Cliche? Sure. One of my all time favorite songs by The Steve Miller Band? Absolutely. While the phrase, take the money and run, is often overused and lacks definitive parameters as to when exactly someone should be taking money off the table and running, it remains a phrase that should be in the back of every option trader and futures traders head. Especially those option traders who are in the business of collecting premium through such strategies as iron condors, bear call spreads and bull put spreads. For those of you new to the option market terminology, these are positions that are sold rather than purchased, and one where a traders max profit is the premium collected on the trade. However, the maximum risk with these trades can often times be more than the original amount of capital allocated to the position. So beware!
The name of the game for this type of trading is time. Typically initiated in one of the near term expiry months, the trader is hoping for a stagnant market, a market where it moves away from your short strike, or a market where it inches toward your short strike without ever trading through it. With each day that ticks off the clock, so too does extrinsic value (or as I like to refer to it, fluff). Without getting too technical this is referred to as theta decay.
So for example if the SPDR S&P 500 ETF (SPY) is trading at $180, and you sell a SPY 179 put that expires on January 18th, your objective for the trade is to have the SPY trade higher than $179 come January 18th. If that happens you get to keep 100% of the premium that you originally collected to initiate the trade (if the 179 put was trading at .50 and you sold 10 contracts you would collect $500 or your maximum profit). If the SPY trades below $179, your risk is that you will be assigned on your 179 puts and will have to buy an equivalent number of shares to the number of contracts sold in the SPY at $179. You can see where this might be a problem. If the SPY is trading at $157 and you have to buy 1000 shares (10 SPY put contract) at $179, thats a paper loss of $22,000 (22x1000).
So where does take the money and run come into play? Well one of the most common misconceptions for those folks who are newer to option trading (and even some veterans), is that you have to hold a position all the way to expiration. This is absolutely, 100%, not the case. One of the distinct advantages with US option markets is that you can get out of the trade at anytime. This serves those premium traders out there particularly well. For instance, if you sold those SPY 179 puts and collected $500 on the trade, and lets say that on December 23rd the SPY has traded up to $182 and you have now secured $250 of that $500, would you exit the trade, knowing you would only make $250 instead of the full $500? I most definitely would. Why? Because I have a rule that if I collect 50% of my premium in half the time, then I exit the trade and move on to another opportunity. Why would I risk that remaining 50% over the course of another 4 weeks?
This is the type of disciplined approach that is warranted when trying to capture premium on a consistent basis. Another rule that I use is if I have collected 80% of my premium with more than a week to go, I will exit the trade taking the money off the table. Personally I am not willing to risk the 80% I have collected for the last 20% over the next week or so. Many of you know, especially those implementing these strategies on more volatile stocks that a lot can happen in 1 week. So why stress yourself out for the next 7+ days when you can take the money and move on to the next trade?
The bottom line here is creating a disciplined approach to trading that works for you. My numbers and parameters are my numbers and parameters. They may be different for you. However, for those looking for consistency in your trading, having such a system is imperative. I like to look at it the same way I would a successful baseball team. Selling premium is all about base hits, not home runs. Do the little things right and you will find that you will be much more consistent in your trading than if you were to swing for the fences on every trade.
Travis McGhee, CEO FuturesANIMAL
OptionsProfits can be followed on Twitter at twitter.com/OptionsProfits
FuturesANIMAL can be followed on Twitter at twitter.com/ FuturesANIMAL
Travis can be followed on Twitter at twitter.com/Travis_McGhee
Select the service that is right for you!COMPARE ALL SERVICES
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
- Real Money + Doug Kass Plus 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV