Accumulating in Directional Options Positions
Although commonplace in stocks both with institutional and retail investors, there is little written about the potential of adding to directional (i.e. bought call and bought put) options positions after initial trade entry.
The famous “Turtles” used accumulation as a major part of their trading , so why shouldn’t you?
The reality is, often this is executed on an excited whim rather than a systematized written process as part of a trading plan.
The purpose of this short article is to offer some guidance to enable such a system to test, trade and evaluate.
Underpinning system rules:
- By accumulation we are meaning adding extra contracts to a WINNING position. We do not advocate averaging down your losses under any circumstances.
- We would only add to a position if there was a minimum of six weeks to expiry and in the absence of impending earnings or ex-dividend dates.
- The potential to accumulate in a particular trade is best pre-planned. If this is the case then an Out of the money option can be bought, with the idea that should accumulation be indicted, that additional contracts are added at the same strike.
- If the circumstances of your initial entry are a lower position size based on concerns re. the market as a whole, impending events or proximity of relatively close support/resistance (dependent on the direction of the trade), such concerns MUST be removed prior to accumulation.
- In any case, ideally accumulation would be based on a strong underpinning market as potentially demonstrated by the broader index and decreasing VIX
- Pre-determine the price action that is the accumulation level – e.g. ATR x2 from entry/break of key price point e.g. Pivot high/resistance break.
- Accumulate a maximum of 1:1 ratio to the initial contract purchase i.e. If the initial contract is 10 contracts then a maximum of an additional 10 may be purchased.
- After entry of the accumulated contracts, the initial stop of the first position should be trailed up to a minimum of “breakeven”. With the caveat of “a Gapping” market against the trade, this should theoretically keep the risk of the overall trade the same as it was on the original entry.
- Re-calculate position based on average of two positions entered to ascertain profit.
- Do not ‘stage’ an exit on an accumulated position. When there is an exit signal then do what it tells you to do – An Exit is an Exit!
- For those of you who use Hawkeye charting software as part of your decision-making you have a HUGE advantage already with the ADDS (or Profit accelerator) indicator which tells you exactly when to accumulate on a position. If using this for directional short term options trading use only the first accumulation point only (long term options can consider the subsequent accumulation points).
We trust that provides you with sufficient guidance to develop YOUR plan for this exciting variation on the basic strategy.
Come and see us at www.hawkeyeoptions.com and should you want to see us in action feel free to register for one of the FREE open trading room sessions or have a look at our trade alert service.