Pro Tip: Always Have a Closing Order

This is a quick post that demonstrates something I’ve been taught from early on in my options trading and I think this example makes it very real. When you open an options position, always have a closing order in your trading platform, even if it seems implausible. Most of the time, nothing special happens and things close around the time you think they will. But ever once in a while, you catch a break and get something unexpected.

As I talk about closing orders, I think it’s also important to stress that importance of the type of order. I only enter limit orders not only for closing a position, but also opening and even adjusting a position. I never enter a market order. In my view, market orders are for suckers. You are relinquishing all control to the broker who has no incentive to get you a reasonable deal. It’s easy to think that you’ll just get the bid or ask price but that isn’t necessarily the case. With a market order, all the broker has to do is fill your order at any price. In some cases, your broker may also be a market maker and so you are literally letting them set the price for themselves. But even in the case where they are not market makers, they will still get their commission for doing no work on your behalf. A limit order puts you in control (as much as you can be in the market). In order for the broker to make the commission, he (or most likely their computers) will have to fill it at a minimum or maximum price set by you. This means you may have to work the order a bit to get a fair price. But at least you have some control over the price you are going to pay with your money. In a perfect world, you’d get filled at the mid every time but, in some cases, it’s reasonable to cave in a bit to get filled. If the market is moving too fast to get a reasonable price (usually on the downside) and you can’t close a losing position then, in my opinion, you grab a long put with enough deltas to flatten out your position and wait for things to calm down. That is far better than doing a market order of any kind.

Now, back to the real topic at hand. I recently put on a calendar trade in Apple (AAPL). It was doing fine and I let it run over the weekend. This is how the trade looked at the close of the market on Friday:

My Calendar in AAPL going into the weekend

As you can see, I’m up a bit with a reasonable delta for a 10-lot (1.2 per calendar), decent theta with good room on each side. I’m perfectly happy going into a weekend with this trade. My goal is to make 10% on the trade but in the first week of a 30-day trade, I’ll gladly take 7-8% and call it a day. You’ll never go broke taking a profit. So Monday rolls around and at the open, my graph looks like this:

My Calendar in AAPL first thing Monday morning

Gee, that doesn’t look very nice. But we did open up a bit and this is just a snapshot of the mid price at that moment. In reality, it bounced around a bit and near break-even or even down $15 or so was pretty reasonable given I was short about 12 deltas on the position. Sometimes the first prices of the day are a little wild and so the mid price can jump a bit. This is normal market stuff and as a trader, you have to be used to it. But what actually happened?

My trade closed for $140 gross profit ($100 net) right at the opening!

My trade closed for $1.56 literally 1 second into the trading day on Monday! Note I paid $1.42 for it the previous week. That’s a gross profit of $140, or $100 after expenses (it’s 20 contracts in and 20 contracts to get out and I pay $1/contract commission) for a 7% profit. WTF?!

This is the magic of having a closing order in the system at all times. Apparently AAPL was trading all over the place at the market open and my broker was able to fill my order for my target price. I have no idea how long this price was available, it could have been literal seconds, but I was filled and my position closed for a good profit for 6 days. It would have been tempting see that it should take several days to get close to my profit target and not have a closing order in the system. What’s the point, right? This is the point. Sometimes you get filled even when you don’t think you should. But you can only get filled if you have an order in. And because it’s a limit order, you are assured at a minimum price to get out.

The one thing of which you need to be mindful when having a closing order in the system is when you want to adjust. If the adjustment you want to do involved any of the contracts in the closing order (e.g. rolling an option), then the closing order will need to be cancelled before the adjustment can be made. If not, the platform may think the adjustment is a new position and it could mess up your position with potentially naked shorts, etc. This is why it’s important to have a clear head even when things are flying around. Take your time and get the orders right. The few seconds you are trying to save by rushing can actually cost you more by putting in something wrong.

So, I hope you can see from this example why having a closing order in at all times is a good thing and really can’t hurt. Also, limit orders are your friend.

Comparing Directional Plays

A lot of folks like to use options because of the leverage and lower costs vs buying and selling shares of stock, especially on high-priced stocks and indices. While I usually use options to trade non-directional strategies that rely on time decay rather than price movement, there are times when it’s fun to get a little directional. Sometimes (like right now), it’s tough to be non-directional because the market is moving all over the place and price movement makes it tough and not worth the risk. So, I thought I’d compare a few strategies for directional trading. The first few you’ve probably seen before, and one that you may not have seen but I think is really interesting.

For the purposes of this post, I’m going to be bearish on Tesla. No particular reason, this is just an example, not trading advise. I actually have no real opinion on Tesla, but it’s a high-priced stock (around $235/share) so it makes for a good example. Of course shorting the stock is very risky and expensive because while a stock can only got $0, there’s no theoretical limit to how high it goes so shorting is a dangerous and expensive game, IMHO. However, I fully believe that retail traders can use long PUTs to go short on a stock without the undefined risk. Since you are in a long or covered position, your risk is defined and so you know how much you can lose and your broker won’t ask for you first born in margin. It’s one of the cool things about options.

