Years ago, I became a student at Options Animal because they promised to teach me something that seemed almost like magic — how to “adjust” a trade that wasn’t working into something profitable. Adjusting is indeed a powerful tool. The techniques I learned at OA and that I now have the privilege of teaching to others have made my trading safer and more profitable. However, I also learned something just as valuable – that there is a time to walk away from a trade and move on to something new.
Adjusting is the art of adding or subtracting instruments – options and/or shares of the underlying equity – or repositioning a trade when the initial structure no longer looks likely to yield a profit. Usually, a trade ends up in trouble because the underlying equity does not move in the way you initially expected. For example, it falls when you were initially bullish, or it moves when you expected it to remain stagnant.
I admit that I rushed through the lower level classes in my eagerness to unlock the secrets and learn how to fix my broken trades. By the way, rushing through the lower levels where we teach all the fundamentals is an awful idea, but that is another story. When I finally reached the upper-level classes and began to study the techniques of adjusting, it really did seem magical at first. I had a very brief period of euphoria where I thought that I would never again lose money on any trade because I could “adjust” my way out of anything. I was especially enamored with the possibility of adjusting credit trades by simply rolling them out in time. Bull puts were going to become my own personal ATM, and if they got in trouble, I would just roll them down and out to safer strikes.
Needless to say, my joy was short lived as I was quickly reintroduced to the unshakeable reality that there is no reward without risk. Equities can and do gap through your bull put strikes leaving you with large losses that are impossible to “roll” away and difficult to adjust. My results improved dramatically when I changed my entire view of adjusting. Instead of scrambling for a way to fix broken trades, I now constantly monitor for ways to profit from the current direction of an equity. I take great care in determining my expectation for how the equity will move prior to placing any trade. However, despite all the due diligence in the world, the market is ultimately unpredictable. News changes, sentiment changes and a stagnant stock can start to move, or a bullish stock can fall. With the tools that I now possess, I can add, subtract or move my options instruments so that I am well positioned for whatever the equity is giving me.
For example, if I have a bull put and the equity suddenly turns bearish, I am not limited to rolling my trade further out in time and down in strikes. If my new expectation is bearish, I have a world of tools at my disposal to take advantage of a bearish move. I can replace the bull put with a bear call, rather than a new bull put. That way, I can work with the bearish trend rather than simply trying to run away from it. I can place bear puts, bear put calendars or any other bearish trade that works. I am not limited by the original instruments of the trade. I can close them and open what works.
This works for me because I do not randomly scan the market for trading opportunities. I trade equities that I have researched both technically and fundamentally. I monitor not only their moves on the chart, but news and sentiment. Even though, many of my individual trades are short term, I feel comfortable trading these equities for the long run. I have a high degree of confidence that if one trade structure does not work, I can adjust into something that takes advantage of a new trend and will ultimately be profitable. I have done my fundamental homework and am confident that the companies will be around long enough for me to profit in the end.
However, once in a while, that changes. Sometimes one of my equities can become too difficult to trade. Its characteristics can change. It can become too volatile to determine a trend. It can become so stagnant that there is no longer premium in the options. It can simply defy my ability to predict its moves. When that happens: when I can no longer determine a trend with a reasonable degree of comfort, it is time to move on to a new equity. There is a time to close a losing trade and simply take the loss. I do not do that very often. However, just as a trend can change, the very character of a company can change until it is no longer the kind of equity I would have chosen to begin with. Always remember that when you are adjusting a trade, you are making a conscious decision to continuing allocating capital to that equity. Often, the adjustment requires additional capital or risk to make the trade work. If it comes to the point where I sincerely believe that my capital can be more profitably allocated somewhere else, then I give myself permission to take my ball off the field and look for a better game. In the end, the only statistic that matters is whether or not your trading is profitable.