Setting Up Targets on Your Option Trades
Posted on Thursday, February 23, 2017 at 2:25 PM
If you know me and I think many of you do, you know how I feel about trade management. To me it is the most important aspect of trading. And if you think about it yourself, it probably should be one of the most important aspects in your trading as well. This is not going to be a big lecture on a trading plan or removing emotions from trading although it does fit into that realm, but more of a simple technique that should become a habit for you and most likely improve your results. There will be plenty of other blogs on trading plans and emotions again in the future…promise!
One of the things I do after entering any position is to set an exit for profit and usually for a loss as well. What this does for me, is to remove some of the emotions of trading. Instead of guessing when to exit a position for profit or loss and letting the emotions that come with trading factor into my decision, I have a pre-destined exit to do that for me.
Let’s look at an example. A trader is looking at the chart of Apple Inc. (AAPL) and he notices a bullish pattern setting up. At the time, the stock closed above a resistance level at around $134. The trader can choose to implement a vertical debit spread, in this case a bull call spread. The trader decides to buy the March expiration 130/135 call vertical. For simplicity sake, let’s say The March 130 call costs 5.00 and the March 135 call produces a credit of 1.50. The total cost of the spread is $3.50 (5 – 1.50) and that is the total risk and the maximum loss potential. The maximum profit potential is $1.50 (5 – 3.50) which is the difference between the bought and sold strikes minus the cost of the spread.
The trader decides that a $0.75 profit or 50% of the potential maximum profit seems to be a good target. In this case, he could use a sell limit of $4.25 to exit the position. This means the spread will be sold for $4.25 or better (130 call is sold and the 135 call is bought) if the value increases to that amount or above. In addition to removing emotions, the position will not have to be monitored maybe as closely as a trade without an exit order.
If the trader wanted to include a stop loss at the same time, he could do that with an OCO (one cancels other) order. This means when one order is filled, it automatically cancels the other standing order. Since the trader is trying to profit $0.75, he might deem it worthwhile to risk the same amount. In this case, he could add a stop loss $0.75 below the purchase price or at $2.75 (3.50 – 0.75). A market order to sell the spread will trigger if the spread drops down to or below the $2.75 level.
Having a buy or sell limit order in place once a trade has been implemented can do wonders for your trading. Not only can it remove emotions from trading, it can also take profits and remove risk without you even watching your account.
Senior Options Instructor