If you have been following this series on Trades Gone Wild, we have been talking about the Uh Oh trade. This is the options trade that we all have at one time or another in which one day it is working well, and the next day it blows up on you.
In parts 1 and 2, we talked about some of the background reasons that trades get into trouble. These can be from a myriad of outside events to your actual trade structure and set up. We talked about ways to avoid stepping in front of a freight train on the initial trade concept and trade set up.
This brings us to Part 3 of this series. Let’s talk about what we can do once we are already in the trade and we are losing money. What are some of the things to consider when things start to go against you. We already know that “something” went wrong, but let’s discuss ideas of what to do AFTER you get into trouble.
Here are the basics steps to consider once you find yourself in a bad trade.
• You can sit on your hands and do nothing – Let me say that this is not the same as denying that the trade is in trouble. What I am suggesting, is that if you have completed your homework going into the trade, you may be comfortable giving the trade a little “wiggle” room. For example, if you are trading an index and based on your projected levels, the trade will survive up or down to certain levels. As long as you are still within your predetermined levels, you can watch and wait to see if it recovers and starts acting better. I will say that in most cases, this is not the best way to handle a trade, but again, if you are confident in your set up, you can at least consider this as an alternative.
• You can double up – This goes along the lines of Alternative 1, but actually amps it up another level. In this scenario, you are so convinced in your set up that you are willing to double up on your original position. This gives you a lower cost basis and a much better risk/reward after the “double-up”. You would have more overall capital in the trade, but again your risk / reward is better. You will hear some people say that this is throwing good money after bad money, but in the right situation, it can work. As with the 1st scenario, this is not usually the best way to handle a problem trade.
• You can do a “close and roll” maneuver – In this scenario, you can go ahead and close the trade and then simultaneously “reset” the trade to a further expiration and possibly different strikes. This gives you the more time to let the trade work. If you change the expiration and strikes, this can give you more time and more wiggle room for the trade to work. One fairly common problem to option traders is that we have the right strategy and trade structure, however we simply run out of time for the trade to work so this is an alternative to consider. The downside with this alternative is that you do encounter more commission as you move the trade around.
• You can just close the trade and go back to the drawing board – This may be the most common way to handle a losing trade. This is simply to have a mental or actual stop loss on the trade. Once you hit your max pain point, simply close the trade for a loss. In this scenario, you were wrong, so you go back to the drawing board and start over.
• You can defend the trade through an adjustment – This is my preferred method and I want to place the emphasis here. Adjusting the trade is always my first alternative that I consider when a trade goes against me. The process of adjusting can be simple or complex depending on what you are trying to accomplish with the trade, and how you are trying to accomplish this. You can adjust based on price, volatility, etc., or you can adjust by using the “Greeks”. The “Greeks” are the most accurate way to defend and adjust a trade in that you can dial up or down the adjustment based on what the “Greeks” are telling you. If you are newer to trading options, you may not be familiar with the “Greeks”, but as you travel further down your trading journey, you will learn that they can be invaluable. The downside is, again, that this can be a little more advanced maneuver. In my opinion, every options trader should know the basics of adjusting.
These 5 alternatives will give you some of the basic things to consider and unfortunately there is not one right answer. We all want to prevent or minimize our losses, so you need to be able to remain flexible and decide which way to handle the problem trade. Things tend to move very fast once you are in a trade. Don’t get caught off guard and don’t panic. If you have followed the basic rules and set things up correctly, you can handle this.
Once you find yourself trading more frequently, you will realize that by going through the process of defending trades, in a lot of cases you will be able to “save” a trade and save your money. Like anything else, the more often you defend and adjust trade, the more comfortable you will become with the adjustment process.
I hope this series has helped you and provided a little insight to alternatives you may not have considered before. Adjusting trades does not have to be complex. If you understand the basics, again you can handle the adjustment. For those that are interested in learning more, I will be hosting a comprehensive class on defending trades. We will cover adjustments from front to back and will cover all styles of trades and you can register for the free class by clicking HERE.
As always, good luck and good trading.
Catch more of Bruce Marshall’s daily analysis, real trade recommendations, & commentary at Simpler Options.