THE MOTHERSHIP FOR ADJUSTING TRADES
Uh oh, the sky is falling! Our trade is losing money!
What should we do when a trade goes against us? How do we manage our losers? How do we fix losing trades?
This is one of the hottest topics that our members bring up. Let’s talk about adjusting trades below.
You might hear us use the word “rolling.” Rolling a trade is another way to say adjusting a trade. It’s the same thing. We are only adjusting/rolling trades that are showing losses.
We have a general framework of guidelines that we use when we are considering adjusting a trade. While the basic premise is the same every time, there are certainly a few different variations of adjustments. Also, naked premium trades have the luxury of more adjustment choices compared with defined-risk trades.
We are going to discuss everything here!
What’s on the agenda?
— Defined-Risk Trade Adjustments
— Naked-Premium Trade Adjustments
— Taking Profits On Adjustments
— Thresholds For Taking Losses
— Subjectivity & Discretion Involved
I’ll also provide some links of Trade Review Videos you can check out which illustrate exactly what we are talking about in each adjustment.
There’s going to be a lot of information in this piece. Read it all in full first. After that read it again. And then maybe on that third time you can read it while also digging through the Trade Review Videos linked throughout it. Don’t be shy! It will only help you.
Without further ado…
Drum roll please!
DEFINED-RISK TRADE ADJUSTMENTS:
We look to adjust/roll a defined-risk trade on the week of expiration, or maybe the week before expiration. Basically once we approach 10DTE it makes sense to start looking at rolling a losing defined-risk trade.
Whenever we roll a trade we want to make sure we roll for a credit. We can typically only "roll for a credit" when price is in-between our short strike and long strike. Meaning, price is in-between the two strikes of your defined-risk spread.
If price has breached both of your strikes, that means they are both In The Money, then it is likely you will not be able to “roll for a credit” — but you always want to check! If you can’t roll for a credit by expiration you simply take the loss.
For defined-risk spreads we are always going to roll OUT in time. We never adjust within the same expiration cycle — that’s a luxury we only have when adjusting a naked premium trade.
To roll OUT in time means to roll from the current expiration cycle you are in to the next monthly expiration cycle, which should be in that 30-60DTE range.
To roll out to the next month you should do it and look at it as 2 separate transactions.
NOTE: Some brokers will have a feature where you can click on “create rolling order” or something along those lines. DO NOT use this feature. It’s too easy to make a mistake.
Simply adjust the trade using 2 separate transactions.
First Transaction: Close the TESTED side of the original trade.
Second Transaction: Open up that same tested side, with the same strikes, in the next monthly expiration cycle.
The tested side is whatever side is closest to the current price of the stock.
Let’s say you have an Iron Condor in XYZ. You have the short 100 call and the short 80 put. XYZ is currently at $78/share. The tested side is the put side, as price is closer to the short put than the short call.
When you close the tested side you will be closing it for a debit. Note, this is actually realizing a loss but that’s okay. Let’s say you closed the 80/75 put spread in the October monthly expiration cycle, and you did that for a debit of $3.50.
Now you want to go to the next monthly expiration cycle, which would be November in this case. From there you want to short the same put spread that you just closed in October (80/75 put spread).
So you would short the 80/75 put spread. It’s important to keep your spread-width the same here. This should be done for a credit.
And the key here is you want the CREDIT you collect on this new trade to be LARGER than the debit you closed the original trade for, which was $3.50 in the example above.
So if you collect $3.51+ in credit in November’s expiration that would mean you are "rolling for a credit.”
What does rolling for a credit do? It ensures you will not add any more risk to the original trade, which in this case started in October.
Say your original trade in October had a max loss of $300.
You then take a $200 loss when you close that trade and start initiating the adjustment. So long as you roll for a credit then the new trade in November will have a max loss of no more than $100.
So if you lost $200 when you closed the October trade, and you take a max loss of $100 on the November trade, combined it’s no more than a $300 loss. It’s not more than your original max loss on entry in October.
Essentially you get to spread that $300 worth of risk out into 2 expiration cycles instead of 1.
