When to take profits

Note: Track that trade (111115) updated. No adjustments needed.


Wayne submitted this (slightly edited) forum comment:

I can close my Jan SPXPM 1085/1095P/1330/1340C by paying $1.82 right at this moment as I type (12/14/2011). I collected $4.28 on 10/18 when opening it.

I know I am not going to close both sides at one time, because I want to develop the habit of managing each side separately, as you’re a proponent of.

But it’s just not easy to know how much to bid, as we don’t want to hold too long. How much profit is sufficient? But I think I am asking a question – and no one has an answer.

I agree that there is no universal answer. There are a bunch of reasonable decision paths, and none of then is bad. I doubt that one is best. However, I chose one path because I believe it is best or me. Let’s consider some alternatives.

When to take profits

Trade for profits

When the trade is made, have a target profit in mind. Remember, on this path, the profit is your focus. Risk must be managed as usual, but when that profit target is hit, there will seldom be any reason to fail to pull the trigger and exit.

When setting the profit target, please be aware of both the profit target for the trade, as well as your Master Plan (see W04). You may not be able to create a true Master Plan until you have been trading long enough – and through a variety of market conditions – to get a good estimate of what you are capable of earning over an extended period of time.

Nothing else matters. When you achieve the profit, close the trade and be satisfied.

There is one important point that may not be obvious. When the profit target is paramount, choose an appropriate opening trade. For example, if you want to aim for $120 per iron condor, there is no point in owning the $428 iron condor example used in your forum post. I think it makes much better sense to collect about $240 and plan to exit when half the premium has disappeared.

The CTM condor suggests a higher profit target.

Pros and Cons

  • Pros
    • Profit taken ASAP. It’s in the bank
    • Easy to pull the trigger because this is the trade plan
  • Cons
    • There is no way to compensate for losing months
    • There are no ‘bonus’ profits during times when iron condors are big winners
    • The average monthly profit decreases every time a loss is taken
      • This makes taking losses much more difficult (emotionally)
      • This path makes it tempting to pay less attention to risk management
      • This path makes it difficult to follow a Master Plan because we never know how many times we will earn our target profit in any given year
    • This path involves exiting trades that the trader would love to own – at their current prices and current risk/reward numbers. Do you really want to pay $1.82 to exit the example trade?

Manage trades by risk

Exit when risk is no longer acceptable. [For this discussion, I’m ignoring the idea of making an adjustment, other than exiting. Sure, make adjustments when they are suitable. But, referring to adjustments in this discussion would take us into an endless loop.]

Convert the iron condor into two positions: Call spread and put spread.
Manage each separately.

  • Pros
    • The disciplined trader never holds a poor position
    • When most of the maximum profit has been earned, the remaining profit potential may become small. Thus, there is too little reward potential. Exit. Do not try to earn the last few nickels on the trade.
    • When a position is uncomfortable – i.e., you may lose too much money under reasonable market conditions – exit (or adjust)
    • It may not happen too often, but when you exit the put or call spread cheaply, sometimes the market reverses and two things happen
      • You get to buy the 2nd side of the iron condor at a low price. This provides a very large profit – far larger than called for in your trade plan
      • You avoid being concerned about the market reversal because you already bought back some, or all, of the position. [NOTE: IF you chose to sell new spreads to replace the ones covered at a cheap price, then this benefit will not apply to you]
  • Cons
    • The nice profit may disappear before you decide to exit
    • Exiting too early often means leaving a lot of money on the table.
    • it does not make sense to decide whether to HOLD an iron condor position based on the price of the original transaction. You own the position right now. Is either the put or call portion good? If yes, why exit now? Today is a new day. You own the position at today’s price. You either like it or you do not. It has nothing to do with the price at which the position was trading on Oct 18, or any other day
    • DO NOT GET TRAPPED. You do not have to wait for that ‘low price’ to exit. You can pay a higher price at any time that it feels right. You can pay a higher price to release margin. You can pay a higher price when you fear that the position will become nasty. Have some price in mind for an exit – and that price can vary depending on conditions.

Trade to generate maximum profits

This is a high-risk path, and I do not recommend it. However, it is a possible path for very experienced traders.

This plan requires serious money management. Not only must risk be managed, but it’s also important to maximize the money in play. That means exiting one iron condor – profitable or not – when a significantly better iron condor is available. This is an example of rebalancing.

The trader must keep enough margin room available for potential margin-increasing adjustments. However, when seeking to maximize profits, it may pay to be more aggressive when taking the good profit. It’s okay to bid more when closing at your ‘small’ price – just to release margin. Newer trades often can produce greater income over the same time.

I do not want to encourage anyone to use almost all available margin. That is too risky. However, the path to maximum rewards is designed for high-risk trader.

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