When choosing and setting up an options trade it is important to have a clear sense of where you believe the market is going over the course of the options contract. While buying undervalued options is important, it is often more important to know when to take profits in an options trade and to know how to do that. Because options prices can be quite volatile, this presents the trader both the profit opportunities and the risk of loss. Choosing the right exit strategy for an options trade can be the most important aspect.

Four Option Trading Challenges

There are four factors to be aware of when trading options. The first is that options contracts have a limited duration. Even LEEPs, which last for years, are limited in time. Profitable opportunities may occur only once before an options contract expires. Thus, strategies that work for long term stock investing are not useful in trading options. Capital requirements can be greatly affected by the margin requirements also. Because many factors affect how prices are determined for options it can be difficult to stick with a familiar and favorite strategy. Time decay, dividend payments, and volatility can reduce short term gains even from an otherwise successful trade based on an extremely accurate appraisal of the market.

Thoughts on How and When to Set Up an Option Trade

Despite the sometimes difficult issues involved in trading options, options trading can be profitable providing that you follow a few simple rules.

Trailing Stops

Although you can stay in an option contract that you bought or sold until expiration you do not need to and often should not. A strategy used in trading stocks is also applicable to trading options. It is the trailing stop. With this tactic an option trader sets a price at which the will exit the contract. As their trade becomes more profitable, they adjust the price either upward or downward depending on whether they bought or sold and whether they traded calls or puts. Although this tactic may result in missed opportunities in a volatile market it commonly limits or prevents losses over the long run. A skill to learn is where to set a trailing stop so that it is not too close to the current price that one does not immediately exit a potentially profitable trade and likewise does not repeatedly incur losses or miss out on profits by setting an essentially unprofitable trailing stop.

Booking Partial Profits

An old saying in the stock market is that you do not have a profit until you have taken a profit. Just as investors can sell part of their portfolio to realize profits before a possible change in the market, so can options traders exit a portion of their trade. When a trader does this, he or she can often guarantee that the trade will end with no loss and still retain the chance of making a profit. Something to keep in mind if you are ahead in a trade and hoping to reap more profits is that time decay generally reduces the profits you are going to make.

Exiting Trades Based on Fundamentals

Options traders commonly use technical analysis to judge when to get into and when to get out of trades. However, for long term trades like LEAPs it is wise to pay attention to market fundamentals and how they are likely to affect the underlying equity in the trade. At Top Gun Options we pay close attention to the DRINCs which is our acronym for Democrats, Russia, Iran, North Korea, and China. Events far from our shores and events based on politics can have drastic effects on the markets and staying abreast of what is going on in the world can help you exit trades in the most profitable way possible.

Work With Other Traders Who Have Your Back

There are times in options trading, like right now, when it is not wise to trade alone. Contact us at Top Gun Options and join one of our trading squadrons where we potentially print money no matter which way the market is headed.