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OPTION ADJUSTMENTS .
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Weekly Options.
The Importance Of Learning How To Adjust Option Positions

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ADJUSTING OPTION POSITIONS

The strategies we use with our Option Income Trading System are simple to understand, easy to put on, have a high probability of success, can produce an excellent weekly yield, and most of the time they work out beautifully.

MOST of the time.

The downside is that some of our strategies have a risk to reward ratio that isn't exactly the greatest.

Even though they DO work out just fine MOST of the time - occasionally an unexpected move in the underlying can occur that COULD cause losses if we don't pay attention and correctly manage and adjust the position.

For example, one of our favorite trades gives us around an 80% or higher probability of success.

It's reasonable one could expect to bring in a credit of around 1.00 on an average trade. The margin - or risk - would be around 9.00.

Or, if using 10 contracts, that is a credit of around $1,000.00 with a risk of about $9,000.00

That's a risk of $9,000.00 to produce $1,000.00

That risk to reward leaves a lot to be desired.

However, it's not completely unreasonable to accept this type of risk to reward as long as one can get a high enough probability of success when initiating the position - AND - has the knowledge to properly manage and adjust.

Let's say the position is put on with an 80% probability of success.

8 weeks out of 10 it 'should' work out fine. It’s the OTHER 2 times we need to be worried about.

Lets say we did the above trade for a total of 10 weeks – and did absolutely NOTHING to manage or adjust the position. We just let the trade run and allowed the probabilities to play out.

Heres what could happen…

We generate $1,000.00 for 8 weeks.

$1,000.00 X 8 = $,8000.00 PROFIT.

Not bad. That’s almost a 100% return.

But then the other 2 weeks lets say we lose our max risk: $9,000.00.

$9,000.00 X 2 = 18,000.00 LOSS

$8,000.00 PROFIT - $18,000.00 LOSS = 10,000.00 LOSS

That's not going to work out to well.

Okay – lets say we don’t lose our max risk. Lets cut it in half.

Lose $4,500.00 X 2 = $9,000.00 LOSS

$8,000.00 PROFIT - $9,000.00 LOSS = 1,000.00 LOSS

Okay, that's not going ot work out too well either.

Obviously – in order for this strategy to work, we need to have a plan to protect – and keep – the profits that we generate during the 8 good weeks – from the losses that will occur (and they WILL occur, believe me) during the 2 weeks that will be bad.

So what is that plan?

We need to know how to properly manage and adjust.

But FIRST – we need to know WHEN to adjust.

So when do we adjust?

Let's go back to those numbers…

If we win $1,000.00 8 times out of ten – HOW MUCH can we afford to LOSE 2 times out of ten?

If we can afford – both financially and psychologically – to just wind up back at break even after ten weeks of trading, then our answer would be around $4,000.00 per trade.

We can afford to absorb a loss of $4,000.00, 2 trades out of 10.

At the end of ten weeks, we could be back at square one.

We win $1,000.00 8 times, we lose $4,000.00 2 times = $0 PROFIT.

On the other hand, let's say we dont want to make any less then $5,000.00 during the 10 week span. In that case the most we can afford to lose on a trade would be around $1,500.00

We win $1,000.00 8 times, we lose $1,500.00 2 times = $5,000.00 PROFIT

THIS scenario makes much more sense to me.

In the above example, $1,500.00 equals about 1 and 1/2 times the original credit that is brought into the trade – or our expected weekly profit for each of the 8 good months.

I've found this a good gauge to work off of.

One may even consider tightening it up to 1 times the original credit. But I would NEVER allow it go more than 2 times the original credit.

Anything more than 2 times would cause me to risk losing too much for my total income goal - AND it would wind up taking me MORE than 2 winning weeks just to make up for the loss - which could be hard to deal with psychologically.

On the other hand, anything less than 1 times the original credit, I would feel as though I am not giving the trade enough room to breathe and do it's thing.

What this type of approach does is change our trades not so acceptable 9 to 1 R-R Ratio to a much more acceptable 2 to 1 – or even 1 to 1 Ratio.

So the first thing I do before I ever even put a trade on is I decide what that ratio - or max acceptable dollar loss number - will be.

I call this my 'Maximum Pain Number'. It's the maximum amount of dollars I am willing to lose while in the trade. In the above example it was 1 1/2 of my orginal / average weekly credit intake - or $1,500.00 Loss.

Most of the time, this number shouldn't be hit.

But when it does (and eventually it WILL, believe me) – that’s my cue that it's time to adjust.

This way, by not letting our losses get out of control, I always know that even in a worst case scenario (I take my Maximum Pain Number LOSS) - based on the probabilities - I should still be profitable at the end of ten weeks.

AND best case scenario (I successfully adjust the position) - I pull out of a losing trade and make it profitable once more.

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