We’re all in the business of trading stocks and options to make gains — preferably BIG ones — but because we don’t live in a perfect world, sometimes trades just don’t go our way. So today, I want to take this opportunity to address taking losses.
There’s simply no reason to lose all your money in an option trade unless a company goes belly-up or the stock implodes in a big hurry. In my trading services, if a trade starts showing signs of getting away from us, we issue a sell alert to tell subscribers to hit the exits faster than you can say “$100-a-barrel oil.”
But when you’re trading on your own, sometimes it’s challenging to know when to sit tight in a trade and ride out the volatility in your position, or when to close out and capture your profits or cut your losses.
With stocks, oftentimes it’s easier to wait out a pullback and to even add shares to a position on dips. And sometimes, that mentality carries over into the options world. But remember, you’re not married to the stocks or the option positions that you put on the table.
In my experience, it’s been way more beneficial (and profitable) to close an option position while it still has most of its time premium intact and reinvest the original capital into another, more-promising trading opportunity.
What is time premium? This is the amount of money you have to pay to buy the option in excess of intrinsic value. It’s your basic rental fee. For instance, if XYZ Corp.’s shares are trading at $90 and the call at the $85 strike is trading for $6.50, then the intrinsic value is $5 (that’s $90 per share minus the $85 exercise price), and the remaining $1.50 (to make up the $6.50 price of the option) is the time value of that $85 Call.
Your goal as a trader is to keep as much of that money in your pocket as possible, because it’s no fun giving back gains that you already have. But if you do have to take a loss, it should be as small as possible.
Although taking losses is part of any trader’s reality, not only do you take smaller losses as an options buyer, but keeping those losses as small as possible means that you get to stay in the game longer. And that means having the capital to invest in more chances to win bigger!
