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Over-Managing Math-Based Trades: When Too Much Control Is Your Worst Enemy



As traders generally want to be in control over our strategies, our risks, and our profits. But there's a fine line between sensible management and over-management and it can greatly impact our P/L over time. I've previously written how we target 50% of the premium received for many of math-based trading strategies. There are definitely benefits to making adjustments to your trades, but we have to be careful to not let emotions or fear hinder our profits. This issue comes up all the time, and I've found myself guilty of it too! I'll be posting a trade review this week to demonstrate what I'm discussing this week (I'll add the link here after it goes live on Friday.) Why do we let this happen? More importantly what can we do to stop doing this: acknowledgement and identifying we are doing this is the first step!


Many times over management occurs when we morph our math based option trades into day trades, not in the conventional sense of opening and closing trades within a single day, but making changes to our targets based on candles, others opinions or news.


Let's say, for instance, you've sold a put on an underlying asset with the intent to hold the position for a month. But then we see a huge candle on the daily chart and you find your trade 30% profitable, or a loss of 75%. Instead of letting your Good-Til-Canceled (GTC) order close at 50% profit as you initially planned, you're tempted to close it early, or even worse you get shaken out of a trade for a loss only to watch it turn profitable after you exit.


Lets consider some of the reasons we shouldn't exit our trades early:


1. You are less Profitable over time: While closing early might lock in some profit, it might also limit the full potential of the trade. Remember, your strategies are based on math, probabilities, and systematic edge. Cutting them short could mean leaving money on the table.


2. Allow time to fix losing trades: A strategy that looks like it's losing today may be profitable tomorrow as the market ebbs and flows. Exiting a losing trade early could mean you're denying the trade the opportunity to become profitable. Always stick to your pre-defined trading plan


3. The ‘Missed Move’ Regret: Markets fluctuate and an early exit might lead to regret if the underlying asset moves in the direction that would have led to a full profit on your trade.


4. Distortion of Probabilities: Math-based options trading is a game of probabilities. The premature closing of trades can distort the mathematical edge you've built into your trading plan.


While it's important to give your options trades the necessary room to breathe, there are few times when closing a trade early or managing it proactively makes sense. Here are a few situations:


1. Your Target Profit is Reached Early: Some traders add different targets for the first day or two of a trade. If you reach your profit target immediately, it might make sense to close the trade and lock in gains (For example: 25% in a day). This allows you to redeploy your capital on another trade, maybe in the same underlying.


2. Significant Market Shift: If there's been a significant shift in the market or the specific underlying asset that alters your original trade thesis, it makes sense to adjust or close the trade early. This might be a major news event, an unexpected earnings report or an accounting irregularity.


3. Risk Management: If the potential loss on a trade is approaching your predefined risk tolerance level, it might be wise to close or adjust the trade early. This is a key aspect of effective risk management and why we encourage you to trade small. You do not want a single bad trade to significantly impact your account as preserving your capital is as important, if not more so, as making profits.


4. Expiry is Near with High Gamma Risk: As options get closer to expiration, the rate of change of their price (Gamma) can significantly increase, making the position riskier. If your option is near the money close to expiration, it may be better to close the position to avoid the potential for large swings in profit and loss. This is why we propose rolling or closing options at 21 DTE.


5. Dividend Risk: If you're short a call option and the underlying is due to pay a dividend, there's a risk that you'll be assigned early by call owners wanting to capture the dividend. If the dividend is substantial, it may be worth closing or adjusting the position to avoid early assignment.


Here are a few strategies to resist the urge to over manage:


1. Stick to Your Plan: Your trading plan is your roadmap. Stick to it, including your pre-determined profit targets and stop levels.


2. Trust in the Math: Remember, your strategies are built on statistical edge. Trust in the math and let the probabilities play out.


3. Diversify: By diversifying your trades across different underlyings or strategies, you reduce the temptation to over-manage any single trade.


4. Have Paytience: Patience really does pay off. Options trading is not a sprint, it’s a marathon. Cultivate the patience to wait for your strategies to unfold.


Remember, losses are a part of trading, GKT is here to help you learn, adapt, and improve your strategies. Discipline and paytience are virtues in trading. Trust in your plan, trust in the math, and give your trades the room they need to breathe and deliver profits. As we often say here at Good Kids Trading, "Plan your trade and trade your plan." Don't forget to join us in our Discord community to share your experiences and learn from others. Stay tuned, trade wisely, and let the math work in your favor. Happy trading Good Kids!

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