You have seen posts from me like this before, but the lesson cannot be taught enough. I have a mantra I like to use in my Group Coaching class and with one-on-one coaching students, and I repeat it frequently: “Know exactly what you will do no matter what happens.” Simple enough, right? What I mean by this is that you should have a trade management plan in place before you enter a position. Do not let the emotional trader come in during the trade and convince you otherwise.
As we have talked about here so many times, having a trading plan is imperative to your success as a trader because it is mandatory to remove the emotional part of trading. This is why knowing what you will do, and actually doing it, can improve your success and profits.
Let’s look at an example using Apple Inc. (AAPL) with the chart and option chain below.mantra
An option trader notices AAPL is holding a bullish base and it looks like it wants to break higher. He decides to buy a June call with 36 days to go till expiration to profit from the expected move higher. He buys the 175 call and pays 4.60 (as seen below).
Based on the chart, the stock has potential support around the $172 area or approximately $2 below where it is currently trading. The trader’s management plan if the stock moves lower (against the position) would be to consider closing out some or all of the position if the stock closes below that potential support level. He could also choose to manage some of the position by risking 25% of the cost. In this case, 25% of the cost is equal to $1.15 (4.60 X 0.25). If the position declines to about $3.45 (4.60 – 1.15), he could close out some or all of the position.
On the profit side, there is no imminent potential resistance overhead. Many times, it is good to consider removing risk at support levels for bearish trades and resistance levels for bullish trades like this. Support and resistance have a better chance to hold than break. In addition, since 25% was risked on the stop loss, 25% (or $1.15) may be used as a potential profit too. In this case, if the call’s value increases to about $5.75 (4.60 + 1.15), the trader could consider taking a profit.
This was just one example of how having a plan in place can greatly improve your trading outcome. Just make sure you know how you will handle every conceivable situation before it happens, and I promise you will be better off and less anxious about your trades.
Senior Options Instructor