3 Exit Strategies For Options Trading

We all know that options trading is a comprehensive topic that includes thousands of small pieces traders should consider before beginning their journey. That’s why beginners focus on finding a good broker and functional platform, creating an account, choosing an options strategy, etc.

While all of that is, of course, important, it’s the tip of the iceberg. Options beginners are focused on learning how to get into a trade that they don’t even think about learning how and when to get out.

But, exit strategies for options trading are just as important to secure profits or limit losses. So, in this article, we’ll discuss the exit of a trade and the factors you should consider when making decisions.

Exit Strategies for Options Trading

Before we go deeper into strategies you can use to profit from options, we should talk about some challenges that come from this trading type.

Options trading has many advantages compared to stocks. For starters, it requires a lower initial capital. The losses are smaller given that you buy options contracts that cost way less than the actual asset.

But options trading has its own challenges. You can’t hold them forever because they have expiration dates. So, if you miss a good opportunity, you may not find another good one during the contract's life.

Making a move to profit can be difficult because many factors affect the price but also the outcome. E.g., the options contract may be favorable at one moment, but the time decay or volatility may reduce its value.

We mention this to explain why having an exit plan is even more important than the entry. You should also keep in mind emotions can affect the trading result, as we often make decisions believing we can save the trade or lower the losses.

That said, you should plan your exit before entry. Let’s see some strategies that can help you bank profit!

Options trades close in one out of three ways

Options traders research and monitor the market for events that can affect assets to move up or down. Based on their research, they buy options contracts.

Once you find a suitable option, you have to buy that contract from the options seller. This action is called “buy to open”. It informs the other participants that you’re establishing a new position.

Now, once you open a position and buy the options contract, the contract can finish in one out of three possible ways, those being:

Out of the money by or at expiry

The expiration date varies depending on the options type you trade. For instance, weekly options usually are listed on Thursday and expire on the next-week Friday, while monthly options have expiration dates on a Saturday that follows the third Friday of the month.

Be as it may, you have to decide what you’ll do before the market decides for you.

Now, if the options contract is out of the money on expiration, the best thing to do is to let it expire worthless. You don’t have time value at this point. So, you can’t sell to close, as paying additional fees and commissions for selling may cost you more than losing the premium you initially paid.

It’s worth mentioning that many traders make a mistake in these situations and double down on losing trades. For instance, the underlying moves in the opposite direction, and the trader buys additional contracts which are out of the money at that point, believing they can get back to even.

This isn't good practice. It’s best to leave the contract to expire.

In the money by or at expiry

There are no particular exit strategies for options trading where the option is in the money. This is a favorable situation for the contract holder. You have the right to buy the shares at a lower price if you have a call. Or, you can sell shares at a higher price if you have a put.

Buying or selling the underlying asset means exercising the option contract. Of course, exercising is not the only option you have. You can also offset the options contract.

Sell to close

Sell to close is the opposite of buy to open we mentioned earlier. It’s an order that it’s used to exit the position you’re holding on to the options contract you bought through buy to open. You can sell to close regardless of whether the option is in the money, out of the money, or at the money.

As a holder of an options contract, you can sell to close the option, which can result in three possible scenarios:

Orders to set exit strategies for options trading

Orders are instructions you give to your broker or brokerage company when you want to purchase or sell options. Logically, your instructions are different for entering and exiting a position.

The important thing you should remember is that orders are a part of the exit strategy you’ll use. Once you open the position, you may give the instructions to the broker, and those instructions will determine how you’ll exit the position.

Orders are valuable and beneficial because they allow you to place restrictions on the trade. This means that you can reduce potential losses or bank profit on time.

You should know that there are many types of orders. The main types are: buy to open and sell to close for those who want to buy options contracts and sell to open and buy to close for those who want to sell options contracts.

The four main orders further lead to additional orders regarding filling those orders and the time matter. The filling orders can be limit orders and market orders. You can also give various orders for setting the timing parameters.

However, we’ll now discuss only the exit order types, that is, the ones you can use to close an open position.

Stop orders

With a stop order, you can instruct the broker to close the position on an options contract once certain criteria are met (the price reaches a particular level). This order is beneficial to prevent losses or grab a profit.

E.g., if you buy a sell stop order, the options contract will be automatically sold once the price reaches the preferred level, and thus, prevent potentially bigger losses.

The stop orders can be market stop orders or limit stop orders.

Trailing stop orders

This is a very popular profit-taking order. You set the stop price below the market price, and with this order, the stop price follows (trails) the market price. But, if the price changes direction, the order closes the trade.

Contingent orders

The contingent order is the most versatile type of options order. If you buy this order, you can instruct the broker to close the open position when your chosen criteria are met. This is something like a customized order.

Conclusion

So, this is it! As we said throughout this article, exit strategies for options trading can be challenging to set up, but they’re a fundamental part of the process because they can help you secure your profit. Most importantly, they can help you reduce losses when assets move in the other direction.

Yes, we know it sounds complex. But fortunately, there are options-alert services that can help you monitor the market to pick the most suitable trades.

One of the best options-alert services is FoolProof Options, which you should definitely try if you want seamless options trading.

The service is free for two weeks, during which you can decide whether it works for you. After that, it costs only $97 per month - money you’ll pay for at least three trade alerts per week and a full trade plan.

Plus, it has a 200% membership refund if you don’t make a return on investment. Sounds convenient, doesn’t it?