Knowing When to Adjust an Options Trade or NOT


Hey everyone this is Kirk here again at OptionAlpha.com
and in this video we’re going to talk about knowing when to adjust an option trade or
not. So adjustment timing is actually a very popular
question we get from our members, in fact, if I could guess we would probably get around
two to five different questions, or support tickets, or forum threads around this concept
of making adjustments and timing almost every single day. So it is an extremely popular concept, hopefully
something we can help address with a little more clarity here in this video. Now first, it’s important to understand that
there are definitely two extremes to adjusting a trade and I think the first extreme that
I’ll go through is using example of medicine because medicine is a great analogy for how
you should be managing your portfolio and adjusting. And I love to use analogies as you probably
have already, already are aware. So my father’s diabetic, actually most of
the men on my side of the family are diabetic, and he had been through a bunch of medicine
with his doctor and got to the point where he was taking so much medicine that they were
actually conflicting with one another. He was taking five things in the morning and
two things in the afternoon and whatever the case is and they all individually were trying
to accomplish their own little mission. But then collectively they ended up becoming
a big mess and ended up sending him into a bad physical state and a bad health state. So the analogy here is that if you’re trading
there is an extreme where too much trading, so too much adjusting, can be detrimental. And yes, you could be trying to do individually
good things to each position, so you’re adjusting this position and it makes sense, and this
one and it makes sense, but collectively all of the adjustments end up being this overdose
or this overload of adjustments. You have to realize there is a point in which
you can over-adjust somethings or over-trade them. Now on the other hand, you could also run
into the other side of it, which is analysis paralysis or overthinking. I love this image and this quote from higher
perspective that says, Overthinking: the art of creating problems that weren’t even there. And this is really a lot of traders I see
actually, most traders I see really kind of over-analyze every possible scenario and situation
for making an adjustment. They basically get into this analysis paralysis
where they end up not doing anything at all, which could be detrimental to maybe doing
something and maybe it didn’t work out exactly like you thought or planned or kind of strategized. But at least it was doing something better
than nothing. So again, there are these two concepts and
obviously you really have to find the balance between too much and not enough adjusting
that’s right for you and your risk tolerance. I can’t tell you what that ends up being at. It’s so many different factors that go into
it as far as the trades that you’re making, your position size, etcetera, etcetera. I can tell you in my opinion I’m always slower
to adjust, so I always air on the side of maybe adjusting a trade but not over adjusting
the trade. Making small adjustments at small increments
along the way and always try to make adjustments on a slower basis, because I know that long
term, the edge in option selling is still in my favor. So even if I didn’t make any adjustments I’d
still win a certain amount of time, I’d still hit my targeted portfolio probability of success
and return. I can still hit all of that long term, so
that’s why I’m just a little bit more slower in pace in how I adjust trades. Again that’s just my own personal preference. So again the question is, when do you adjust
or hedge a trade and how can we make it as systematic as possible to remove our emotions? Well the answer is you have to use trigger
points and alerts. And I think you really have to use both of
these in conjunction with one another to really makes this effective for your trading. Trigger points for me have been incredibly
helpful because it’s a set of road markers or guide posts, whatever you want to call
them, that basically tell me when it’s time to make an adjustment or hedge a trade. And basically what I do is I set up these
automated alerts in advance that help take my emotions out of the game, and now it becomes,
get an alert, make an adjustment. So the if, then statement. If I get an alert, meaning I’m not going to
watch and monitor and babysit the trade the entire time. If I get an alert, or I get a notification
that something’s happened that triggers me then to make an adjustment, I’ll make that
adjustment immediately. And so that’s the ways that I’ve set it up
with my portfolio. And again I’ll go through some examples here,
in detail, as we work through this video. So there are some popular trigger points and
I want to first talk about them and then we’ll go through them here with an example from
a live trade that we currently have going on right now. The first trigger point that you can set up
is your short strike reaches a thirty delta. I have to tell you that the initial assumption
here is that you’re entering all of your trades at about a seventy percent chance of success. Okay, so we’ll go through a couple of examples
here but we’re assuming that all of your trades are entered at about a seventy percent chance
of success and in this case if you did a strangle, each side of your trade has about a fifteen
percent chance of being in the money. So if you sold the call option and you sold
a put option, they each individually have about a fifteen percent chance of being in
the money or they’re at about a fifteen delta when you initially enter the position. The first trigger point then is if your short
strike on one side or another reaches a thirty delta. And what that basically means is that on one
