Learn to Adjust Options Positions

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Posted on Thursday, October 25, 2012 at 11:08 AM

Dan's online Options Education series this month has all been all about helping traders learn to adjust options positions. Adjusting option positions is an essential skill for options traders. Adjusting options positions helps traders repair strategies that have gone wrong (or are beginning to go wrong) and often turn losers into winners. Given that, itís easy to see why itís important to learn to adjust options positions.

Adjusting 101

Adjusting options positions is a technique in which a trader simply alters an existing options position to create a fundamentally different position. Traders are motivated to adjust options positions when the market physiology changes and the original trade no longer reflects the traderís thesis. There is one golden rule of trading: ALWAYS make sure your position reflects your outlook.

This seems like a very obvious rule. And at the onset of any trade, it is. If Iím bullish, Iím going to take a positive delta position. If I think a stock will be range-bound, Iíd take a close-to-zero delta trade that has positive theta to profit from sideways movement as time passes. But the problem is gamma. Gamma is the fly in the ointment of option trading.

Gamma

Gammaóparticularly negative gammaóis the cause of the need for adjusting.

Gamma definition: Gamma is the rate of change of an optionís (or option positionís) delta relative to a change in the underling.

Oh, yeah. And, just in case you forgotÖ

Delta definition: Delta is the rate of change on an optionís (or option positionís) price relative to a change in the underlying.

In the case of negative gamma, traderís deltas always change the wrong way. When the underlying moves higher, the trader gets shorter delta (and loses money at an increasing rate). When the underlying moves lower, negative gamma makes deltas longer (again, causing the trader to lose money at an increasing rate).

Wrap Up

Therefore, traders must learn to adjust options positions, especially income trades, in order to stave off adverse deltas created by the negative gamma that accompanies income trades.

To find out more about next month's topic and have access to the archived previous seminars including "Option Trade Adjustments" please visit Options Education.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

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