What Tastylive tells you about when to close options trades is WRONG because you're leaving a lot of money on the table.
My two biggest criticisms of Tastylive is that they trade way too often, instead of waiting for the best opportunities and, secondly, they do not deploy pro active hedges, leaving their followers susceptible to tail risk.
By following my option trading strategy and learning how to exit an options trade at the optimal time (and hedge your positions), you will likely improve your returns.
Now we're going to discuss how, and when, to exit an options trade.
When should you buy to close or sell to close?
As an example, let’s say that ABC Stock is currently trading around $130 per share.
You then sold a put option with a strike price of $120 and bought a $110 long put option.
Hypothetically speaking, you collect $3 of option premium on the $120 put, while the long put that you bought will cost $1.
By trading this vertical credit spread you collect $2 in net premium.
If you sold this position as a naked put then you'd have collected $3 per share, or $300 per contract.
According to Tastylive’s recommendations, you should close out the spread at $1 and the naked option at $1.5 (closing out both positions at a 50% profit).
However, this does NOT make sense mathematically because:
The decay of the higher priced option (the option that you sell) will guide your profits.
It’s crucial to keep this in mind.
When you close out the spread at $1, you will buy back your $120 put option at approximately $1.20 and you'll sell your $110 put option for ~$0.20.
On a net basis your $110 put decayed $0.80 while your $120 put decayed by $1.80.
Remember: the risk of the trade is with the short put. If you’re willing to wait for the $120 put on the spread to decay to $1.20, why wouldn’t you wait for the naked option to decay to $1.20?
The long put is primarily used for capital efficiency purposes and to control tail risk.
Yet closing spreads and naked options at the same percentage doesn't make sense mathematically (and financially).
Giving up an incremental 10% - 15% of premium is not good trading.
In this example, you should close out the naked option at 60% and the vertical credit spread at 50%.
My research has indicated that closing out naked options at a 60% - 65% profit and closing vertical credit spreads for a 50% profit is the most optimal way to make money when trading options.
If you close out all your positions at 50% then you're missing out on 10% - 15% of additional premium on every trade.
When trading options, everyone has a different opinion on when is the best time to close out trades.
While I believe that selling vertical credit spreads will almost always be a better choice than selling a naked option (because it's more capital efficient and protects against tail risk), it's best to close out spreads at a 50% profit and naked options at a 60% or 65% profit.
For more information, enter your email address below to receive $400 worth of free options trading information.
When should I close out an option trade?
In general, closing out a naked option at a ~65% premium capture rate and a vertical credit spread at 50% is best.
When buying options, when should I exit?
Due to theta decay, it's best to close out long options positions when you're showing a decent profit and there's still significant time left on the option.
If you're purchasing the option as a hedge, and not for speculation, then you can be more aggressive and hold onto the long option position until VIX spikes above 40.
I discuss hedging and the best time to sell a long protective put in the options trading education course