If you were okay risking $300 in 1 expiration cycle, chances are you are okay risking $300 spread over 2 expiration cycles on that same premise. You just buy yourself more time to be right, essentially looking for a reversal in price at some point.
Does that make sense? If it doesn't, don't sweat it! This is something you likely have to actually go through a few times before it really clicks.
This is one reason we are big advocates for papertrading, even alongside any live trading you are doing. You need to expose yourself to more trades, which exposes you to more experiences, which builds confidence and comfort. Don’t be shy. Overwhelm yourself in your papertrade account. It will only help you.
We have some good Trade Review Videos that illustrate these points well. The first two videos are going to be “light ones” and then I’ll hit you with a couple much more comprehensive ones!
In this first video we discuss a few trades from the day, but we started off discussing an adjustment to an XRT trade we had. That’s what is relevant here. Just copy and paste the below link into your web browser to view the video.
You can also check out this video where we closed that XRT adjustment trade. It’s the first trade we talk about in the video.
Now for some more comprehensive ones! This first video is a great illustration of adjusting a defined-risk trade, and all of the math involved as we discuss a TLT adjustment.
That trade actually ended up expiring a max loser after the adjustment. It happens. It’s good to know we did all we could and kept the dream alive as much as possible. Not to mention, rolling for a credit helped reduce that original max loss anyways!
This next video is just as good as the first one above, illustrating a lot of the same points with a few more. We are adjusting an IWM trade here. Check it out!
Here is the video of us closing that IWM adjustment trade, which is another great one!
I hope those helped! Now we can move on to talking about the big guns.
NAKED PREMIUM TRADE ADJUSTMENTS:
With naked premium trades we have a few more luxuries. All luxuries in life come with a price of course. The reason we have luxuries in the naked premium world is because the risk is “undefined” and therefore uncertain. We get paid for that uncertainty.
With defined-risk trades we have a max loss that is capped. It gets to a point where we can’t lose any more money. But in exchange for that certainty and comfort there are less adjustment choices we can implement.
One of the main differences with naked premium trades is we don't mind adjusting the trade within the same expiration cycle. If you remember, we don’t do that with defined-risk trades.
If there is more than 21-25DTE left in the trade and one of our short strikes is breached we will consider rolling up/down the untested side.
We tend to be a bit more patient and wait for our break-even price to be breached rather than just the short strike. However, once a short strike is breached it’s time to start paying closer attention.
Rolling up/down the untested side means closing the original strike, and shorting another strike closer to the current market price. This is done in the same expiration cycle. The strike we short would be around the same delta as we had shorted originally.
Let’s say we have the 70 call and the 50 put for a strangle in XYZ. If the price of XYZ is at $71/share it has breached our short call and is probably getting close to our break-even price of the stock. Somewhere in here it makes sense to roll. The sooner you roll the more conservative you are being.
The untested side is the side furthest away from price. In our example above with XYZ at $71/share, the untested side is the 50 put. At this point the 50 put is probably trading for pennies. Maybe 10 cents. Or we’ve probably made close to 90% of all we can make on that short put. So there’s not much more left to gain. Time to roll it up.
That means closing the 50 put for a debit, and then shorting a put at a higher strike price. Maybe 52, 55, 60, which is of course done for a credit.
Net net it’s a net credit. It’s typically wise to collect at least another $0.50 in credit. We are going to stick to typical entry guidelines looking to short a strike in that .15 - .30 delta range when we do that.
Picking up a little more credit as you roll up the put (in this case) allows you to extend the break-even price on that tested call side. The more credits you collect, the further you push your break-even away.
From here you are still short (need a down move in XYZ), just a little less short than you were before the adjustment, and you are still looking for a reversal in price.
Here’s a video where we discuss rolling down our call in XOP.
I hope you enjoyed that one!
Here’s another really good one. We discuss two adjustments. One in IWM and another in JD. In both cases we are rolling up our puts!
Here is the video showing us taking profits in our IWM position after the adjustment above. It starts about 6 minutes in.
Here is the video showing us taking profits in our JD position in that same adjustment video above. It’s the only trade discussed.
