Options Trading Profit Targets – When Should You Break the Rules?

These are the 3 potential market setups that lead us to break our profit-taking rules, based on the Profit Matrix research about holding positions longer towards expiration.
Options Trading Profit Targets – When Should You Break the Rules?
Kirk Du Plessis
Oct 24, 2019

Oh, profit targets. The double-edged 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 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 3 potential market setups that lead us to break profit-taking rules. Yes, you heard me right. Longtime members have known this for years, but we don't always take profits at 25% and 50%. Shocking? Shouldn't be--our Profit Matrix research 2 years ago laid the foundation for holding positions generally longer towards expiration.

Show Overview

  • Generally, there is a range where you can potentially take 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, you might need to deliberately break your profit target rules to keep your portfolio from getting out of balance.

The three market setups that would lead me to breaking my profit target rules are the following:

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 neutral, then I am more likely to hold it and look for a better profit target.

Example: You are trading EWW. You have a straddle or strangle centered at $44 and EWW is trading at $44 right in the middle of your profit target range (not challenging on either side). You will be more likely to hold the position and look for a better profit target. 

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. You have to take a global look at your portfolio.
  • For example, if your portfolio is bullish, then any bearish positions should remain on well beyond their profit taking level to keep your portfolio balanced. 
  • You need these positions to give your portfolio more bearish exposure and remain profitable if the market goes lower. 
  • Ultimately, the need to balance your portfolio overshadows the need to close out the individual position early for a profit. You need to let the position stay in your portfolio to capture 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 (i.e. you 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 move 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, such as bullish or bearish credit spreads, and there is a massive move early in the right direction, then you should definitely look for 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 early.
  • However, this strategy does not work as well when you have neutral positions. 
  • For a neutral position, if there is a massive drop in implied volatility early in the expiration cycle, you should be more likely to take the profit early because you hit a profit target 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. 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 position statement section of the monitor tab, 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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