During the previous three videos on the tastytrade & dough trading strategy, we’ve covered the concepts of selling options premium, liquidity, and high implied volatility. Now, for our final video in the series, we explain one of the most important aspects of the strategy: managing winners.
For most traders, managing winners is their favorite thing to do because it means that they’re closing out of a profitable trade. At tastytrade we practice managing winning trades when the trade reaches a certain percentage of its max profit. What does this mean? Well, since we receive a credit when we sell premium, we are looking to close our trades when they reach a price lower than the credit we initially received, this results in the trade being profitable. We can then close the trade by buying the option(s) back at the lower price, but we do so only when the price we are closing the trade at is a certain percentage lower than the initial price we sold the trade for.
As a rule of thumb, we tend to manage our winning trades when they’ve reached around 50% of their max potential profit. This means that if we sold an option for $2.00, closing the trade when the option is trading for $1.00 would be managing a winner at 50% of max profit.
We do this for two main reasons, to free up additional capital for more high probability trades and to manage risk. As there is a limit to the profit we can make when selling premium, managing a winning trade frees up the buying power that the trade was using and allows us to place a new high probability trade and in turn manage more winning trades. Using the example above, if when we placed our trade and received $200 for selling the option, by closing the trade for $100, we make a $100 profit and we can then place a new trade for a $200 or higher credit, using the now available capital that the initial trade was tying up.
It also makes sense to manage our winning trades as a way to reduce potential risk. Since the amount of potential profit we can make when selling premium is limited, it doesn’t make much sense to hold on to a trade once it’s reached as certain level of profit. The reward that’s left is not worth the risk of holding on to the trade. Many times traders make this mistake and winning trades that they could have closed at 50% of max profit turn into losing trades at expiration.
So remember, it’s very important to take profits! Manage winning trades when they’ve reached around 50% of their max profit, use the capital that becomes available to put on more high probability trades!
Be sure to check out the last post in the series here.
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