When I'm in a losing trade, there 4 action types that I can take:
Do nothing - and hope it will recover. (my risk is capped by the option's premium).
Take a stop - save partial amount of my R, if the rational behind the trade is proven to be wrong.
Average Down - not recommended action since you increase your risk.
Change the R:R and the probabilities of the trade for becoming a wining trade, without increasing the risk.
In the following example I will show you how action 4 can be done without risking more money.
Devon Energy broke down its support level after I was already in a long option trade.
I had 20 Call 10.74 to Jan 21 that cost me 1.1$ each (total of 2200$).
As DVN broke down the support level, I can take the following actions:
Do nothing, and hope it will recover over 11.84 until Jan (BE).
Sell the Calls at 0.77$ and take a 0.3R loss (660$).
Average down. Buy another 20 calls for 0.77$, which will lower my average price to 0.93$ (BE = 11.67) but will increase my risk to 1.7R
Buy 20 Calls 8.74 and sell 40 calls 10.74 (20 that I have and 20 short), thus creating a bull call spread of 20 call 8.74 & -20 Call 10.74. This Rolling down will not cost me anything !
Notice that the rolling of the spread can be done by using a combo order with your broker, meaning the spread is done simultaneously, without exposing you to market risk.
So now, lets compare the 4 action types:
So, now ask yourself what are the probabilities to get to a profit in each scenario.
Obviously, Rolling down has the max chance of turning into a wining trade.
But is 0.8 R winner worth staying with the position until Jan?
Lets check the margin requirements:
As you can see the initial margin for this spread is only 1244$ , and even if we take initial 2200$ that we payed as the maximum margin, we can still make 1800$ profit if DVN will go above 10.74 by Jan (82% profit).
Conclusion:
By actively managing the options position, we can change the R:R and improve our winning rate, without increasing our risk.
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