Since the Covid-19 pandemic, retail investors have flocked to option markets, sending options trading to new highs the New York Stock Exchange says are likely here to stay. Option trades by retail investors hit 48% of total volume in July 2022 before settling back to 45% in July 2023.

The involvement of so many individual investors — especially new, inexperienced investors — has drawn the attention of the Securities and Exchange Commission and the Financial Industry Regulatory Authority. Even the Sloan School of Management at the Massachusetts Institute of Technology (MIT) authored a study on the concerns of retail investors trading options.

One of the key findings of the MIT study is that many retail investors increase options trading around earnings announcements and fail to close options trades, resulting in losses.

Not surprisingly, many options traders struggle with how and when to close options trades and take home profits.  

Investors face several challenges and decisions along their journey to profits. When to close option trades is one of their biggest, especially if they’ve been flooded with information on entering options trades but not exiting.

Exiting Options Trades With a Profit

For many investors, deciding when to exit an options trade is the most difficult part of trading options. Investors often focus on getting in at the best price possible. But no matter your entry position, the money is made at the exit.

That can make closing trades stressful. In order to help tamp down that stress and ratchet up profits, it is crucial to have an exit strategy before opening a position. If investors plan out an exit strategy before beginning trading, they are prepared for every possible outcome and know what they will do in each situation. 

Here are three basic strategies for determining timely exits of options trades.

Profit Target Strategy

The profit target strategy is straightforward but hard for many investors, especially if the trading is going in their favor. Investors set a profit target as they enter the trade, and then they stick to it. Period. Selecting a profit target is like picking a destination before setting out on a trip. Travelers on a long trip map out a route and head toward that goal. Investors shouldn’t “throw” an option position on without setting specific profit and stop-loss targets.

And then, most importantly, follow them! Investors who stick to their targets avoid one of the common pitfalls of trading, especially when they have a profitable trade — GREED.

Setting Price Targets

So, how do investors set these targets? Typically, they set a target price for the underlying stock, and then they calculate the potential option returns of such a move using an options pricing calculator (easily found online).

Investors can generally operate in an environment where the profit target, or upside, is defined by a stock that will move enough to yield a 100% return (or more) on the option. This is one of the ways an investor can select an option for the trade (but that’s a discussion for another day).

Many investors recommend targeting a return of 50% to 65%.

For example, if an investor buys a call option for $200 with a strike price of $50 and the underlying stock rises, the option is now worth $300, a 50% increase. The investor, having set that as a profit target, sells the option and takes the profit.

Technical Analysis Strategy

Common tools used by traders to identify optimal entry prices for a stock position are the various levels of support and resistance arising from the technical analysis of a stock. The same applies to closing options trades. An investor must keep an eye on the significant technicals of the underlying asset to identify timely exits for option positions.

A return to a significant support level can be a signal to close out a put because that indicates the stock may be due for a short-term bounce.

Or investors can close calls as the underlying asset approaches significant resistance in the form of a declining moving average.

For example, an investor buys a call option, and the underlying stock begins to rise. However, the investor sees that the stock is approaching a level of significant resistance. This could indicate a potential reversal. The investor decides to sell the option before the stock reaches significant resistance and locks in the profit to that point.

Event-Based Strategy

Investors must watch the market for events that are likely to cause uncertain movements.

One of the most frustrating things in options trading is watching the market react to an event, dragging investors’ options into the “red.” For this reason, investors should consider avoiding event trading unless it provides an edge for them.

Events such as employment reports, GDP announcements, interest rate decisions, etc., are less predictable and can have a huge effect on individual stocks. Investors would do well to keep their eyes on upcoming events in the market and close positions to lock in profits before these announcements are due.

Earnings Announcements

The exception to the event-based strategy is an earnings announcement, which can give an investor an edge. An underlying catalyst of many trades is earnings announcements. Investors who do a large amount of due diligence and research on what the market is expecting for a particular earnings announcement can gain an edge.

Using the research, investors can take advantage of disparities between expectations and reality to tilt the market’s probabilities in their favor.

Investors may help themselves by keeping an eye on events and earnings, even with due diligence and research.

For example, an investor can hold a put option on a company’s stock, and the company announces better-than-expected earnings. At that point, an investor can close the position since feelings about the positive earnings can push the stock price higher, lessening the value of the investor’s put option.

Exit Strategies for Option Trades

Many investors know how to get into a trade position, but the harder part is getting out of it. Investors use many strategies to close options trades. These are just three. Determining when to close option positions can improve investors’ effectiveness as traders. The key to exiting option trades and locking in profits is entering a trade with a plan for exiting.

On the date of publication, Sarah Edwards did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

On the date of publication, the responsible editor did not have (either directly or indirectly) any positions in the securities mentioned in this article.