Gosh that is all some good stuff, isn’t it! Let’s go ahead and chat about if we have less than 21-25DTE now. The adjustment is slightly different in this case.
If Less Than 21-25DTE:
If there is less than 21-25 Days To Expiration we treat the adjustment a bit differently. The lower the Days To Expiration on a trade — the more reliant our positions become on direction. That means small directional moves cause large price fluctuations in our P/L.
Because we are doing everything we can to take the “importance” of timing and direction OUT of our trading, we really don’t like being in these naked premium trades that are losers with less than 21DTE. So we will look to roll them OUT in time. Again, the sooner you roll the more conservative you are being.
If there is less than 21-25DTE for that naked premium trade then we will roll OUT to the next expiration cycle. Again, we want to roll for a credit. And in this case we are rolling the TESTED side out for a credit, just like we do with our defined-risk spreads.
The untested side we can typically leave to expire worthless, but you can close it to eliminate all the risk and free up a tiny bit more buying power if you want.
With naked premium we're almost always going to be able to roll that tested side out for a credit. And we will typically be able to increase our probability of profit by rolling to a strike even further away than the current tested strike we had.
So we basically want to go as far away as we can while still "rolling for a credit." This is a luxury we don’t really have when adjusting a defined-risk trade.
For example let's say we had a 70 call strike that was tested in October and trading for a $5.00 debit. We might be able to sell a 75 call strike in the next monthly expiration cycle (November) for a $5.10 credit.
In this scenario we still rolled for a credit because the debit to close the 70 strike was $5.00 and the credit for the 75 strike in the next monthly expiration cycle was $5.10 -- and we also moved further from the 70 strike to the 75 strike.
That’s pretty cool as it not only extends duration on our trade from October to November, but it also pushed our short strike AND break-even further away!
Here’s an example of us rolling out our put in an MU trade. It’s the only topic discussed in the video.
Here’s the video where we took profits on that MU adjustment. This one is much shorter, but another great one!
Here is an example of rolling our our call in an XOP trade. On this trade you will see we do the adjustment all in one order. We also comment on why, and why we think it’s best for you to do it in 2 separate orders. We start talking about the adjustment 4:50 into the video.
Here is the video of us taking profits on the above XOP adjustment trade, and talking about the life cycle of the trade which is really cool. It’s the first trade we discuss in the video.
Hopefully those helped!
The only difference in these naked-premium cases is the risk is undefined still. So while we can extend duration and increase our probability of profiting with these adjustments much more so than we can with defined-risk trades — it comes with a little bit of uncertainty.
But don’t let this scare you too much, because you will have time to make adjustments and/or cut a trade if you need to from a day to day basis.
Now that we understand adjustments a bit more let’s touch on when to take profits on these adjustment trades, as well as when to potentially take a loss and move on.
TAKING PROFITS ON ADJUSTMENTS:
So you’ve adjusted your trade and you want to know when to take profits on that adjustment, right? The process here is the same regardless of if it’s a defined-risk trade or a naked premium trade. So this should be brief.
Whenever we adjust a trade there are 3 goals.
Goal 1: Reduce the loss of the original trade.
Goal 2: Break-even from the loss of the original trade.
Goal 3: Profit on it all.
We’re typically okay with just goals 1 and 2. If we can just make 1 goal then it means we had a successful adjustment.
A good rule of thumb is to keep your management mechanics the same for that “adjustment trade.” What I mean by that is to treat it as an individual trade. Manage it like you would manage any other.
If it’s a defined-risk spread and you are collecting 1/3 - 1/5 of the spread’s width in credit — that’s a trade you manage at 40-50% max profit. If you collected 1/2 of the spread’s width in credit — that’s a trade you manage at 20-25% max profit.
If it’s a naked premium trade and you are short deltas less aggressive than the .30 delta you should manage that winner at 40-50% max gain. The closer to the .50 delta you are short — the closer you should manage at 20-25% max gain instead.
Those are the general guidelines we have for managing trades. Keep those same guidelines for the trade you adjusted. From there you can let it fall at how ever many “goals” you were able to make. And remember, just 1 goal is successful enough!
