Posted in
Education
By: Tom Gentile
on February 17th, 2023
When trading options like trading stock, there are times when the trade goes against you. The question is when to either stop out and preserve capital or add to the same options trade resulting to what’s known as dollar cost averaging. Here are some thoughts on that.
Recent followers of my education know I highlighted a bullish 5-month pattern for the Energy and Oil sector. It typically runs from mid-February to mid-July. The date chosen for the start date of the pattern is usually February 14.
The security used to assess this bullishness is the United States Oil Fund
That day of the week this year 2023 was this past Tuesday. Based on today price action the USO and other energy and oil ETF’s and individual securities are trading down since then.
Over the 60-trading day view it shows USO is more in a trading range sideways than in any kind of trend, up or down. Despite what happens over a day or two or the anticipated move over the next 5 months is higher.
Stop Out or Add to the Trade
What you do with any investment on any security is up to you and your financial professional and when it comes to an options trade even that is up to all of you.
Because I am an options trader I will give you some insight as to my consideration when an options trade of mine starts to work against me.
If your rules-based approach calls for a stop loss of a percentage dollar or percentage amount and that option hits either of those consider stopping out.
For an options trade, know how much time you have until the option expires. If you believe it has time to recover and do better than it is right out of the gate then you can decide to either hold on to the trade at current prices or consider dollar cost averaging.
If you bought an option say for $2.50 and it is now trading at $1.00 a consideration is to add the same number of options you originally bought at $2.25 at the now price of $1.00, (let’s just go with 1 contract to keep things simple).
Again, I consider doing this if I believe I have enough time until expiration for the security to trade higher.
You have now accomplished two trades in which you have spent a total of $3.50 or $350, (and I would still consider myself having only one trade/position in my account), but the average price cost of the option is $1.75 per contract. It would be like you originally bought two contracts at a cost of $1.75 or a total cost of the trade of $350.
After Averaging the Option Trade, it Doesn’t Have to Work as Hard to get Profitable
The thing now is if the security traded higher and the option was trading back at $2.50, where you bought the first option (or batch of options), instead of the original 1 contract trade being at a break even it should be a situation where the two-contract trade is profitable.
If you had two contracts at an average price of $1.75 that would be a cost of the trade now would be $3.50 or $350.
With the option now trading at $2.50 again your two contracts would be a value of $5.00 or $500 or a profit potential of $1.50 or $150.
Originally, if you did not cost average you would have to wait for the stock to rise enough to make the option price $3.50 to see that same $1.50 increase/profit.
For the option to get back to $2.50 it means the security has come back and is trading higher.
To get the value of the original 1-option to where the profit is a $1.50 or $150 per contract the security would have to work even harder, meaning it has to go even higher in price than that.
App: Toms Option Tools
Market Insight articles may show images of lists of stocks meeting a variety of options parameters like Unusual Call and or Put activity or Expensive IV found on my app Toms Option Tools.
Other times I will have other charts may work to amplify my educational points.
Those options data lists, however, can be found on my app Tom’s Option Tools. Use your device to search up and download this app and get free access to the Morning Reports section of the app.
Other parts of the app are available at a premium subscription rate, but the Morning Reports Lists are yours free.
Disclaimers
Stock and options trading has large potential rewards, but also large potential risk.
You must be aware of the risks and be willing to accept them in order to invest in the stock and options market. Do not trade with money you cannot afford to lose.
This is neither an offer to buy/sell/ or recommend a particular stock or option.
Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been actually executed, the results may have under or overcompensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with hindsight.
No representation is being made that any account will or is likely to achieve profits or losses similar to those shown.
Disclaimer of Warranties and Liabilities Tom Gentile and TomsTradingRoom, LLC including employees, consultants, and editors (“Publisher”) cannot and do not warrant the completeness or accuracy of the content found in our areas, or its usefulness for any particular purpose.
Tom Gentile and TomsTradingRoom, LLC also make no promises that our content or the service itself will be delivered to you uninterrupted, timely, secure, or error-free. Under no circumstances will Tom Gentile and TomsTradingRoom, LLC be liable for direct, indirect, incidental, or any other type of damages resulting from your use or downloading of any content on our site.
This includes, but is in no way limited to, loss or injury caused in whole or in part by our negligence or by anything beyond our control in creating or delivering any portion of Tom Gentile and TomsTradingRoom, LLC.
You are agreeing that you bear responsibility for your own investment research and investment decisions. You also agree that Tom Gentile and TomsTradingRoom, LLC will not be liable for any I, investment decision made, or action taken by you, or others based upon reliance on news, information, or any other material published by Tom Gentile and TomsTradingRoom, LLC.
Tom Gentile and TomsTradingRoom, LLC relies on various sources of information that we believe to be accurate and reliable. However, we make no claims or representations as to the accuracy, completeness, or truth of any material contained on our site.
Tom Gentile and TomsTradingRoom, LLC are educational portals, providing content for educational and informational purposes only. Neither Tom Gentile nor TomsTradingRoom, LLC are a broker/dealer. Investors need a broker to trade stocks and options and must meet certain requirements. All securities, futures, and investments data and ideas are offered to self-directed investors. All prices in USD unless noted otherwise.
A full disclaimer can be found here: http://www.tomgentile.com/legal_disclaimers.html.