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The Importance of Having a Trading Plan

Mark,

In my last post I explained how I am in my second month of trading
spreads. I also explained that for this month I entered the call side
first and entered the put side last Friday. As you continue to point out,
the key to being successful in these spreads is how you adjust (or NOT
adjust) not just whether you make or lose money.

At this point, I could
exit my call side (these are May index options) for about a 60% of
max profit. If I exited my put side I would probably lose most of that
profit, and have a slight gain from the whole transaction. the delta on
my puts are about .06 so I am not at risk at this point.

How would
you normally handle this situation? There are many "options" I see, but
most likely are:

1. Close all positions, take a small gain

2. Close the Calls for a 60% of maximum profit and either

a) sell a new call
spread to try and bring in more premium; or

b) do not sell a new call
spread and wait and watch the put spread

3. Do Nothing

Scott

***

I've previously explained my personal methods.  They suit me but may not suit you.

1) The point of adjusting is to prevent loss and to give yourself an increased chance to earn profits going forward


2) When you opened this trade, did you have a plan?  Did you have some idea of WHEN you hoped to exit or HOW MUCH you hoped to earn?

Having such a plan makes these decisions so much easier.  The fact that you lack a plan is why you are asking questions now.

The plan is not the absolute final word.  You can be flexible.

Would your plan call for exiting now at a small profit?  If not, why are you considering doing that?  Are you afraid?  Are you outside your comfort zone?  Do you fear a rally – is that why you want to repurchase the calls?  You cannot expect to be able to continue trading when you don't know he answers to these questions.


3) I always exit my 'winning side' regardless of whether the 'losing side' is in serious trouble.  The problem is when to exit and how much to pay.  I trade my iron condors, collecting about $3 credit.  I close almost any spread at $0.15, and will bid as much as $0.25, depending on circumstances.  That's my plan.  Decide what your plan is.

I don't care about 60%. That's not enough information.  For example, if you sold @ 10 cents, would you pay 4 cents to cover?  You'd lose money after commissions. 

How much would it cost to cover?  That's the key issue.  Are you willing to take the risk of remaining short this call spread at its current price?  If yes, then do nothing.  If you are a bit concerned, then consider covering a few of your short call spreads.  Enough to move you back withing your comfort zone.

If you are covering because you are bullish – that's okay, if you want to trade with a market bias.  There is nothing wrong with doing that.  It's your money.  But be certain that's what you want to do.  There is no shame is risk avoidance.

Selling another call spread is a legitimate way to play this.  But I dislike that idea.  I prefer to establish a plan and not increase risk at any time.  Selling a new call spread brings the position back near delta neutral and that is desirable for many traders. 

I prefer to be satisfied with my target profit – if I can get it – and not be greedy.  To me, selling new call spreads just sets up the possibility of a huge whipsaw.  You are too new to do this.   One major decision you must make:  how much extra cash must you take in to make this trade worth the added risk?  You are too inexperienced to have a good idea.  I recommend saving this idea until you have proven that you can manage risk well enough to take the chance of increasing it.  That does not mean six months.  Take your time.

Keep in mind:  Some extra cash from call spreads provides very little protection if those put spreads get into trouble.  That's why I don't like selling replacement spreads.  Too little to gain, too much chance of losing.

When I cover a call spread, I almost never sell other call spreads as a replacement.

4) If you have no plan write one right now.  Look at your position as it exists right now and make some decisions:

  • When do you hope to be able to exit?
  • How much would you like to pay when that time comes?
  • How flexible do you want to be in the above goals?
  • How much are you willing to pay to exit the call (put) spread?  How much is cheap enough?
  • Does time remaining prior to expiration affect that low price you are willing to pay?
  • When do you plan to take a good look at risk?
  • How high must the delta of your short option be before you plan to adjust; or
  • How much money must you be losing before planning to adjust; or
  • How much time must pass before you would consider exiting the whole thing at a small profit?
  • Anything else that occurs to you

The trading plan offers guidance in making a difficult decision under stress.  If you already have a plan in place, you can execute that plan. 

As a beginner, the more guidance you can provide for yourself – in advance – the easier it becomes.  A good exercise is to look at that plan daily and decide if it's still good, or whether you should revise it.  The point is for you to THINK about your positions frequently and make a plan often.  It is NOT to change the plan.

The plan gives you more confidence because you have already thought about what's important.

It truly helps manage risk.  It makes decision-making easier.

668


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