This article teaches what a stock option is and how to profit through stock options investing. This is key #5 in a series of 10 keys to successful stock options trading.
Welcome back, this is the fifth part of a ten part series on how to trade options. Keep with it, you have learned a lot but there is more to come. Keep practicing what you have learned so far. Last week we looked at how to enter a trade, this week we will look at how to exit it.
There are several strategies and ways to exit a trade and you must decide which way (or ways) suits you. It is infinitely more difficult to decide when to exit a trade than when to enter it because it is at this time that you will either be making a profit or taking a loss! You will be faced with a myriad of different emotions while you are in a trade, most notably fear and greed. Fear appears in several different forms, fear of losing a profit already made, fear of getting out too early, fear of taking a loss and facing a mistaken trade. Greed also rears its ugly head by encouraging you to stay too long in a winning trade and possibly giving back some or all of your gains. There is an old adage on Wall Street that says “Bulls can make money, bears can make money but pigs always get slaughtered.”
As I mentioned you must determine what suits you when it comes to deciding how much of a loss you can handle and how much of a profit you want to take. This is a direct reflection of your risk to reward ratio. For example, I often say “I never feel bad when taking a profit”. I like to take profits when I see them and I generally have a fixed dollar figure or percentage in mind. Unless there is no good reason to exit the trade I will take my profits and if the trade keeps going in my direction after I have exited it doesn’t bother me. Conversely I always have a fixed % loss I will accept. Some people would not be able to handle leaving money “on the table” so they may prefer to let their trades run, but then they may need larger stop losses as well. When trading options stop losses need to be much larger than when you trade stocks because options are so much more volatile. For example if you set a 10% stop loss it could easily get triggered during a normal intraday move. Bear in mind that there is not as much at risk when trading options as opposed to trading stocks. The capital investment is much smaller so a larger stop loss will not impact your account as much.
Some good rules of thumb are: First if there is profit on the table and the underlying stock breaks down or crosses below its 7 day moving average, take the profit. It is very painful to watch a profitable trade lose value while you wait for it to reverse. Don't let that happen. However if market conditions have not changed and your technical analysis supports staying in the trade make sure you do not exit too early. Often the most outstanding profits are made by patient traders. Second, always exit the trade if you are at a 50% loss. Chances are if you are in a trade that is losing 50% it will keep going that way. It is imperative you preserve your capital in order to trade again. Third, always exit a trade if there is 30 days or less before expiration. During the month before expiration time decay can rob you blind of the value of your option.
I trust this has given you some things to consider when deciding to exit your trades, stay tuned for next week’s installment where we will discuss how to put together a complete trading plan.
US Government required disclaimer: Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of the Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker, from any exchange on which options are traded or by contacting The Options Clearing Corporation, One North Wacker Dr., Suite 500 Chicago, IL 60606 (1-800-678-4667).
Roger Cox, born in New Zealand, was President of a large international freight company in Los Angeles before starting his own consulting firm. Roger has been successfully trading stock options for 4 years and teaches others how to do the same at
http://www.prosperitywithoptions.com