side of your trade the probability of losing went from fifteen percent up to thirty percent. So basically a doubling in your probability
of losing on that side of the trade. You could also use a short strike going to
forty, so if you’re maybe a little bit more, or you want the trade to work a little bit
more you can withstand a little bit more pressure. Meaning that you can withstand the trade going
against you a little bit sooner and maybe for a little bit longer you can enter a trigger
at a forty delta short strike. Instead of the delta going from fifteen to
thirty, you’re going to let it go even more, all the way up to forty. The stock really has to move against you in
a bigger way for you to actually be triggered to make an adjustment. The third way that you can do it is you can
do a two X of your initial credit, or really, I mean, you can put anything X here. You can do a three X of your initial credit,
four X, whatever the case is. But let’s say that you entered a strangle
and you took in, let’s say a hundred dollars. If the value of that strangle goes up two
X to three hundred dollars and now you’re looking at a two hundred dollar loser. That might then trigger you to make an adjustment. So now the trigger is now based on the value
of the contract that you traded, or the strategy that you traded verses the short strike probabilities
and deltas. Not something we typically do here as far
as adjustment techniques, we don’t typically use this value two X credit but I know it’s
very popular out there and obviously I wanted to cover it. So the last one that you can try to use is
when the long or when the stock breaches your long strike. So this would be an adjustment technique where
you’re really going to wait for the stock to go completely against you, maybe you sold
a call spread or sold a put spread down below the market and you’re going to wait for the
stock to breach the long strike of that strategy. Not the short strike that we can maybe look
at in trigger number one or trigger number two. But you’re going to actually wait for the
stock to go completely in the money on either end beyond your long strike before you make
an adjustment. And again, it’s not to say that any of these
are necessarily better than one or the other it’s just you have to understand how long
you’re waiting, maybe how much risk you’re willing to take or not or whatever the case
is. Let’s go through number one here and talk
about what a short strike thirty delta might look like and again we’re going to use a really
good example by building out a new trade here in Linkedin. And again we’re on our broker platform in
Thinkorswim. This is all live, real time market data at
the time we’re doing this video, but we’re going to build out a trade here in Linkedin,
assuming that you entered a neutral iron condor where you can do it as a straddle. Whatever you want to do and we’re going to
use these adjustment trigger points and kinda set them up one by one so you can see how
each of these might work. If we’re looking at the Macon tracks for Linkedin
you can see that to initially set up this iron condor and again be at about a seventy
percent chance of success we’re going to target each side of the trade or our anchor strike
price to be around a fifteen percent probability of being in the money. Now the eighty fives in this case for Linkedin
about twelve and a half percent, so we’re going to go up to the nineties. There’s no fifteen percent probability on
either side but the nineties are around a 12 delta, about a seventeen percent chance
of being in the money. We’re going to use those on the bottom side
and then on the top side we’re going to use the one forty strikes cause those are almost
right out of fifteen percent chance of being in the money. So we’re going to basically set our anchor
strikes or our short strikes for this strategy at the ninety puts and then the forty calls
above the market. In this case, we’re going to build out an
iron condor in Linkedin and we’re just going to add each of these sides here real quick
so we can build out this strategy and kind of talk about it a little bit more. And then we’re going to sell the put spread
down below the market. Great. That can get us our advanced order here, which
is our iron condor. So now you can see we’ve taken a creed of
about one twenty five and I’m just rounding up here, roughly a seventy percent chance
of success. Okay, so this might be a trade that you look
at but we’re just going to use it as an example here for the purposes of adjusting. Now if we enter this trade, let’s assume we
hit confirm and said enter this trade and it’s now working in the market. So we’ll throw it over on the analyze tab
and take a look at what the risk profile looks like, and you can see it’s a very neutral,
even, iron condor. Again, a very simple trade that most people
would make with the stock trading right in the middle of our range basically as neutral
as possible. Now the question becomes how do we set up
these initial trigger points to let us know when we need to make an adjustment to this
trade because we don’t want to babysit this trade. Meaning, I don’t want to come in here every
single day and have to check Linkedin or any of my other trades and say okay, do I have
to make an adjustment, when do I have to make an adjustment. Then I get emotional, what’s the market like? Am I winning on the position, am I not? Whatever the case is. Setting up these trigger points is going to
be really, really helpful in streamlining your trading process and removing your emotions. So how do we do it? The first on that we looked at was a thirty
delta trigger point. What a thirty delta trigger point basically
means is that if either side increases the short strike, which is the one forty on the
call side or the ninety on the bottom side, on the put side. If either side increases it’s delta from basically
wherever it is to a thirty delta then we would make an adjustment. In this case we think about it logically as
