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Are You Ready To Be an Options Trader?


Four ways to gauge your preparedness.

Dear Professor Wolfinger,

1. I've been told that you should close a position if you have more than 6% or 7 % loss. I'd prefer to wait for a 12%-15% loss. What's your opinion?

2. Do you agree that you should take your profit quickly? What do you think should be the minimum profit percent for trading options? Is 20%-30% too low? Is 50%-80% reasonable, or is over 100% ideal in option trading?

3. I'm a beginner, and I live in Hong Kong, so it's unlikely that I'm going to buy any covered call or put, or buy the actual stock. I intend to profit by selling the up and down of the call and put premium. Is my strategy too risky?

Minyan Alex

Dear Alex,

1. My opinion is that you should not allow anyone to tell you what to do. As you read and learn and collect the opinions of different people, you can decide for yourself which of those opinions make the most sense. I'll describe how I'd handle certain situations, but I always explain that these suggestions suit my trading style, and that readers should decide if my choices make sense for them.

When trading options, a 6-7% loss can occur quickly. When you trade individual options (as you plan to do) instead of spreads, then a change in the option's implied volatility -- not only a change in the price of the stock -- can easily move the options 10%.

When trading stocks, setting a 6-7% limit (or some other number) makes sense; if the stock moves against you, there's a very good chance the reason you bought the stock in the first place has changed. When that's true, it's a good idea to reconsider the trade, and perhaps exit.

But options are different. I believe you should exit when you realize you were wrong. When the stock isn't moving as anticipated, too slowly. etc. Yes, you shouldn't hold an option until it expires worthless, and it's often difficult to determine an exit point - but I don't think it's good practice to exit an option trade when the loss reaches x%.

Exception: If you find you can never let go; if you find you're losing 100% too often, then you will need some artificial loss point to protect yourself.

2. Take profits quickly? If you want to take profits, then do so when you no longer believe the underlying stock is going to continue to perform as you predict. It's also a reasonable idea to compromise by scale selling, as the price moves higher (to sell 1 or 2 at a time).

But, in general, my answer is no. Don't take profits quickly.
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