150 notional credit. This reduces your risk from $400 to $350.
2. Never Move the Tested Side.
- You do not want to move the challenged or tested side because it will compound the loss.
- Instead, take what the market gives you and keep moving up the unchallenged side.
- Do not force a losing trade into a compound loss situation.
The stock is trading at $50 and you sell the $55 calls. If the stock starts trading higher from $50 to $55, one technique the people like to use is to move the call strike higher. They will close out of the $55 short calls and re-sell the $60's to give themselves more room for the market to move up against their position. However, this exposes you to another potential loss if the market continues to moves up. Instead, realize that that side of the trade might be the losing side and take what the market gives you and roll up the put side — move your $45 up to $50 and if the market continues to move up, move them from $50 to $55.
3. Extend Your Duration Whenever Possible.
- Duration defines the trading timeline.
- Whenever possible, you want to extend the amount of time that you have in the trade.
- This gives you extra time for the market to potentially move back into a profitable zone.
- Do not extend your timeline at a cost; extend it on a credit or at no cost.