Your Simple Checklist Before Adjusting An Options Trade

options trading checklist

Whenever we go to buy or sell an option it is vital to take the time to make sure we are entering the trade correctly in the first place. It is 100 times more important to enter it correctly than to be able to properly adjust it later on as changing a trade that was made badly in the first place won’t necessarily fix it for you. However, the reality is that sometimes positions will go against us and so it is important to learn how to, correctly and more efficiently, adjust option trades and become a flexible trader, which is why we created this options trading checklist.

Adjusting an option position really is an essential skill for any investor – I would even say it is a mandatory requirement. Making trade adjustments incrementally can improve your performance by helping you to manage risk and reduce losing trades. Use our options trading checklist every time you plan to make an adjustment.

It should not become a way to fix deals that were badly made initially but it can be used to stop the bleeding. If you priced incorrectly to start with then you could face losing money no matter what adjustments are made, the adjustments might just help you to lose less.

As a disclaimer, it’s important that you know both HOW to adjust an options trade and that you are aware of the additional broker commissions you will be charged to exit/enter other contracts. Take your time when adjusting so that you don’t adjust and create an even bigger hole to dig out of. Follow this options trading checklist before making adjustments.

Options Trading Checklist – For Making Trade Adjustments

1. What’s The Goal Of Your Options Trade Adjustment?

Don’t sit and watch the stock market all day and then just adjust because you are bored. If your trades are made correctly at the beginning, you should be able to walk away confident and just check at the end of the trading day. If you need to make an adjustment, the goals should be either to reduce the risk to you or to create a new strategy to create more profit.

If you are trying to reduce your risk level, then make sure the adjustment does do that for you. If your risk is high enough to consider adjusting, then never increase the position size or your risk level, as that is just adding fuel to the fire and you face losing even more. Rolling into a position with a lower premium and bigger risk is never a good idea, especially with credit spreads.

2. Is Your Trade Adjustment Reducing Risk?

You need to be able to answer this question positively. If you are just panicking, then you could make a rash decision and dig an even bigger hole for yourself. If you are in a bad trade that is going to lose money, then sometimes you just have to accept that and just try to minimize the amount you will lose. It is not always possible to turn a loser into a winner, and that needs to be accepted in an unemotional and logical way.

To reduce risk, make an adjustment to reduce your losses. I favor reducing risk by purchasing OTM puts/calls that will hedge against big moves in volatility and Vega.

Remember to keep an eye on the bigger picture – look at the impact of adjusting the single trade against your whole overall portfolio and try to be systematic, rather than panicked.

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3. Could You Just Close Out The Trade?

This should always be your first consideration before thinking about making adjustments and continuing with a risky trade. If you’ve made a small profit and things are starting to go south it might be a wise decision to just close out the trade and re-evaluate the market.

Don’t let your ego get in the way of making money. Nobody is right on the market direction 100% of the time (not even 51% of the time). The best traders know when they are wrong and get out fast. And even better traders learn to take profits when they see them.

4. Have The Market Technicals Changed?

I’m sure when you entered the trade you had a firm opinion on the market. Has that changed now? Have some of the major technical analysis indicators turned the corner unexpectedly? If so, does this change your opinion on the market outlook?

More importantly, if the trend is changing then is your options strategy structured to profit from the new market? Wait to see a medium term change to adjust and remember that one day doesn’t make a trend. It’s important to remain systematic and unemotional when planning your strategies and any adjustments to them.

5. Listen To Our Trades Adjustment Podcast

Just recently we published one of our most downloaded podcasts all about how managing winning and losing trades (via adjustments) can help break the “zero-sum” game that everyone always assumes when it comes to trading options.

This idea that over time you will lose big and a few trades that wipe out the small wins on lots of trades just isn’t true. Listen to the podcast via the link before making your decision and to take the myth and emotion away from what needs to be a mathematical calculation.

Which Strategy Do You Think Is The Hardest To Adjust?

I hope our options trading checklist has helped guide you in making adjustments but please do add your comments below and let me know what you think is the hardest strategy to adjust; credit spreads, naked options, ratio spreads, etc.

I’ll follow up this post with a new post on how to adjust the strategy which receives the most comments.

 

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. 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 two daughters.

  • Quadrupletree

    Good stuff

  • The most difficult trade is the one when you have to take loss before it hits your stop (assuming the stock just broke through an important technical support/resistance line). I always look at the event as a positive opportunity to re-evaluate the market and take a breather. Usually when I’m wrong either the trend has changed, or the stock is trading at an extreme which may give me a new opportunity to re enter a similar spread at a higher/lower strike. In the end adjusting spreads are important. If they are not managed correctly then the investor will find themselves in a perpetual circle of making lots of incremental gains, and then losing all of it on one bad trade. Sometimes I take my loss before the trade hits my stop because I no longer feel confident in the trade, this is difficult because you know it will probably take 1-2 new trades to make the money back…but this is trading….and this is how it is. If you wait till the position hits your stop loss…then it could take months to make the money back….this situation is just demoralizing. This is why it’s important to stay on top of your positions as the author says. Jesse Livermore said trading is not for the mentally Lazy, this infers that you cannot just let your position ride all the time…you must adjust or close it every once in a while….

  • tim marlow

    Adjusting written positions on OTM traded options towards expiry, when big moves threaten to
    move positions into ITM losses. Basic positioning I use is an OTM strangle, always trying to
    keep within the same trading month.

  • The hardest strategy to adjust is the Iron Condor. There are a variety of methods, but only a few work consistently. It’s not for the novice trader. Even intermediate/advanced traders have a problem adjusting Iron Condors.

    • But the one thing that condor traders should avoid is the purchase of OTM options. That just increases risk. Sure the risk graph looks better, but so what? The true risk is that the position will move towards its maximum loss – and buying OTM options just increases that loss. Kirk: I expected better from you.

      • I agree that you don’t want to buy expensive OTM options on those. That said the best way to adjust an Iron Condor is rolling one side up/out and collect more premium. Even still if the OTM options are extremely cheap (0.01 or 0.02 each) then I do favor buying those in some cases because it’s cheap protection for big moves.

      • Yes. Great protection for the BIG move. I was just pointing out (to the rookie) that buying OTM options is not a good choice as a standalone adjustment.

      • 100% agree.