Managing a Weeklys Trade

Options Risk Management

Credit Spread
Put credit spread. Wikipedia Commons

Successful option traders understand that positions are not bought to be owned forever (i.e., until the options expire), but have to be managed. These traders know that our predictions concerning the stock market do not always come true, making it necessary to have a plan that: a) locks in profits before they disappear, and b) exits bad trades before a loss becomes untenable.

Along those lines, I received the following questions from a reader:  

  1. When do you recommend exiting a profitable put credit spread or put debit spread (or call credit spread or call debit spread, for that matter) on a monthly (or weekly) trade?  
  2. How do you adjust any of those monthly (or weekly) credit/ debit spreads trades that are going against you?  
  3. Is it even possible to adjust a weekly trade, or would you just exit at a certain time?  
  4. How do you recommend exiting a profitable or failing weekly ​iron condor trade? I was thinking that possibly the best way to trade a weekly iron condor would be to get in on a Monday and get out, say, on that same Wednesday, whether the trade is profitable or not.

The Reply

Adjusting strategies have one idea in common — and that is to reduce the risk associated with owning a given position. There are two basic ways to mitigate risk: a) close the position and b) change (adjust) the position so that risk is less than it was prior to the adjustment.

Do not fall into the trap of building a new position with more money at risk than the current position. In other words, do not close a 5-lot position and convert it into a 10-lot position.

1. I recommend exiting a profitable spread (regardless of which of the four spread types mentioned in the question) when the remaining reward (additional profit) is too small, when compared with the potential risk.

 

Note that these spreads come with a maximum possible profit: credit spreads can expire worthless and debit spreads can expire at their maximum value. Thus, when the remaining profit on a 5- or 10-point spread is only another $0.05 or $0.10, I cover and avoid any risk that the market will suddenly change direction. 

Alternatively, exit when the position has earned the target profit according to the trade plan. I encourage you to write a trade plan for each trade — even when it is short-lived, i.e., when you use Weeklys options. Include a target profit (which you can tweak as time passes, but be careful not to get greedy) and a target exit point. That exit occurs when the loss has become as large as you are willing to accept, or when the THREAT of an imminent loss is too large for your comfort zone and/or tolerance for risk.

Note: Selling a credit spread or buying a debit spread are equivalent positions (same profit/loss) when the options are on the same underlying asset and have the identical expiration date and strike prices).

2. and 3. It is very difficult to adjust a credit spread when time to expiration is nigh. Thus, you will seldom be able to execute a well-conceived adjustment trade for a Weeklys spread.

Why? Because when negative gamma is too high (as it is when expiration is near and your short options are close to being at the money), there are (almost) never any reasonably-priced adjustment available. It is better to define a maximum acceptable loss (as part of the trade plan) and exit if and when your loss reaches that point.

When you elect to adjust, as you would with a spread that has more than two weeks of remaining lifetime, my simplified plan is: 

  • Do not allow your short option to move into the money. Take action (see next bullet point) when its Delta reaches a point that suits your comfort zone. It takes some experience to determine where that point lies, but I encourage rookies to choose a delta between 35 and 45.
  • The adjustment trade. You want to accomplish two things simultaneously, by entering a spread order (In a spread, you buy one option and sell another) at a limit price. First, cover the current short (i.e., previously sold) option that is causing trouble. Second, roll into a different short option by selling an equal or lesser quantity of an appropriate option. That option is farther out of the money and expires on the same or a later date than the option being bought.

    Note: Much of the time it is necessary to pay a cash debit to make this trade. Do not let that stop you. There will be times when you can collect cash for the adjustment, but your priority is to reduce risk -- not to seek the maximum potential profit for the adjusted position. Do not believe that your goal is to recover lost money. Do believe that the goal is to cut risk and restore your investment portfolio to a comfortable level of risk and potential reward.

    IMPORTANT: Make this adjustment ONLY when you want to own the adjusted position. If the position does not fit your trading style or if the position is too risky for your comfort zone then do not make the trade. It shows a lack of discipline and poor risk-management skills. To succeed over the longer term, it is essential to be a good risk manager.

    Too many beginners make the mistake of adjusting a position for the single reason that it avoids the immediate locking in of a trading loss. The hope (hope is not a strategy) is that time passes, the market behaves, and the spread can eventually be closed at a profit. That may be one rationale behind making the adjustment, but please be certain that it is a minor factor in your decision-making process. 

    4. When initiating the iron condor position, it is a good idea to look at the iron condor as a single position. But when managing risk, I urge you to manage an iron condor position as if it were two separate credit spreads. Thus, everything above is appropriate for iron condor trading, including exiting one of the debit spreads when it gets to a low price. 

    I approve of your plan for trading Weeklys iron condors. Enter early (emphasis on early) Monday morning, using limit orders. Never use market orders when trading options. Enter the order once trading settles down from the opening. Perhaps 15 to 30 minutes after the opening bell. Exit late Wednesday, approximately 15 - 30 minutes before the closing bell.