When To Sell An Option (4 Things To Consider)

|July 24, 2020

Andy Snyder:

Hello and welcome. Today we’re going to answer the number one question for my trading services, when to sell an option? Huge question. But before we get to it, do me a favor, hit the like button, hit the subscribe button, so you can continue to get this valuable content.

When it comes to selling options, we’ve got a ton of questions. With stocks, we have a pretty simple explanation. I use trailing stops, other people use hard stops. But with options we don’t really have, well, that option. My number one rule with selling options is don’t go with a trailing stop. This is a big problem, a big question. And the reason you don’t want to go with a trailing stop is simply because options are too volatile. We get days where an option, it might drop 15% over the course of a week, it might go down 50%, but with one big volatile day in the stock market, it could surge a 100% and you’ll be getting knocked out of your option plays too often. What do I do? I do four things. There are four different things I look at to determine when to sell an option.

The first thing is I look for a double. If you double your money on an option contract, sell half of it. Take those gains, put them aside and then you’re risking somebody else’s money with the remaining portion. If you get a 100% on an option, it might trading services, we almost always take that first half of the gain, lock it in and then we’re off to the races.

Number two, I look for a catalyst. Say we have an option contract that it might be down 25%, 50%. When you’re holding an underlying stock, an equity, a 50% decline is huge. For an option, it’s not a big thing. One good earnings report, one headline can send that forward. If I’m on the brink of thinking, should I sell this? Should I keep this option? Look for those catalysts. Earnings dates are the easiest one. You can see when the announcement’s going to come out, but you can also look at, if your biotechs, FDA announcements, trials, that sort of thing. Look to see if there’s a catalyst. If you think there’s a good opportunity for big move down the road, keep with it, stay with it and keep holding that option.

Number three, time decay. This is probably the hardest and as you can see, I’m going from the easiest to the hardest. Time decay is getting up there. I won’t go into a full on options primer, but the closer we get to option expiration, the less premium we’re seeing on that price. If an option is expiring, let’s say exactly one month from now, it’ll have a different premium on it than an option that’ll expire in two weeks. You have to look at that and kind of weigh the volatility, those catalysts to see if that time decay is going to overcome that. There’s some mathematical formulas, but really it’s going to be a gut feeling going back to that number two idea, the catalyst. Can that stock in that amount of time, that’s getting smaller and smaller, overcome the pressure that’s on it?

Time decay is a big one and it ties directly into number four, implied volatility. If you look on an options chart to pricing, you always see a column that says, implied volatility or just IV and it’s a percentage. And it shows you what the market is expecting that stock to do based on that option price. And as that implied volatility goes up and down, it tells you how big of a swing the stock has to take. And again, you have to go to your gut and say, “Is this implied volatility meeting my expectations?”

You add that to all those other three criteria above and you start to get a feel for the overall risk of that option. There’s no simple answer. If there was a simple answer, people wouldn’t be asking me these questions. But to review, the easiest thing is when an option hits a 100% gain, sell it. Absolutely lock in those gains. Number two, look for catalysts. Earnings updates, FDA announcements, that sort of thing. Then we get a little tougher into time decay and implied volatility. Those are sort of gut moves. You really have to be in tune to the stock to figure those out. If the other two aren’t working out, you have to pay some more attention to number three and four. When it comes to stocks, stick with that trailing stop. With options, stick with those four criteria.

There you have it, when to sell options. And this is a big part of what I call know how, something we cover every morning in Manward Digest. I included a sign up link below. It’s entirely free. I mail it every morning. We talk about topics just like this one. Sign up and I’ll see you next time. Thanks.