Before we get into any option trade adjustments, I want to emphasize the importance of a correct entry. Adjustments are not the key to success in our strategy. You should be able to make some good money without any adjustments at all, AS LONG AS you do the right trades from the beginning and stay consistent with them. The correct setup and entry are everything. This is the most important thing and therefore you should focus on a correct entry. If you enter into a bad setup/trade from the beginning, no adjustments will ‘rescue’ this trade. You can improve your situation with adjustments, but you can’t enter into a losing trade and transform it into a winning one with adjustments. Therefore, if you have the motivation and can spend a little more time for your trading activity, you could improve it by starting to adjust these high probability trades. In this article, my goal is to teach you when and how to adjust high probability option trades.
When to Adjust your Position – Adjustment Requirements
I suppose the reason why you even want to adjust a trade in the first place is because you have a losing trade on. This would be the first requirement for an adjustment. I would rarely suggest you to adjust any winning trades. Rather, just take them off at a profit (doesn’t have to be max profit: around 50% or more is good enough). But you shouldn’t adjust every losing trade. You should never adjust too fast. Many option positions are losers at the beginning or in the middle of a trading cycle. So don’t adjust if you have lots of time left until expiration. Before making any adjustments you should check the importance and impact of your losing position on the whole portfolio (mainly if you have a bigger account and more than 5 positions open at a time). If this position helps your overall portfolio to stay neutral, you shouldn’t necessarily adjust it. Your entire portfolio will probably still make money anyway. But if the adjustments could neutralize your portfolio more, you should definitely adjust the position if you want to. (To check the impact of a position on a portfolio precisely you can use beta weighting).
What you want to achieve with an Adjustment
Before getting into any adjustment techniques I want to make clear that you have some main goals with an adjustment. Your first goal would be to minimize your risk on that position, the next goal would be to widen your break-even points so the price has more room to move. An optional third goal could be to neutralize your portfolio. I will now present you how to fulfill these goals on our selected spreads within the high probability option selling strategy
Option Spread Strategy Adjustments
1. Credit Spread Adjustments – How to Adjust a Losing Credit Spread?
When you have a losing or almost losing credit spread, the price of the underlying security will be somewhere around the break-even point. What many people then do is roll the existing losing put/call side further in the direction of the underlying price. I wouldn’t recommend this because this actually would increase your exposure and risk which you don’t want. I would much rather add another leg with the same expiration date on the other side (on the side where the security’s price is not at) to create a short iron condor (if you have a put credit spread, add a call side, if you have a call credit spread, add a put side). The new leg should still be at a high probability strike. By doing this you will collect more premium. This will then help you widen the break-even points and reduce risk. If the price then continues to move against you, you can do this (close the newly added leg at a profit and open new positions closer to the market) a few more times to achieve the same goals again and again. Even if this won’t necessarily turn your trade around, it definitely can help you decrease your risk and loss by a lot.
Below you can see the effect of the adjustment of a credit spread on the payoff diagram. As you can see risk gets reduced and the break-even points get (further) OTM/away from the current trading price.
2. Option Strangle and Iron Condor Adjustment
The adjustment technique I teach for iron condors and strangles is very similar to that of the credit spreads. You want to adjust the side of the iron condors or strangle where the market price does not create a loss (the side where the price is the furthest away from). Then you will close out that side for a small profit to open a new leg with the same expiration date but a strike closer to the 2nd leg. This again helps you widen the break-even points and reduces your risk.
Setting Option Trading Goals Beforehand – Adjustment Points
There are many possible adjustment points you can choose for your positions. One important thing with adjustment points is that you have to set them before you enter any position and stick to them. If you do so, you will trade much better and more mechanically. Some different adjustment points would be: a certain probability of success/delta, certain IV or the most standard adjustment point would be a certain price in the security. For stock trading, it makes sense to use the price of a security as an adjustment point because it is the deciding factor for making or losing money. But for options, things are quite different. Even if the price of the underlying security moves in the direction you wanted it to, you can still lose money. This is because there are other factors that options take into account (IV, time…). Nevertheless, it probably isn’t the best idea to set an adjustment point only at one of these factors (e.g. certain IV). I would choose an adjustment point which takes all these factors into account. The factor which does this is the probability of being ITM. Therefore, I recommend setting an adjustment point at a certain probability of success or delta. This is what our option trading strategy is based on, thus the probability is the most important thing here. If your probability of making money changes dramatically, you should be concerned and maybe consider an adjustment.
As an example, a 15% change in the probability of ITM/0.15 change in the delta could be an adjustment point. This could mean that your odds just changed from 75% chance of winning to only 60%. This is quite a remarkable change which shouldn’t be ignored. You can decide for yourself how big of a change in the probability you are willing to accept before you adjust.
This Article is part of the Advanced Option Trading Course. If you are reading the article as a part of the course, you can continue to the next lesson: HERE