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Time Stops Strategy
The Smart Profits Report: Issue #300
Thursday, April 13, 2006
Time Stops Strategy: Your 10-Day Profit Test
By Steve McDonald
Advisory Panelist, Mt. Vernon Research
Time may not be on your side in every option play. But it should certainly be on your mind.
A stop loss, or the predetermined price at which one sells a stock or option to avoid a major loss, is an invaluable tool for protecting your principal. But in the world of options trading, “time stops strategies” are becoming more commonplace to head off unprofitable plays and collect quick gains.
Just as they sound, “time stops” have more to do with when you get out of a trade than at what price to close the position. And some of the most reputable options strategists around are using them to increase their profits.
Today, let’s look at these moneymakers more closely…
Option Price Trends Form Early
A buy-and-hold strategy has its place. Just ask Warren Buffett. Over time, a sound company that posts quarterly earnings of 15% or more above the same quarter for the previous year is considered a good play, all other things being equal.
In options management, that strategy can work, too. Long-term options, known as LEAPS, can last up to two years.
But short-term options fall into a different category. They are likely more volatile, which can work in your favor. But they can work against you if you use a wait-and-see attitude adopted by long-term strategists.
In the past, I have had a vague timeline for selling options. My mental stop is at around 15 to 20 days before expiration. That’s when value erosion accelerates if you are out-of-the-money. This doesn’t necessarily apply if you’re in-the-money.
“Opt” In With Short-Term Options
A few weeks ago, I was in Chicago meeting with several options strategists at a major brokerage firm. Their view, which is just starting to take hold in the options world, is that short-term option traders should “opt” out of their options if the play is not moving in their favor at the seven- to 10-day mark.
At first, that seemed premature, hardly enough time for the option to make a run or gain momentum. But when I returned to my office, I went through my option picks for the previous six months. Here’s what I found:
Most of my winners - those in which I captured a 20% gain or more on a play - started making their run within two weeks.
The losers were consistently flat or down almost from the first day of the play.
For more years than I care to mention, I have held options until their price movement proved them beyond a reasonable doubt to be losers. Now, there may be an entirely different way to control losses and pocket quick gains. Obviously, time erosion is always a concern, but controlling time as tightly as price fluctuation is going to take some practice.
I’ve started tracking my results using the parameters of the time stop strategy, and I will keep you up-to-date on the findings.
Good Trading,
Steve
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Today’s Smart Profits Cribsheet
- “Time decay,” also known as theta, begins to develop in options in the last 60 to 30 days before expiration. If an option is deep in-the-money, it will happen more rapidly; holders may discount the time value, attracting buyers and realizing intrinsic value. For more useful terms, see the Smart Profits Glossary.
- So, we’ve looked at when to close a position based on “time stops.” But when your time stop or stop loss hits, there’s one vital rule to selling your current options. And it all comes down to getting the best price when you close the trade. Smart Profits #279, The Options Bid: “The Bid, the Bid, Always the Bid,” shows you how to get the most profitable execution on your options.
Related Articles:
- Option Losses: How to Grow Rich From Your Options Losses
- Trailing Stops: How to Give Your Options Room to Grow
- Limit Prices: Tip the Odds on Options Trades In Your Favor
