Top 10 Option Trading Tips

Option Trading Tip #7

My top 10 call and put option trading tips that I have learned, and that you MUST know before you start trading calls and puts.

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Trading Options Tip #7:

When you have a profitable option trade, Ride Your Winners.

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Ride your winners! is a popular stock and option trading axiom. This means that when you have a profitable call or put option trade, it is often times best to hold onto it and let the stock price keep moving in the direction that gave you the profit in the first place.

For inexperienced traders, it is often tempting to cash out and pocket the profits and play the "bird in the hand is worth two in the bush" thought pattern. But with stock and option trading, because the Trend is Your Friend belief, once you have a profitable trade, just sit tight and let the stock continue moving in its trending direction, and let momentum carry it further.

In fact, a lot of successful and popular option traders and option newsletters, like Bernie Schaeffer and Larry McMillan, argue that the way to manage a portfolio of options is to limit your losses to 50% but shoot for 100-200% returns on the winning option trades. Think about the math here. If you invest $100 in 3 different option positions and allow yourself to lose 50% on two and you double your money on one trade, then you still have you initial $300 in cash and you haven't lost anything. Your two losing positions would be at $50 each and your one winning position would be at $200 so you still have your $300. So what this is saying is that you can shoot for having only 1 out of 3 option trades as a winner provided that you limit your two losing trades to 50% or less.

Here's an example of the way that I often Ride My Winners. Suppose AAPL is at $450 and I buy 5 of the $455 call options for $2 each or $1,000 total. The next day AAPL suddenly spikes up to $460 and my $455 call is in the money $5 and the $455 call option is now trading at $6.50. My $1,000 investment is now worth $3,250 and I have a $2,250 profit. In this instance I would do one of two things. I could put a stop loss order on the $455 calls at $4.10 to make sure I keep at least keep my 100% return (remember I bought the $455 call option at $2 so I want to sell it for at least $4). The other thing I might do is sell the $455 calls, pocket the $3,250, and immediately buy the $460 call options (at $1.50 or so) to keep some money on the table and to continue with the axiom of Ride Your Winners.

Which way I would play this scenario depends on the exact pricing of the options and how my other open option positions were performing. If I continued to see the trend being my friend, then I would continue to ride my winners!