Strategy 1: But Long Puts

This is the simplest strategy and probably one that most folks who know anything about options would understand. So if I’m bearish on TSLA, I could buy a put at-the-money (10 days out) for about $665 (plus commissions, of course). Not bad for a $235 stock. And way less than what your broker would want you to put up to short 100 shares of TSLA. Your total risk is what you paid for the put (so $665/contract) and you can scale your up to whatever level at which your are comfortable. The trade looks like this:

Buying a single $235 put 10 days out

In this trade, my break even is if TSLA hits $223.35 since I need to cover the cost of the put. And because we are only 10 days from expiration, I’ll need it to move soon as I’m losing about $30/day in time decay and this will increase a bit each day. I could always go out further in time to allow it more time to work, but I’ll pay more. For example, at 31 days to expiration that same put would cost $1208 which means TSLA needs to get below $222.83 (similar) but I’m only losing $18/day to start to time decay since I have more time.

Buying a single $235 put 31 days out

You could go further up or down in price and time and the number would change, but you get the idea. This is a very simple strategy that is bearish on TSLA but gives you limited risk. Nothing wrong with it, but what if we could do it cheaper?

Strategy 2: Put Vertical Spread

So one way to reduce our risk and still be bearish on TSLA is instead of just buying a put, also sell a lower cost put against it. This does a couple of things for us. It reduces the risk since we are getting a credit for selling something, and it reduces our time decay (and can even get time to work for us). So to keep it consistent to start, let’s do a 5-point vertical spread buying the same $235 put 10 days out, but also selling a $230 put against it.

Buying a 10-day put vertical ($235/$230)

Look at what happened. First, we have reduced our total risk to $205 plus commissions per spread. That’s a 70% discount to just buying the put. And on top of that at the start of the trade, time is working for us instead of against us as we’ll make $.40/day to start and if TSLA goes down that will increase significantly.

Now, there’s no free lunch so what have we given up by doing this? The big thing we give up is because we sold a put along, we cap our maximum upside to $293. That’s about 140% of the risk where if you look at the long put, it can make a lot more if TSLA goes down hard. With the vertical, even if TSLA went to $0, the most we’ll make is $293. That’t still a really good gain and I’d probably get out before it ever got there, but it is a limit so if you’re shooting for the moon, you may not like this strategy. However, I like the idea of the reduced risk if we’re wrong and the initial positive theta which means we aren’t losing money to time decay (unless TSLA goes up). And, of course, our commissions will be a higher since we are trading more options so keep that in mind.

But what if we could make this even cheaper?

Strategy 3: Directional Butterflies

Here’s a strategy you may not have seen before, and it may not be to your liking, but I really like it for certain situations. It’s a bit more complex but it’s REALLY cheap. It’s called a directional butterfly. What’s a butterfly? Well, if you’ve never seen a butterfly before, check out my Options Fundamental Series, particularly my episode on Butterflies. But, in short, a butterfly is 2 vertical spreads with the same short strike. So a single butterfly will typically follow a 1-2-1 pattern which you’ll see below. In this example, I’m going to keep the same vertical spread I did above, but add a second vertical even lower to reduce the cost even more.

Buying a TSLA directional butterfly. Buying 1 put at $235, selling 2 puts at $230, and buying 1 put at $225

Wow! I put on this trade for $55 plus commissions! That is the most I can lose. And I have even more positive theta so at the start of the trade I’m making $2.67/day. Too good to be true? Again, what am I giving up? In this case, if TSLA goes way down, I can lose money again. I have some risk on the downside as well as the upside. So TSLA has to go down, but not down too far too quickly. And because this trade has 4 contracts, my commissions will be even higher than the vertical. I can scale this up by adding more butterflies, but watch the commissions as it’s 4 contracts per fly. On the plus side if TSLA only moves to around my short strikes ($230), I can make quite a bit more than the vertical. I get that in exchange for having risk on the downside as well. I can tweak this around by moving the fly up or down for more or less money as well as adjusting the width of the “wings” (say 10 points instead of 5). Here’s an example of the same fly starting at $235, but with 10 point wings:

A 10-point directional fly

As you can see, the profitable area of my fly (the “tent”) is wider, but my cost is $182.50 rather than $52. So I get more room and higher starting theta, but I’m paying up for it. But $182.50 is still better than the put and the vertical with respect to risk.

Conclusion

So, what’s the best way to do this? There isn’t a best way. All three strategies have pluses and minuses. Risk vs reward, time decay, and area of profitability are all factors in choosing a strategy. The point of this post isn’t to sell one strategy over another, but rather to show that in the world of options, there are multiple ways to do things and the more tools you have at your disposal, the more you can decide what kind of trade works for you.

Any questions or comments? What kind of directional plays do you like? I’d love to hear from you so feel free to leave a comment here or reach out to me on Gab @MidwayGab or on my BitChute channel MidwayTrades. I’d love to talk about what people are doing or even try to explain some concepts if that helps. I’m always learning as well so let’s talk options!