a doubling of risk on one side, because if the initial probability of losing on, lets
say, the call side, or the stock going up to one forty is only about fifteen percent. If the delta or the probability doubles on
that side to basically thirty percent then we have a doubling of risk. We have a two times higher likelihood of losing
on the call side, meaning that the stock has moved against us. Remember the only way that the delta increases
is if this strike price becomes a lot closer to where the stock is trading. Notice that if the stock is right now at about
one fifteen the delta or a strike price with about a thirty delta right now is about a
one thirty strike. Basically what we’re looking at is if the
stock moves up about ten dollars we should see this delta move up to about a thirty delta,
okay? So what we’re going to do is we’re going to
right click here and look at the delta, it’s currently nineteen so it may be a little bit
different, again deltas are just a very rough approximate. But you’re going to use that probability that
you still used to enter your initial trade. We’re going to right click here and we’re
going to create an alert. Once you create an alert this new alert dialog
box is going to come up and basically what it’s going to say, is it’s going to say okay
we’re going to look at the stock or the spread and it’s going to notify us whenever the delta
crosses at or above whatever it’s at. Now, initially it’s going to give us a price
of where the delta is right now. In this case what we want to do is we want
to change this to thirty. So once we change this to thirty then we’re
going to say okay, this new alert will only activate if this delta on this option goes
up to thirty. That’s the only time that it’ll actually trigger
us and we can get notified via email, or we can get notified via text message, or whatever
the case is you can get notified a bunch of different ways. I like to do email because I just want to
be notified via email. I’ll get a nice little email that says, hey,
the delta for Linkedin is now above thirty. That is my trigger point to come in here an
make the adjustment technique, some of the stuff that we’re going to talk about further
along in track number three here. But that’s how you set up this adjustment
or this alert on the top side. Now again, you could set up this delta to
be at a forty delta. So if you want to say, okay, I’ll only adjust
this trade if the delta goes up to forty. Okay great. Set up the trade to adjust only at forty,
but remember what you’re doing here. A forty delta is basically letting the stock
move about fifteen dollars against your position before you make an adjustment. Remember the option with about a forty delta
right now or something close to it is the one twenty five strike. So if the stock were to move up about fifteen
dollars, that would create a basically a forty delta for your short strike. You just have to understand that you might
be, you have to willing to accept maybe a little bit more risk on that trade initially,
and maybe adjust it a little bit slower later on in the process, okay? On the put side we can do the same technique
for adjusting our short strike on the put side. The short strike on the put side is a negative
twelve delta right now because we sold the nineties. Again we can just right click on this, say
create an alert and now what we want to do is we want to say delta at or below. This is the key point here because you want
to make sure that with your negative put deltas that you put it at, at or below negative thirty
or negative forty or wherever you want to be. If it says at or above, when you create this
alert you’ll automatically get an email because it’s basically going to be above whatever
price that you entered in there. Just make sure that you double check and you
say, okay on the put side I want the delta at or below negative thirty. And, again, when the risk in this trade goes
up from a 17.73 percent probability to somewhere around a thirty, thirty two percent probability
of losing on that one side, then you’ll get an email alert that says, hey look Linkedin
has moved far enough that this trade is now at risk on one side of the spread or one side
of the iron condor. Again, with these anchor points and these
trigger points you’re basically doing everything off of the short strikes. The one forty calls, the seventy puts or the
ninety puts, you’re doing everything off of these anchor strikes. If you’re doing an iron condor this works
the same as if you’re doing a strangle. It doesn’t matter as long as you’re doing
a short premium strategy this is the best way to do it. If you’re doing a credit spread you can do
it the same way, you just have to set it up one side versus with an iron condor you might
have to set up two of these alerts on either side of the trade. If we go back to our popular triggers here
we basically really cover the short strike at a thirty delta, how to set that up, how
to set up those triggers. Same thing with a forty delta. Again you can use any combination in here
we just arbitrarily said you can look at thirty you can look at forty, whatever the case is,
use something around these numbers, thirty five, forty five, whatever works out best
for you. Set up those triggers to let you know that
the value of the options or that the probability of the options going in the money has now
increased and now you might need to make an adjustment to this trade. Number three is the value of the contract
has now gone up two X from the initial credit. This one’s going to be a little bit different
and harder to set up triggers. In fact, most of the ways that you can set
up triggers for number three here or the value going up by some X percent is very antiquated
and takes a lot of steps. We’re not going to go through in this video. I don’t think you need to do it. I think number three is one of those ones
where if you’re going to use that as your basis for making an adjustment you just have
