Trades go down sometimes …
It happens to the best of us.
Believe it or not, every now and again … even I put on a losing trade.
In fact, this week I put on a loser in BlackBerry (Ticker: BB)!
I bought puts and two things happened:
The stock stopped dropping
Implied volatility dropped, so the “insurance premium” for the option fell
I pulled the plug on Friday’s open, right before the stock took off.
But how did I know it was time to close?
That’s a question I often get from readers.
And the answer is built on three analysis points that I apply in these (rare for me) situations.
Can the trade still win?
And I don’t mean in a “So you’re telling me there’s a chance” way.
The odds of the trade winning have to be close to 50/50. (And if you’re unsure of how to calculate those percentages, that’s something the team at Option Pit can be very useful in helping with.)
If they are not — and I can’t stress this enough — CLOSE THE TRADE AND GET OUT!
You are throwing good money after bad if you insist on staying open.
Now, in the case of BlackBerry, while it rallied Friday and vol came in, I firmly believe that the 11.5 puts I owned in February can win — eventually. So …
If I close now, can I get in at a better price later?
Retail traders miss this point so many times.
During my career on the floor, there were times when I would sell 50, maybe 100, options, realize it was a bad selling price and buy them back for a loser …
Then, lo and behold, a few days later the options were FAR more expensive, and I could sell them at a much better price.
In the case of BB, I thought to myself, “Do I want to set this up later at a different price?”
My answer was a pretty strong yes.
With my 11.5 puts closed and IV lower (and still falling), there are really good odds that I will get to play BB short — at a higher price AND at a lower implied volatility.
That trade will have much better odds of not just winning — but winning enough to more than make up for what I ate on the first trade.
Is there a better place to put my money?
This is the point that costs retail traders the most.
Have you ever been so busy concentrating on something (ahem, your cell phone) that you missed a wonderful opportunity or experience somewhere else?
I see this happen all the time in trading.
For instance, in futures, traders who are already short and losing are so focused on the negative that they miss a GREAT chance to sell a top …
Next thing you know, they cover for break-even just as the future is actually breaking lower. (The premise holds true for long positions, as well).
It’s the same in options.
Traders are so wrapped up worrying about their losers, that they don’t take the time to look for winners.
Look, if a losing trade stops you from making a winning trade, you should have closed.
Because losing trades can cost you twice.
You can lose on the bad trade AND you can lose because you didn’t make the good trade.
Retail traders often forget that opportunity cost — missing out on potential gains elsewhere when a certain option is chosen — is the biggest cost of trading …
Your money is precious and you have the ability to get in and out when you want.
That is the best part about being a retail trader — and your most valuable asset.
It can also be a liability if you don’t pay attention.
Your Only Option,