Mastering the 3 types of exit for confidence with directional options trading (or for any other trading vehicle really!)


Exits, Exits, Exits…. Although they may not be as ‘sexy’ as looking for an entry, being able to exit in a timely and appropriate manner IS the indisputable truth of how traders make money.

Clearly MOST of the principles covered here are applicable for any trading vehicle, there are a couple of exceptions relating to options due to time decay and the way that options pricing works but they are few. Many are just damn good rules of the game for all traders.

Let me explain, the purpose (and only purpose) of entry is to give yourself a high probability of a trade going in your direction…that is it…and all it is ( and fortunately many of you in possession of Hawkeye software have an awesome toolkit to enable this to happen). What happens next is the deal-breaker in terms of your sustainable success for a lifetime of trading.

Generally speaking, stops can be classified into what we call discretionary and non-discretionary (although we have chosen added another to match our current thinking we are terming partial non-discretionary as there are things you can articulate in your plan but ultimately there is a discretionary component).
Non –discretionary should be your norm. i.e. you have a WRITTEN trading system, is defining how you set your initial stop and subsequently trail stop system AND you follow it. These should comprise more than 80% of your exits are in an options context are usually based on the movement of the underlying stock.
Non-discretionary stops you will see us use include:
a. An initial stop
b. A trail stop – e.g. moves with the Hawkeye trend dot or Hawkeye stop immediately after entry (and how and when you would tighten it)
c. A profit target set on a technical landmark e.g. a pre-defined ATR level or line of potential resistance (if bought call) identified by a pivot high (or visa versa for a bought put
d. A time stop – usually articulated as the next move down if there is less than 3 weeks to expiry.
e. Company event stop. Occasionally we may enter positions where there is some time to earnings or ex-dividend dates. Particularly with the former if we STILL in the position immediately before the announcement then we will exit.
f. We do not partially exit ANY positions taking the stance that an exit is an exit.

Partial discretionary stops you MAY see us use include:
a. A delta risk stop – as the underlying share moves up using a bought call as an example, so delta increases meaning there is a bigger movement of the option value in relationship to the underlying. As a general rule, and particularly in circumstances where we are fully positioned in the market, a delta of in excess of 0.75 would lead us to consider this
b. A Position sizing stop – Again as a general rule we would have no more than 4 directional positions open at any time when the overall market has a good defined direction. Should this change (or Hawkeye is telling us it is looking likely so we can articulate what his looks like in our plan), it seems logical to look to reducing the number of positions open and so reduce risk. There are a number of things we can look at to choose which positions to close which will be the topic for a future article.
c. Market Event stops – There are some market events e.g. Macro-economic events (e.g. debt ceiling negotiations), Major Federal reserve potential actions, Accelerating Geo-political concerns that are VERY market sensitive. Again if highly positioned we may consider reducing the number of positions open. As this will vary depending on our market exposure and of course the potential severity of the event, although we can articulate what these are within our plan and it will be our intention to do this (and how we would make that decision) it is impossible to be completely non-discretionary about this.

Really this is all about YOU. Good trading decisions on a consistent basis need you to be in the best decision making state. If there are other events going on in your world that necessitate attention to a level where appropriate decision making may be impaired then don’t…apart from the decision to step back from the market.

What next for you?
Which of these you use (or choose not to) should obviously be chosen, measured, tested (that’s forward tested NOT just back-tested – back-testing indicates ONLY that something is worth a forward test before trading as should an alteration in your plan.
Clearly you now have the opportunity to look at the above next to your trading plan (assuming you have one written) and make an assessment:
a. Does my plan offer guidance on ALL of those exit types that appropriate for me?
b. Are there any of my exits that should be more clearly stated so that there is NO doubt that they can be executed appropriately i.e. if it is non-discretionary it should BE non-discretionary and not open to interpretation in the heat of the market.
c. What is the next piece of my exit plan that I should properly test?


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Trade Safe

Mike Smith

PS if you would like to be included for information in our up-coming Exit Mastery workshop please email and we wil make sure you receive the information you need to know if it something that is a fit for you.

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