Closing Your Position
Let's assume that you have a LONG hit that was reported on Friday, November 23, 2007 and it was for EOG. That sets it up for a possible trade next Monday morning.
- View the Option Chain [1st level in the Money]. The symbol is +EOGLP.
- Let's check out the delta. It turns out to be 0.71. Good!
- Check the price: Bid is $5.10 and Ask is $5.50. A little high. Looks like the folks wanting to sell think it is going to go up as indicated by the price and the size of the spread.
- You have looked at the checklist, you have checked the delta, price, general movement of the stock on the chart, etc. You have check the news and any earnings reports that may be coming.
- You decided to acquire the option and you are "in".
You are now in a position of option ownership. Now comes the discussion on exit strategy!
I. The Exit Options:
A. Take a small profit: It is usually quite easy to get a short term $1.00 "bump" in the stock that will translate to a nice "bump" in the option. Remember, a delta of 0.6 means that if a stock moves $1.00 the option will move $0.60. That would give you a $60.00 gain on a $450.00 investment [our default example] usually within in a couple of days. That would be a 13.3% gain in that period of time and then off to the next trade. A lot of folks trade that way.
B. Closing the position when receiving an exit hit: This exit strategy holds until we receive an exit signal from the algorithm of American Option Trader. This strategy can give greater gain, but the strategy is more waiting for it to occur than the previous short hold strategy. You will just have to evaluate your own exit strategy and decide which is better for you.
In either case, don't watch the charts all day. You will go crazy! Set your trade profit limit order or strategy to exit the next morning and follow it.
II. I have acquired an option--- it is going south!
- This is a tough one! Our experience is to be patient and "expect" a turn around. In most cases it occurs. Many stocks dip after the entry pick. If you "panic", and don't give it time to turn around -- a premature exit can cost money.
- Remember, all our entry picks are based upon S&P500 and NASDAQ100 stocks. We are only working with the time proven stocks. Nevertheless, there may have been bad news before the option matured or other unforscene circumstances. In that case, there is nothing you can do but take the loss and move on.
- We have done hundreds of tests to determine the value of a protective stop loss and are confident that overall all, in the long run, it is best to ride it out. You will receive an exit hit on the 22nd trading day as a last resort.
III. The right plan for a stock sale can protect gains or minimize losses
Knowing when to sell a stock can be far trickier than picking one. It may not feel right to unload a stock that's soaring or to dump one that's down. You can sometimes give up a gain or magnify a loss by sticking around too long. Mike McGrath, Director, Trader Products at TD AMERITRADE, gives these exit-strategy tips.
- Revisit your entrance strategy
"Is the reason you entered the position still there? It's possible that a number of factors could have changed that make it time to exit," notes McGrath. "Your price target may have already been met, or new information may have been uncovered that changes your outlook."
- Remember Your Risk Tolerance
"How strong is your stomach?" McGrath asks. "Investors often amplify losses by hoping for a rebound in a stock that has depreciated. Identifying an exit point up front and then sticking to it can prevent bad investments and allow you to move on to potentially better ones."
- Consider the Fundamentals
Stock price moves are often prompted by changes in the underlying economics of a business or industry or by a corporate announcement. "If a company's about to report earnings, you may want to consider such events when planning an exit," McGrath says.
- Employ Analytical Tools
Using technical analysis to detect price patterns and market trends can help you identify exit points. Charts, for example, can show support and resistance levels in a stock price. McGrath suggests using multiple indicators to help confirm your outlook.
- Use Advanced Orders
"Conditional Orders and Trailing Stops may help you stay disciplined," McGrath says. "Trailing Stops can let potential winners run and protect from pullbacks. Using Conditional Orders to help bracket a position will help you identify upside and downside exit points." — JP
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The Team at American Option Trader LLC