THRESHOLDS FOR TAKING LOSSES:
Do we ever just pull the plug on a trade? Does the trade ever get to a point where we should cut the loss? When do we just move on from a losing trade?
These are also some very common questions members ask us.
For defined-risk trades we never “cut a loss” early. Defined-risk trades already have a maximum loss. They get to a point where they cannot lose any more money.
Because of that it doesn’t make sense to cut a loss early. We instead trade small enough where we can stay patient with our losers, and will accept a max loss the few times that it happens.
For defined-risk trades we look to see if we can roll for a credit, and if we cannot do that by expiration day we simply take the loss and move on.
We will keep rolling defined-risk trades so long as we can roll for a credit. Remember, we don’t always have that luxury with defined-risk trades. If price has breached both of our strikes so that they are both ITM we likely will not be able to roll for a credit. At that point we take the max loss and move on.
For naked premium trades we will almost always be able to roll for a credit. That’s true whether we are rolling up/down the untested side, or rolling the tested side OUT in time.
Rolling into perpetuity sounds great because we can theoretically keep giving ourselves better break-even prices on the trade — but that comes with a tradeoff. The tradeoff is the risk is undefined, right? So there’s an element of uncertainty in there.
How big will the loss get?
Because of that uncertainty some traders have thresholds where they like to close naked premium trades. One common threshold is 3X the credit received. So if you sold something for $1 and it's trading for $3 they take the loss there. Or if you sold it for $2 you would take the loss at $6. Etc etc.
Another common threshold is a percentage of the account, and 5% is a common one. So if you lose 5% of your account on one trade you would close the position. That means if you had a $20,000 account and you were down $1,000 on one trade it would be time to take the loss there.
Others like to try and roll forever. That’s rolling into perpetuity. The reason they like this idea is because it gives them the highest probability of breaking even on the trade at some point. But that of course comes with the risk of not knowing how big the loss can really get.
Rolling into perpetuity gives you the highest probability of making back the loss eventually — the question is can you stay in business long enough for that to happen?
One last word:
I want to make one last point on adjusting trades. This is very important to understand.
Adjustments are not magic.
Adjustments do not guarantee anything.
Adjustments can result in further losses.
Just because you adjusted the trade does not mean much. You still need the market to accommodate you.
If your put was getting tested and you rolled out your put you still need a bounce in the market. You still need the market to reverse. You still need a little directional help from the market.
Adjustments simply reduce deltas. In English that means that it “slows down the P/L movement of your trade.”
After an adjustment you will be making money and losing money at a slower pace compared with if you did not adjust.
That’s why making an adjustment is always the most conservative thing to do, for better or for worse. It just slows everything down.
Adjustments are defense. We make adjustments when we are in trouble and we need to defend ourselves.
They are important when we are running out of time, a loss is getting too large, or your emotions are getting too uncontrollable.
SUBJECTIVITY & DISCRETION INVOLVED:
Here’s another very important point you need to understand.
Because adjustments are not magic it means there is some slight discretion and subjectivity involved with making them.
Some traders are more conservative than others.
Some traders are more aggressive than others.
Some traders can handle more risk than others.
Some traders have more directional opinions than others.
Because of this, some traders will adjust quicker than others.
Because of this, some traders will risk 3X the credit received on a trade while other traders will risk 5% of their account on a trade. Then you have the group that will keep adjusting until they break-even or go bankrupt.
Personal preferences and Trader Ego’s come into play.
It’s up to you, the trader, to find something that makes sense to you and helps you feel comfortable. Stick to that. That’s all we can ask for.
Subjectivity and discretion is a part of this wonderful endeavor we have chosen and fallen in love with. Embrace it. Be a trader.
All of these approaches make sense. But they make sense for different traders, personalities, risk tolerances, etc.
We are here to share the thought process of different traders with approaches that make sense. Now it’s up to you to run with it and make it your own.
I hope this helps.
Remember to dig through the document more than a few times. Watch the videos more than a few times. Papertrade and try to get yourself in these experiences more than a few times.
Then come back to us with your experiences for some feedback and watch it all come together.
I wish you all good health, good trading, and great adjustments!
Director of Trading Success
Sky View Trading