How to close an option trade

how to close an option trade

When is it time to close an Options trade? Posted on Tuesday, July 21st, Knowing when to close out of a trade can be challenging when the markets are constantly moving back and forth. Holding on to a trade too long or not long enough can lead to inconsistent returns.

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When buying long call or long put options the key to remember is you are holding a ticking time bomb. Every day that passes those options will lose value. In order to make money you need the stock or ETF to move in your favor quickly. If the move takes too long you will be left with a much smaller return, or even worse, no return at all.

Our Guidelines For Closing Options Trades When buying options long calls, long puts, debit spreads we like to follow the criteria below: Trade options that have days left to expiration.

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These options will give you more time for your directional assumption to play out and will also typically provide the best volume in the options. Look for the stock to move within the first days of placing the trade. Remember we need a quick move to take place in order to make money. Limiting the damage on a losing trade is crucial to successful trading long term. We know there will always be winner, losers, and breakeven trades along the way.

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When selling vertical spreads we like to follow the criteria below: Trade options that have days left to expiration. We are able to hold the trades longer when using credit spreads due to the time decay helping us.

Every day that passes is a good thing. Credit spreads will typically need days to hit our desired profit goals. While holding all the way to options expiration can lead to bigger profits, it also ties up our capital for a longer stretch of time. While the guidelines above provide a nice road map for managing your options trades, it can also be very helpful to have a trading system in place that provides technical levels on the charts to follow.

For example, when identifying our options trades at NetPicks we use a set of indicators that provide our entry points and stop points to the penny before we ever get into a trade.

This allows us to stay disciplined to a rule set that we know will put the numbers in our favor long term. Whether you are using a custom trading system or following our trade management guidelines above, the key is to have an approach in place that you can stay disciplined to.

Pros and Cons Of Trading Options

If you keep your risk small and follow the trade management guidelines you will be well on your way to creating a consistent source of income. Before you can exit an Options trade, you have to know the basics of Options trading.

Options Review Having an understanding of the options basics will allow to make trading decisions with a much higher level of confidence. An options contract is a known as a derivative. A derivative is linked to some other security like an individual stock, Index, or ETF.

When To Close Your Option Trades

Stocks Index Products ETFs Trading options on the products listed above will allow you to create a consistent source of monthly income. The beauty of trading options is they allow us to take these trades with defined risk. Buying and selling options takes some of that risk away while still allowing you to make a substantial amount of money. You just need to have a defined system in how to close an option trade that puts the odds in your favour over time.

Types of Options An option is a contract that allows you to buy or sell an asset like a stock or ETF at a fixed price before the contract end date.

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The key point here is that an option allows you to buy or sell before the end date but does not require you to buy or sell. There are two types of stock options. Call Options Put Options Call Options: When you buy a call option, you have the right but not the obligation to buy shares of stock at a certain price by a future date. The call option will increase in value as the stock moves higher. This provides you with unlimited profit potential on the trade while limiting the risk to the price paid for the option to open the position.

Put Options: When you buy a put option, you have the right but not the obligation to sell shares of stock at a certain price by a future date. The put option will increase in value as the stock moves lower.

Parts of an Option If you are going to trade options successfully, you need to know and understand the different parts that make up an option and how they work. Strike Price Expiration Date 1. Strike Price The strike price is the price at which you are willing to buy or sell your option.

In a call option, this is a price where you can buy the stock or asset during the life of the contract. If the price of the stock or asset goes above the strike price before the expiration date of the option, you make a profit. In a put option, this how to close an option trade a price where you can sell the stock or asset during the life of the contract.

If the price of the stock or asset goes below the strike price before the expiration date of the option, you make a profit. Premiums When you buy either a call option or a put option, you have to pay a price.

Sell to Close Definition & Examples

The amount you pay to act on that option is called a premium. The premium paid to buy the option is your max risk when you buy an option. Remember, when you buy or sell an option, you are not actually buying any of the underlying asset.

Instead, you are buying the right to buy or sell underlying asset at a later date. The premium is the price you pay for that right or option.

When you purchase a call option, you are looking for the price of the underlying asset to increase over your strike price. Intrinsic Value The intrinsic value of an option is based on the current market price of that stock or underlying asset. The intrinsic value of an in the money call or an in the money put is calculated differently.

For an in the money call option, the intrinsic value is the market price of the underlying asset minus the strike price. For an in the money put option, the intrinsic value is the strike price minus the market price of the underlying asset.

On the other end, if a stock loses value below the strike price of the call option, it is considered out of the money. When trading put options, they are considered out of the money if the stock rises above the strike price of the options.

Because stock options that are out of the money have no profit, their intrinsic value is zero.

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  • Once you are long or short an option there are a number of things you can do to close the position: 1 Close it with an offsetting trade 2 Let it expire worthless on expiration day or, 3 If you are long an option you can exercise it.
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Time Value Options are decaying assets meaning they lose a little of their value for every day that passes. As an options buyer you want the stock to move in your favour as quickly as possible to overcome the time decay that adds up daily. When selling an option, the time decay is your friend. Every day that passes allows the options to get cheaper which in turn allows you short options position to make money.

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Time decay moves in a non-linear fashion meaning it is not equal for every how to close an option trade that passes. As an option gets closer to its expiration date, the daily time decay becomes more significant. When an option reaches its expiration date, it is worthless. Investors are willing to pay more for an option that allows the underlying asset to grow in value.

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The farther away from the expiration date the option contract is, the greater its potential for growth. The closer the stock option gets to the expiration date, the less value it has. This is called time decay.

As the time value decreases or decays, the price of the premium is based more on the intrinsic value of the asset or stock.

Expiration Options have a defined life span and will expire once they get to the end of that lifespan. The lifespan of the options contract is referred to as its expiration cycle. Options are most often traded in weekly and monthly expiration cycles. Weekly options will expire each Friday and Monthly options will expire on the 3rd Friday of every month. Financially, all you have lost is what you paid for the cost of the premium.

If the stock price falls during the term of the contract, you can sell the options at the market price or let it expire. Again, what you have lost is the cost of the premium you paid for the stock option. You cannot buy just a single share when you buy an option. Options represent shares per contract.

How Options Work

This means that bonuses for options you are buying or selling, you need to multiply your cost or profit by Therefore, whenever you calculate your expected profit or potential loss when purchasing an option, you need to add in the amount of the premium and multiply it how to close an option trade Pros and Cons Of Trading Options While the concept of buying and selling options is fairly straight forward, planning your strategy so that you can maximize your profit and minimize your losses, is more detailed.

As with anything, option trading has its advantages and disadvantages. Before you decide if you can make a living selling options, you need to consider both pros and cons carefully. Pros of Trading Options.

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