Master This Trading Tactic to be Profitable

You have a profitable options trade. Congratulations. Here’s one way to manage it, according to Market Rebellion’s chief options strategist.

There are a lot of dumb trading axioms out there.

My favorite (of the dumb ones): “Cut your losses, and let your profits run.” That is something that every novice trader is told in one way or another—probably a couple dozen times.

But you know who ignores that advice? Professional traders. They know that both losses and profits have to be managed.

Rolling: The way professionals manage profitable trades

Professional traders manage their winning trades. In options trading, that means rolling positions that are in-the-money.

Ryan Mastro, chief options strategist in Market Rebellion’s Unusual Option Activity services, recently outlined his rolling strategy, honed over thousands of trades.

To understand it, you first have to be familiar with two options terms: delta and rolling.

Delta

Delta is the amount that your option’s price changes with a $1 move in the underlying stock. So if you have a 50 delta call, that means that for every $1 the stock price moves, your call will move $0.50. If you have a 30 delta put, that means that for every $1 the stock price moves, your put will move $0.30.

Deltas are unique to the strike price, depending on how far in- or out-of-the-money your option is. This should make intuitive sense. If a stock is at $100 and you own an $80 call, the price of your option will closely mirror the price of the stock, meaning that the delta will be closer to 100. If you own a $120 call, then your option won’t track the price of the stock as closely. A $1 gain in the stock price might only get you $0.10 of value.

Since delta relies on strike price, volatility, and time until expiration, it is dynamic as those factors change. An option with a higher delta will always be more expensive than an option with a lower delta. Higher delta options are in-the-money, while lower delta options are out-of-the-money.

Rolling

Rolling is what you do when you have an existing position in an option, but are changing to a different position. You can roll to change the expiration date of an option, to change the strike price of an option, or a combination of the two. But you would always stay with the same fundamental trade.

For instance, if you own a Tesla September call at $500 (after the recent stock split), you can roll that to October, in which case you would sell your Sept $500 call and buy an Oct $500 call. When you do that, you have successfully rolled the trade. You can also roll the strike, in which case you would sell the Sept $500 call for a Sept $550 call, for instance. Or, you can do a combination of the two, when you would sell the Sept $500 call for an Oct $550 call. In all the cases, you are matching the trade 1:1 with a current position.

You would not be “rolling” a trade if you sold the Sept $500 call, and instead bought a Sept $500 put.

How to Roll Profitable Trades

At the heart of managing profitable trades is the idea that you can reduce the amount of capital that you have committed to a trade, while keeping exposure to that same trade idea.

If you purchased a 60 delta call and the stock price moves higher, that call may transform into an 80 delta call. Now, instead of moving $0.60 per every $1, your option price is moving $0.80 for every $1. In addition, the value of your option will have increased, meaning you have unrealized gains in the trade.

This differs from equity trading where the amount you gain or lose per $1 change in the stock price is fixed at a constant $1 per every share of stock you own.

In total, Ryan says, a change in delta on profitable trades from directional movement increases your overall risk in the trade. Therefore, he recommends that traders manage this trade by rolling the position to a lower delta option to lock in profits and reduce capital exposure.

While the specifics of when and which option to roll into should be consistent with your trading strategy, Ryan outlined a guideline.

If you purchased a 60 delta call that became an 80 delta call, you can follow Ryan’s guide below based on where you think the stock may move before expiration:

Of course, these are rough rules of thumb that Ryan uses to manage profitable directional momentum trades. You may have more risk tolerance and feel comfortable rolling into a 60 delta call when your option has appreciated in value. There are other variables like implied volatility levels to take into consideration.  The important part is having a methodology that you can use to approach the market, and to do that every time.