Even a monkey can buy/sell an option, catch the market at just the right time, and watch the money roll in.
Yet we all know that these trades are only in our sweet trading dreams (at least that’s what I dream about don’t you).
The reality is that positions will go against us and you must learn how to adjust option trades and become a flexible trader.
Adjusting an option position really is an essential skill for any investor – I would even say it is a mandatory requirement. Properly managing risk by adjusting can help you repair strategies that have gone wrong, limit huge losses or even create additional potential gains.
Yes adjusting positions can add to your bottom line sometimes – but your goal is always first to stop the bleeding.
As a disclaimer it’s important that you know both HOW to adjust an option trade and that you are aware of the additional broker commissions you will be charged to exit/enter additional contracts. Take your time when adjusting so that you don’t adjust and create an even bigger hole from which to dig out of.
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1. What’s the goal of the adjustment?
Don’t adjust because you are bored. Make sure that you are either A) reducing risk somehow someway or B) creating a new strategy that could make you more money.
More often than not you are going to be adjusting to reduce risk so make sure that it does that. Rolling into a position with a lower premium and bigger risk is never a good idea, especially with credit spreads.
2. Are you “REALLY” reducing risk?
Just as I mentioned above ask yourself this question honestly.
Forget for a minute that you are not going to make money if you get into a bad trade… focus on NOT losing all the money you have left! I favor reducing risk by purchasing OTM puts/calls that will hedge against big moves in volatility and Vega.
3. Should you just close out the trade?
This is always one of my 1st considerations.
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. How 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 1 day doesn’t make a trend.
Breaking The “Zero-Sum” Game
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 and we’ll show you why in this podcast episode you can listen to above.
Vote On The Hardest Strategy To Adjust…
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 with the most comments.