to watch the value of the contract go up. In this case, if the contract that you sold
in Linkedin was valued at one hundred and twenty five dollars, a two X of that would
basically be about three hundred and seventy five dollars. Again, if the value of the contract goes up
from one twenty five all the way to three hundred and seventy five, again two times
higher than it is right now or two X higher than it is right now, then you would consider
making an adjustment. The reason I don’t use this technique to be
completely open and clear, the reason I don’t use this technique is because the value of
these options can actually go up if implied volatility goes higher. Meaning, if we didn’t properly enter the trade
with really high implied volatility or fairly high implied volatility, and volatility rose
in Linkedin, the stock doesn’t have to move anywhere. Meaning the stock price can stay exactly the
same. Volatility going up then creates the value
of this option to go up as well. The reason I don’t use this is, one, you can’t
really automate the value of these options and checking these for alerts, it’s very hard
and antiquated to do. It would create a lot of work to do that. Number two is that it’s not really directional
based, based on the value of the underlying stock. What I like to look at more so is the directional
basis of the underlying stock. Is the stock really moving against me or is
it not? In this case you could have a situation where
the stock doesn’t even move against you at all and the value of the options go up, you
get triggered to make an adjustment but there’s no adjustment really to be made. There’s nothing you can really want to do
or would need to do in that situation. Number four is a very popular one. This is, again, one that you would want to
use if and only if the stock really made a large move against your position, you’re willing
to hold it. That’s if the stock breaches your long strikes. Again, going back here to our platform, if
we were looking at our Linkedin trade, our long strikes in this case are our forty five
calls and our eighty five puts. If you’re going to do this with a straddle
or a strangle you’d be looking at the stock breaching the short strikes because you wouldn’t
have any long strikes. That’s obviously what you’d be focusing on. But, if you’re going to be doing an iron condor
or credit spread or something along those lines you’d be looking at the stock breaching
these long strikes. Which, again, the one forty five call and
the eighty five put down below the market. You’d set up these alerts very similar to
what you did before and we basically just click on the eighty five strikes here, we’d
right click on create an alert, and then now what we want to say is we want to say that
the actual stock itself, so instead of the spread but the actual stock itself, is now
at or below our eighty five strike price, okay? That’s how you’d set it up for the actual
strike price, or the stock breaching that long strike price. Again, this is setting it up on the bottom
side with our put strike. We basically set up this alert all the way
down below the market. You can see Linkedin is trading all the way
above the market at one fourteen right now. It’s only going to trigger and notify us via
email if the stock price is at or below eighty five dollars. Again, that would then trigger us to come
in and make some sort of adjustment. If we want to do it on the top side we could
say okay, at or above our call strike on the long side, which is the one forty five calls
above the market. Now you can see your trigger is now set up
all the way at the one forty five strike above the market and the stock still is about one
fourteen, one fifteen or so, trading right now. Very, very easy to do that but remember that’s
going to basically push you to the limit and basically not give you a lot of time to make
an adjustment. It is going to give the stock more room to
move, obviously a lot more of a fluctuation in price as it gets closer to expiration. There’s no right or wrong way to do it here
I’m just trying to help you understand these different ways that you can set up triggers
for how you adjust a trade going forward. Some common sense comments that I want to
add. Generally, if there’s a lot of time left in
the expiration in the contracts I’ll let the trade run against me a little more. Again, this is not to say that every time
that we get an alert we have to make an adjustment. Because as we talked about previously, making
an adjustment has to make sense for the trade and for the portfolio. If there’s a lot of time left until expiration,
maybe the stock made a quick one day move against me and now my delta went from fifteen
to thirty in the first day okay, maybe I’ll let it run another couple days to see hey,
is this trend really going to continue or was this just a one day pop against me? If I’ve got a lot of time I’ll generally let
the contracts work a little bit more and be a little bit more flexible in when I adjust
it because I want the probabilities to have a lot of opportunity to work themselves out. This also means, obviously, that if we are
limited in time meaning it’s nearing expiration, fifteen days or sooner, then we want to be
a little bit more proactive in some of our adjustments. We don’t necessarily want the stock to run
against us a little bit more. We want to be a little bit more proactive
in how we trade. Always try to avoid adjusting too close or
too fast. This kind of goes on the same lines of the
other one. You can always make more adjustments if needed
later on. I’m a big fan of making small incremental
adjustments along the way, meaning I will roll contracts closer by a small amount because
I know I can keep rolling them closer and closer and closer all the way to expiration. What you don’t want to do is you don’t want
to be triggered to make an adjustment and then make the most aggressive adjustment possible,
