Entering options orders can be a daunting task for beginners due to the variables in play. This post aims highlight the procedure and best practices of how to enter option orders correctly, manage option positions, manage risk and repairing trades, and utilize the different techniques to roll and take partial profits.

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Entering and Closing Option Orders

Entry Order: 

When looking to open an options position, the first task is to establish a directional view - bullish, bearish or neutral. The next step is to select an option strategy, expiration and strike price based on the directional view chosen. When opening a position, a "To Open" order is used. This can be either a "Buy to Open" or "Sell to Open" order and these are placed using either limit or market orders. 

Exit Strategy:

An exit strategy is used to set rules for yourself on when to get out of a trade. It is important to have a sense of when to cut losses or take a profit on trades. Exit strategies should be developed using a rules-based approach. 

Example of placing a multi-legged order

One thing to remember when entering multi-legged option orders is to enter them as a single strategy and not as two separate legs. The OptionsPlay tool will provide you with the parameters for each individual leg. Consider the example below of how to enter a vertical spread strategy:

Enter the following legs into your brokers platform as a single strategy

*As this is an "open" strategy, Buy to Open and Sell to Open is used. Most brokers will populate the parameters above when an option is clicked.

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Options Orders and Actions

Knowing whether to "Buy to Open" or "Buy to Close" etc. can be confusing for first time traders. Whenever you want to open a trade, "Buy to Open" or "Sell to Open" is used. Closing a trade requires using the opposite - "Buy to Close" or "Sell to Close":

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Pricing on Options Orders

Options have larger bid/ask spreads than stocks and vary depending on large cap and small cap companies. Large cap stock tends to have options with smaller spreads and are less volatile when compared to small cap stocks with wider spreads and tend to be more volatile. 

Options Liquidity and Orders

Options on stocks that are outside of the top 100 names in terms of market cap tend to have lower open interest and options as well as a wider bid/ask spread. The liquidity of an option is tied to the liquidity of the stock. Therefore, large cap stocks tend to have more liquid options. This means that higher open interest does not necessarily mean that the option is not liquid. Due to the large increase in number of strike prices added in recent years, open interest is more divided. Open interest will usually pool around in the money strikes, more so if the strike price is a round number. Even if an in the money strike price that has a decimal has lower open interest, it is not any less liquid than a strike price just above or below with a much higher open interest. This is important to keep in mind when placing limit orders. Pro tip - Don’t be afraid to place orders in between the bid and ask price. Most orders are filled within 5-10 cents around the mid-point of the bid/ask spread

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Managing Options Positions

Cash Secured Puts

This strategy does not involve active management.

Goal - To acquire stock at a discount

Outcomes:

1. Expires worthless - in this case, rinse and repeat this strategy and sell the put again to keep generating income
2. Exercised - in this case, you now own the stock at the strike price of the put minus the premium received. 

Covered Calls

Goal - To generate yield on the stock that you own

The first two scenarios below do not require any management until the last week.

Possible scenarios:

1. Stock moves above strike - the general rule of thumb in this case is to hold the position until the last week of expiration and then decide to either roll or let the option be exercised. 
2. Stock moves sideways - let the call expire worthless, rinse and repeat the strategy to collect more premium
3. Stock moves lower - Buy back the call option @ 20% of premium received

Credit Spreads

Goal - Let credit spread expire worthless and keep credit/premium

Credit spreads are best used when price is ranging between support and resistance. It is important to time the entry with expected tops and bottoms. 

Exit scenarios:

1. Take profits early if there is a 50% gain with more than half the time left to expiration
2. Cut losses at 75%-100% if the credit received is greater than 1/5 of vertical width
3. Cut losses at 100%-200% if the credit received is less than 1/5 vertical width

Long Calls and Debit Spreads

Unlike the previously mentioned strategies that only required selling options, long calls and debit spreads require buying options. In this case, risk management is key. 

Rules for losses:

1. Cut losses at -50%
2. Never double down and increase portfolio risk

Rules for gains:

1. Take profits at +75%-100% 
2. Take partial profits if possible
3. Roll positions up or out when targets are extended in time or magnitude

Rolling options positions

A roll strategy in the options world is defined as closing an existing option position and opening a new option in a single order. The following roll strategies should only be used when the trade is in profit. This is done when either the target price has not been met, when more time is needed or when the price target has been raised:

1. Target price not met example - a trader is currently long 10 $100 Calls @ $3 ($3000 premium paid) with a target of $110. There has only been a modest directional move to $105 with 3 weeks to expiration.
   In this case, the roll strategy could be to close half the position by selling 5 of the $100 calls @ $6 ($3000 premium received). This allows the trader to still have 5 contracts exposed until expiration while eliminating the full $3000 risk. This roll strategy requires at least 2-3 weeks remaining before expiration. 

2. Time extension example - a trader is currently long 10 Aug $100 Calls @ $3 ($3000 premium paid) with a target of $110. There has only been a modest directional move to $105 with 3 weeks to expiration.
   In this case, the roll strategy would be to sell all 10 Aug $100 Calls @ $6 ($6000 premium received) and buy 8 Sept $100 Calls @ $7 ($5600 premium paid). This strategy allows the trader to effectively finance the next month for free. The overall risk on this trade has been reduced from $3000 to $2600. Leverage has also decreased as only 8 Sept contracts are bought using the premium paid from selling the 10 Aug contracts. Do buy contracts that exceed the amount received from selling the original contracts. 

3. Price target raised example - a trader is currently long 10 $100 Calls @ $3 ($3000 premium paid) with a target of $110. There has been a quick directional move to $107 with 5 weeks to expiration.

In this case, the roll strategy would be to sell all 10 $100 Calls @ $10 (10000 premium received) and buy 15 $110 Calls @ $7 ($7500 premium paid), This creates a net credit of $2500 and the overall risk is therefore reduced from $3000 to $500. Long exposure is maintained with lower risk and an increase in leverage as there are now 15 contracts. 

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Summary

When entering options orders, it is important to understand the difference between buying or selling to open and buying or selling to close. Many beginners confuse this concept and end up opening an additional position instead of closing their position. Managing options orders varies depending on the strategy used, but a few common best practices should be utilized when managing losing trades - never add to a position and do not roll the trade as this could compound the risk. Profit taking should be done early if possible. Using best practices to enter and manage trades can help you maximize the effectiveness of your trades and lead to a greater probability of profit.

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