by Ken Trester 08/11/08
Taking half of your profits at the target price serves two beneficial purposes. One, it forces you to take some money off the table, protecting you from a sudden reversal in the stock price. And two, it leaves money on the table for possible future gains. Protecting profits and preserving capital is critical when you're buying options.
As important as taking profits is cutting losses. Losses are part of the game, and if you don't take them and move on you will soon be out of the game.
There are two ways to cut losses. One is by setting a stop loss on the underlying stock. If the stock closes below (for a call option) or above (for a put option) its stop loss, close the option position the next day.
Another way to cut losses is to use the option price. If an option falls in value by 50% after you buy it, sell it and close your position.
We can't stress this enough -- if you do not cut your losses quickly, you will not last as an options player.
That, in a nutshell, is the best way to maximize profits with short-term options. It is a system that takes profits when they are available, and cuts losses when necessary. Most important, it removes emotions from your decision-making. Follow this system and you'll have your best shot at real success when you buy options.
The key to long-term success as an options speculator is to hit home runs. And the key to successful investing with options is to buy extremely cheap ones.
Cheap options have the potential for spectacular gains. But finding those that are inexpensive and have the potential for a home run is not easy. You need tremendous patience.
You may have to enter a lot of orders before you get one filled at your price. More cheap options expire worthless than don't, so you must have the patience, discipline and resources to keep trying for a home run.
Try to find options that are priced under $1.50 and whose strike price is close to the market value of the stock. Make sure the options are underpriced and have a probability of profit of at least 20%. To get your best deal, try to buy put options on stocks that are rallying and call options on stocks that are falling.
Most important, try to buy options on stocks that have the potential for surprise volatility. Stocks tend to fall much faster than they rise, so buying put options tends to be a better bet on surprise volatility.
If you enjoyed this article, check out Ken Trester's "Short-Term Gains Using Long-Term Options" and "Leverage Your Options Investments."
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