take in as much credit as possible and try to reduce as much risk as possible so early
in the expiration cycle that you basically price yourselves out of the market. You basically create a strategy that has no
potential for really winning. For example, if we go back to our Linkedin
trade, a common adjustment for an iron condor is to roll one credit spread closer to where
the stock is trading. Let’s say that Linkedin all of a sudden starts
moving up to, let’s say one twenty. Which is a five dollar move but or a hundred
dollar stock, not a huge huge move that would necessarily trigger us to make a massive adjustment. But if you then rolled up your put spread
side all the way to one twenty and now you’re new resulting position in Linkedin looked
like this, a really tall, thin, iron condor, you’ve pretty much given yourselves a very
small window of opportunity to make money. Yes you made an adjustment, yes it probably
reduced risk, but you’ve also dramatically limited your ability to make an adjustment. Again, these contracts are forty or fifty
plus days away. There’s a lot of time for Linkedin to move. It’s going to be hard pressed to really pin
a stock in a twenty dollar range like Linkedin that might be a big mover. What I favor is just making small adjustments,
roll up that put spread side a little closer then you can roll it up closer if the stock
continues to move against you. If it continues to move against you, you keep
rolling up that put spread side closer and closer and closer. You make these small incremental adjustments
along the way so that you don’t over adjust the position too much and be too aggressive
in how you do it. The last thing is, there is no perfect adjustment
timing sequence and you always have to consider the impact on your overall portfolio before
adjusting. As we’ve talked about in numerous videos before,
it is more important to consider the impact o an adjustment on your portfolio than the
individual position. If your individual adjustment to, let’s say
Linkedin that we’re looking at right now and that was our case study, if this adjustment
in Linkedin turns Linkedin from a loser to a winner, great. But if that same adjustment that turns Linkedin
from a loser to a winner also turns the entire portfolio from begin winning right now, even
without adjusting Linkedin, to a losing situation and unbalances you then it’s not really a
good adjustment for your overall portfolio. Consider that, analyze the trade, take a look
at it, see what really can work for your portfolio. Again, the key here is to have something in
place and stick with it for awhile. My suggestion, pick from one of the four popular
trigger points, work with it for a couple months, then switch if needed. To give you guys an idea on where I stand
on trigger points, before we end this video. Where I focus a lot of my adjustment timing
and techniques is around the thirty to forty delta. There’s no right or wrong answer in here. Again, I’m a little bit fluid in which one
I might pick based on timing. If a stock moves against me really quick initially
and it’s the first day the I have the trade on, I might be a little hesitant to adjust
it so quickly in the cycle. I might give the stock another couple days
to move against me, if it does, before I make an adjustment. I’m always slower to make adjustments than
possibly necessary. I do focus on the short strike deltas, I think
that’s the better way to go. I think when you actually look at a trade
and think about the logic behind why I focus on the short strike is because I want to know
more so than the value of the option, because the value of the option can go up or down
any given day based on implied volatility et cetera, but I really want to know is the
stock really moving against me or is it really not? Is my position really becoming less and less
likely to profit or is it not? For me I base a lot of that decision on delta
and probability of being in the money for the short strikes. I want to know, look if the stock’s really
moving against me to the downside, these deltas and this probability’s going to go up, they’re
going to alert me to the fact that I might to make an adjustment. Same thing on the top side. If the stock moves against me to the top side
and starts moving higher, these deltas and this probability of losing is going to go
up. That’s going to alert me to how long or how
short I should get in the stock or make an adjustment, whatever the case is. The other thing that I like about using deltas
and probabilities is that it’s time dependent. Remember these probabilities and deltas will
adjust as you get closer to expiration. We’re about fifty days out from May expiration
right now, if we looked at this exact set up and if Linkedin didn’t move in between
now and let’s say the next ten days, these deltas and these probabilities would adjust
to refect the fact that there’s ten days less to go in the expiration cycle. By using delta you naturally have this hedge
or this time factor that’s built in so it can help you know when to make an adjustment
based on how much time is left. Again, that’s another reason why I like to
use the delta of each individual short strike as my trigger point for making adjustments
versus the long strike of a particular strategy or the overall credit received. That’s how I focus and how I’ve been taught
and find to be very successful in how we make adjustments here at Option Alpha. Hopefully that helps out, I hope you enjoyed
this video, hopefully it brings a lot of clarity to adjustment timing. If you have any comments or questions, feedback,
I’d love to hear them in the comment section below. If you thought this video was very helpful,
if you loved it, please consider sharing it online. Send it to a friend, a family member, a co-worker,
somebody who might need some help with trading. We’d love to obviously spread the word about
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