When it comes to options selling, the number one struggle that people often face is overcoming the emotional barrier to cutting losses. Questions like this pops up in one's mind:
"Maybe if I wait a little longer, it will rebound."
"What if after I cut my losses, the stock starts going up again? I will look like an idiot!"
When it comes to selling options and cutting losses, the key idea to remember is this:
Cutting a losing trade quickly clears your head and restore your objectivity.
Now, before I go on - I need to emphasize that the above applies to trading. It does not refer to fundamental stock investing - where you are able to happily hold fundamentally sound companies, dollar cost average, and more than likely you will do well in the long run. However, for selling options, there is little to no consideration of stock fundamentals. So, don't confuse the two of them and randomly sell off shares of your fundamentally good companies.
Why You Need To Cut Losses
When the odds are no longer in your favor, cut your losses and move on before the bleeding gets so deep that it becomes hard to recover from.
Many people make the mistake of deploying the "hope-and-pray" method, placing their hopes on a reversal so that the losses can turn into a breakeven where they are able to close their positions without a loss.
Well, let me warn this first - the "hope-and-pray" method will simply put a heavy emotional burden on you, and you end up making silly decisions in the stock market. In short, it really isn't worthwhile. Just cut your losses and move on.
Don't be a rabbit. Be an Assassin.
For those of you who might be familiar with these terms - it is from one of my favorite book, "The Art of Execution".
- An assassin is someone who deals promptly and unemotionally with his failures; cuts early, or at least at a pre-determined level and moves on.
- A Rabbit! They watched the positions continue to fall, without the courage to cut losses. The rabbits tended to have the worst performance by far.
How I Cut Losses When Selling Options
Personally, I take losses off at 2X the value of the original option premium credit.
For example, if I sold a META vertical spread and collected $70 per option contract - I will cut my losses when the losses are $140.
There are generally two ways to cut losses:
- Place a stop loss order so that the market automatically takes off your positions when the stop loss price is met.
- Actively monitor the stock market and cut losses manually.
On a personal basis, I tend to put stop loss order. Being an employee, I do not have the time and energy to monitor the stock market and close my positions manually. However, of course, this is up to the individual.
Will I have a better exit if I were to do it manually? Yes, probably.
However, we all need to find the trading system which suits our own lifestyle and circumstances.
The Bottom Line
If you like to find out more about how you can sell options for income, you can read up on my other blog posts.
If you are interested in learning more practical knowledge, I recommend that you register your interest in my upcoming Options Cash Flow Mastery Course. Act fast and take advantage of the early bird special.
P.S Note that this is different from the Profitable Watchlist Challenge (which is for investors). The Options Cash Flow Course focuses on options selling.
