Closing options trades: "When should I exit a trade?" "How should I manage a winning options trade?”
There are quite a few misconceptions about the best time to close options trades (whether it's a naked option or a spread).
This post will teach you how to exit an options trade (and when to exit a trade).
Tastytrade.com believes that both spreads and naked options should be closed out at a 50% profit (although since my video came out, they've updated their recommendation to manage positions at 21 days).
Option Alpha recommends the same thing.
TastyTrade is the only other YouTube channel that I recommend (besides YouTube.com/BestStockStrategy) and I believe that Tom Sosnoff and Tony Battista are good teachers of basic options strategies and principles.
They encourage traders to Sell Option Premium and trade small.
Selling option premium is the best way to make money consistently in the stock market.
However, I believe there are a lot of inaccurate information regarding closing and managing trades.
Will you make money by closing positions at 50%? Yes
Will you achieve optimal returns by closing out your trades at 50%? Absolutely NOT
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Closing Options Trades: Bad Information
Realistically speaking, what Tastytrade tells you is WRONG (in my opinion)
Simply put: you will likely make money using their strategies, but you will also leave a lot of money on the table.
Additionally, by entering trades at less than optimal times, you’re going to increase the probability of having to manage positions (my BIGGEST criticism of TastyTrade is that they trade way too often and tend to act like they have "unlimited bullets" when hunting, instead of conservatively using their ammunition wisely).
Although I have great respect for TastyTrade & it’s founder Tom Sosnoff, by closing out all your positions at 50% profit you’re leaving a lot of money on the table.
You’re missing out on considerable annual returns.
By following my strategy and learning how to exit an options trade at the optimal time, you will likely improve your returns.
This can be proven easily mathematically (as shown in the video above)
Key Points: Closing Options Trades
We Close Out Our Trades Early
We Patiently Wait for the Great Opportunities
We Close Naked Options at ~65% Profit and Spreads at 50% Profit
"This is how we earn our money. We close out our trades early, we only trade the most stable underlyings, and we patiently wait for great opportunities to arise." - David Jaffee, BestStockStrategy.com
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Closing Option Trades: Most Optimal Strategy for Managing Winning Trades
Now we're going to discover how to exit an options trade.
When should you buy to close or sell to close?
Let’s use Facebook as an example.
Early in January 2019 Facebook was trading around the $130-$132 range.
Let’s say you sold a naked option with a strike price of $120, and bought a $110 long put option.
Hypothetically speaking, you will collect a $3 Premium on the $120 Put, while the put you bought will cost $1.
By doing this spread you will collect $2 in net premium, and by selling it naked you will collect $3.
According to Tastytrade’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, and here is why.
The decay of the higher priced option (the option that you sell) will lead your profits.
It’s crucial to keep this in consideration.
When you close out the spread at $1, you will buy back your $120 Put at $1.20 and sell your $110 Put for $0.20.
As a result, on a net basis your $110 put decayed $0.80 while your $120 put decayed $1.80.
This is exactly where you’re leaving A LOT of money on the table.
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 spread is primarily used simply for capital efficiency purposes.
Giving up an incremental 10% - 15% of premium makes zero sense.
In this example, you should close out the naked option at 60% and the vertical 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.
This adds up over time.
Closing Option Trades: Use Limit Orders
It is crucial to use limit orders with this strategy.
For example, let’s say you sell a $250 naked put in Lockheed Martin for $2 of premium.
Immediately after the trade fills, you would then submit a buy to close, good-to-cancel ("GTC") order with a strike price of anywhere between 70 to 80 cents. This would allow you to keep 60% to 65% of the premium, 10% - 15% more than Tastytrade recommends.
If you wanted to sell a spread by selling the $250 Put and buying a $230 put for a net premium of $1, once this trade fills you would submit a buy to close order that would have a limit good-to-cancel price of $0.50.
Again, it makes no sense to close out spreads and naked options at the same price.
Even with a spread, you’re still assuming risk by waiting for the option you sell to decay even more than it would if you sold a naked option.
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Closing Options Trades Conclusion
With options trading, everyone has a different opinion on closing options trades.
While I believe that selling naked options will almost always be a better choice than selling a spread (because it provides you with more freedom and flexibility), I believe it's best to close out spreads at a 50% profit and naked options at a 60% or 65% profit.
Leaving 10-15% of option premium on the table (when following TastyTrade's advice) is not smart.
For more information checkout BestStockStrategy.com.and enter your email address and receive over 50% percent over $400 worth of free options trading information.
Frequently Asked Questions (FAQ)
When should I close out an option trade?
In general, closing out a naked option at ~65% premium capture rate and a vertical credit spread at 50% is best.
When should I exit an option position?
In general, exiting an option position at ~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 in holding onto the long option position.
I reviewed your July ’18 eTrade statement and I see a number of closing trades, on or close to the position expiration date, where it is closed for a couple of pennies. I understand your logic for taking profit at 65%, for naked positions, and would like to understand the thought process applied when you carry a trade to near expiration and presumably beyond the 65% profit point.Reply