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To Hold or to Exit, That Is the Question


This decision requires that traders think about what they're doing -- looking for formulas is cop-out.


Steve writes:

I originally sold a far-out-of-the-money SPX put option for $1.10 with 49 days to expiration, with a potential profit of $2.24/day.

Currently the option is priced at $0.60 with 27 days to expiration. This gives the same potential profit of $2.24/day. Then I see no point in closing the position.

I'm looking for a formula that tells me when to exit.

I consider this to be a very important point -- one that keeps too many traders from being profitable. It requires that you think about what you are doing -- and looking for formulas is one way to be certain that you do as little thinking as possible.

I was trying to help you solve a problem, but this entire discussion is inappropriate. I've written about this previously, and I know that many readers believe I'm as wrong as one can be.

But, if you learn to trade with logic and without emotions, the common sense of this approach should overwhelm any hesitancy you may have to adopt a similar trading philosophy.

The decision on whether to hold or close has nothing to do with the original trade.

Let me say that again. It doesn't matter whether you sold the put and collected $6, $2, or $0.50.

The option price -- at the time you made the trade -- already reflects your trading style, tolerance for risk, your preferred time frame, delta and theta requirements for the trade, etc.

The decision to hold or exit must look at the position now. Does it still fit within your comfort zone? Do you want to be short this option? Do the parameters of the option -- right this minute -- still work for you? Are you confident that $2.24/day time decay is all you need to know about an option to make a decision on whether to sell it?

Look at it another way. If you were forced to exit every trade every morning (no commission expenses) and given the opportunity to keep that closing trade, or re-establish the position at the same price you just paid to temporarily exit (again no commissions or fees), would you re-establish the position? Is the risk/reward acceptable?

If the reply is "no," then why are you holding? How can the original selling price play any role in the decision? It can't and it shouldn't.

No positions in stocks mentioned.

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