Greater Profits In Less Time On

Your Option Trades

In a previous article, 3 Ways to Keep More Profits & Know When to Sell, I discussed how to take profits on long premium directional trades. I tried pointing out some techniques that could be applied when you’re in a winning trade.

However, it’s not always black and white…and to be honest, it’s situational. Sorry, but that’s how it is.

Now, for the most part, I like to put on option trades that collect option premium. In fact selling options responsibly (via structured trades like iron condors, butterflies, put spreads and call spreads).

I establish these type of positions when I feel option volatility is elevated and/or If have a directional opinion on the stock. For example, if I have a bullish opinion on a stock, instead of paying up for calls, I might look to take advantage of the high option volatility and sell put spreads.

Another example when option volatility is high…is selling a put if it’s a relatively low priced stock or will stick to spreads if it’s a high priced stock like Priceline.com (PCLN) or Amazon.com (AMZN).

By the way, if you’d like to learn a little bit more about my process check out: How To Sell Put Options For Max Profits In a Shorter Time & The SPX Method.

Now, when it comes to taking profits on these type of trades, I have strict rules in place that I follow. Unlike long premium directional trades, taking profits on short premium trades is not as grey.

You see, when you put on a short premium option spread, your profit potential and risk are already defined.

Before I get into it, I’d like to quickly explain how one can make money on short premium trades.

1. Option Volatility decreasing.2. The stock price moving in your favor (or not moving much).3. Time decay.

Options are said to be wasting assets…with that said, we don’t have to worry about the time decay element…because we know time always moves forward and option decay accelerates as it approaches expiration. With that said, we can put our focus on finding stocks that have charts we like and options that have rich premiums.

Why is finding stocks with elevated option premium important?

Because a lot of the time you can make money on the trade if the stock doesn’t move or even goes against you a little…that’s if the option volatility drops.

Remember, the higher the option volatility, the more expensive options are…the lower the option volatility, the cheaper options are.

For example, 7/28/14, shares of Trulia (TRLA) opened up at $63.14…The September $65 calls (expiration 54 days) opened for $6.20….the stock traded as high as $67.50…but the high print on those call options was $6.40. How can the stock rise $4 but the options only trade $.20 higher than the opening price?

(Hint: It wasn’t the time decay)

The option volatility dropped significantly…even though the stock moved higher –benefiting the calls, the drop in option volatility offset many of those gains.

So… are you ready for the best approach?

Drum roll…

When your short premium option trades, you’ll want to take profits between 40-60% of total premium taken in.

That’s it…nothing fancy…simple and easy.

In the past, I used take off my position at 75% of the total premium received. However, my friends over at Tastytrade.com, had their research team do some homework and discovered that the best area to take profits with the shortest amount of time is at 50% of the premium collected.

After I learned that, I reviewed my own notes and trading results and saw that I would have avoided some issues (and likely taken advantages of other opportunities) if I took profits at those levels.

For example, let’s say I sold an OTM $3 call spread and collected a premium of $1 (expiration in 40 days)…if the trade started working, I would look to buy back the spread for $0.40 to $0.60.

Why this range?

Well, a couple of reasons…

First, an opportunity for quick profits is there.

An option spread losing half its value in a couple days to a couple weeks is pretty common. Especially if the options are OTM and have relatively high option volatility.

Second, the risk-reward changes.

Third, you can take the range I provided and find your own sweet spot to taking profits.

When volatility is higher in the overall market, you might consider the 40% area so you can lock up profits quicker and take advantage of more opportunities.

When volatility is lower in the overall market, you might consider the 60% area so you stay in the trade a little longer because opportunities will be limited.

For example, initially I was risking $2 to make $1…now I’m risking $2.50 to make $0.50. In addition, there is an opportunity cost involved. When you’re selling a spread, money is tied up in the form of margin.

Your capital could be working elsewhere.

Not only that, but there is still time left in the spread. Sure, it’s likely that the options will expire worthless.

However, there is also a chance that the stock trades higher and the spread regains its value…or even goes ITM.

Too many times premium sellers get stubborn. They think because they sell premium that they’re entitled to all of it. Sorry, but that’s not how it works.

They either don’t want to spend the commissions to close out the trade or feel they are entitled to all of it.

I can’t tell you how many emails I’ve gotten over the years from premium sellers who were sitting on good profits…but instead of closing out…they held on trying for the entire premium …but only to get stuck in a dog fight. This happens a lot when they’re trading weekly options.

Weekly options can go from nearly worthless to deep ITM. If you’re in a position to take profits in that situation…don’t hesitate.

In my SPXMethod.com I always talk about taking risk off and buying back those short strikes. Last June, on a Friday, I was at the dentist’s office getting my two wisdom teeth pulled out on the right side. I had on a weekly SPX IC2 trade, which I teach in the course.

The position was expiring that day…in the morning, the profits were at break-even…but as the day progressed, it started to show a profit.

On the last hour, my short puts were 15 S&P 500 points away from the market…but I knew I wasn’t going to be around to babysit the position…so I decided to buy back the short puts for $0.10 to take off all the risk.

Well, what happened next was pretty shocking…

…a random sell order triggered several market orders over the last hour and the S&P 500 dropped by 20 points…those puts I bought for $0.10…would have been a $3-$4 loss. That’s why I buy back cheap options…because you’re always vulnerable to random outliers.

After the dentist, I was happy to find out that my teeth were the only things aching and not my trading account.

Like I said, I’ve found the best time to get out is when you’ve received 40-60% of the premium collected. Remember, the name of the game is to make money as quickly as possible…not to sit on these trades until the risk-reward no longer makes sense.

By the way, have you ever had a short premium trade on and was too stubborn to take it off when it was profitable? If so, I’d love to hear your story.

Also, do you have a method for managing profits on short premium trades? I’ll be hanging out in the comments section below.

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