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Managing Positions at 21 DTE: The Key to Directional Risk Reduction

Managing trades is a crucial part of ensuring success as a profitable trader. At Good Kids Trading (GKT), we have a rule that we follow for most of our traditional math based trades - managing positions at 21 days to expiration (DTE). This rule applies mainly to undefined risk positions and serves as a strategy for directional risk reduction. Today I want to explore why managing at 21 DTE is important for reducing the risk associated with market direction. Lets jump into the some of the Greeks to backup our trading rule.

When it comes to profitability in options trading, there are three main factors: time, volatility, and stock direction. While other factors such as interest rates and dividends sometimes impact our profitability they don't have as much of an impact. By us managing positions at 21 DTE, we focus on reducing risk associated with market direction, which is unpredictable and out of our control.

By selling premium, we benefit from the simple passage of time. Theta is the Greek used to track the Time component of an option. All option prices decay over time, which works in our favor as sellers. You already read how Theta Decay is my best friend! The certainty of time passing allows us to benefit from Theta, which contributes to our overall profitability. Time is a consistent profit driver that we can rely on, making it a crucial part of our trading strategy.

Volatility, unlike time, is not as certain. It is more of an expectation based on historical patterns. Remember Vega measures how much the price of an option changes when the volatility of the underlying changes. As sellers of premium, we are negative Vega or short Vega, which means we benefit from volatility contraction. I don't always track Vega, but I do stay focused on the IV or IVR of individual names. Volatility can spike or expand, especially during certain market conditions, but I still find comfort in the general tendency of volatility to contract over time. Eventually thing should settle down. This volatility contraction contributes to our overall profitability and risk reduction, this is why we sell more premium in high Volatility environments.

Direction the biggest unknown in options trading, this is why GKT also uses technical analysis in addition to looking a probability of profits and checking the volatility. Regardless of whether we are bullish and have a positive Delta, or whether we are bearish and have a negative Delta, we can NEVER fully predict the direction the market will take, even when the chart gives us hints. This unpredictability is what makes managing directional risk crucial. As we get closer to expiration, Gamma, which represents how Delta changes with stock price movements, increases in magnitude. Although we don't actively discuss gamma often, this means that moves against us in the stock will hurt us more and more as the contract is getting closer to expiration. To avoid being overly dependent on market direction, we manage positions at 21 DTE which keeps our Gamma risk in check.

While managing these positions at 21 DTE is a rule we primarily follow for undefined risk, we may not apply this to all our strategies. I will keep a naked short put open if want the shares in the company for a wheel strategy. I understand that this is not in my favor from a math perspective. Defined risk trades, such as vertical spreads or iron condors, have less exposure to directional risk and are not as affected by gamma. Sometimes you get a large move in your favor, and your risk is defined. If you have a low enough risk, the final 21 DTE might give you the profit you were looking for. It's crucial to strike a balance between controlling risk and avoiding unnecessary added risks.

By focusing on time, volatility, and controlling directional risk, we try to create consistent and successful trading outcomes. While each trader may have their own approach, managing at 21 DTE without a doubt is a proven rule backed my math and remains a staple in risk reduction.

If you want more information you should join the GKT discord to discuss more and connect with like minded people who trade the stock market! I hope this article was valuable to you. We want to help educate and show you trading doesn't have to be complicated, and you can do this.

Happy Trading Good Kids!

Disclaimer: this is NOT financial advice. I’m basically just some dude on the internet who’s been trading a while, and I use the stock market as my primary source of income. None of this is financial advice it’s purely educational!

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