Options Trading Strategy For Locking In Current Profits

In this video, we are going to discuss a trading strategy aspect of options math and risk reward evaluation that is referred to as options trades profit locking.

You have a good profit in an options trade, but a lot can happen before expiration – how can you lock in profits for your trade, while also giving it additional profit potential?

This would be done instead of taking the profit and exiting the trade, based on minimizing the giveback risk to your profits and because of the existing potential for a bigger profit.

Option trade profit locking is an options trading math question that considers the following:

  • The time value component of your profit – if this was an underlying trade you could just use a trailing stop
  • Math to expiration for your open trade
  • Current profits compared to expiration profits
  • Options trade[s] that could be done to lock in profits

Also, it is necessary to remember 2 factors while doing the options math:

  1. The expiration price is an unknown variable – price could keep going in the direction of your trade, but it could also reverse.
  2. At least part of your current profit is time value [and depending on the option strike it could all be time value].  This time value has to progressively decay until expiration, because all options expire at their intrinsic value – and the closer expiration is to when you took your trade, the greater the amount of time decay [option theta].

All of these questions and factors make the trading math, for locking in your options profits, important to understand.

Options Profit Lock Scenario

Let’s look at the following trading scenario and the related math to expiration, compared to locking in your existing trade profits:

With 3 days to expiration, the underlying went to price resistance at 76.60.  This was followed by a trading method sell setup at 75.80 and you bought a 75.50 put for 1.15.

There was then a sell-off and the underlying price went down to 72.00, with next support at 70.00.  On this move, the 75.50 put has gone up and you can close it for 3.40 – do the math:

  • Current profit is 2.25 = 3.40 – 1.15
  • If expiration is at the current price of 72.00, your option will expire at 3.50 and a profit of 2.35 = 75.50 – 72.00 + 1.15
  • If expiration is a 70.00 support, your option will expire at 5.50 and a profit of 4.35 = 75.50 – 70.00 + 1.15
  • But if there is a retrace and expiration is at 74.00, your option will expire at 1.50 and a profit of .35 = 75.50 – 74.00 +1.15

Clearly, there are big risk-reward concerns to your current 2.25 profit.  If you expire at the current price you can only make another .10  – and while you can increase your profit to  4.35 on an expiration 2 points lower, you will give back your profit to .35 on an expiration 2 points higher.

Is there anything else that could be done to lock in the current profit, while minimizing the give back and still having an increased profit potential?

For instance, what if you could lock in a minimum profit of 2.20 at a 72 or 74 expiration, and have a potential profit of 3.20 at an expiration of 71.00 or lower – would you be fine with keeping your trade open –vs- taking the profit and closing the trade because of the retrace risk, regardless of the potential for an even greater profit.

Before going on, let’s talk a moment about trade and profit management.  With the scenario presented, I would hold the trade.  I would even risk around .50 giveback to make an additional .90 – if the current swing still had room to support or resistance, without having made a pmd low or high.  But I would take profit on 25% to 50% of the trade.

But if there was a risk reward of .50 giveback to make an additional .50 – I may take 75% profits and hold the rest, but I would be very inclined to just close the trade and thank you very much.

A risk reward analysis and remaining profit potential is a critical component of trade management.  And remember that you are comparing real profits to potential profits – being greedy, when the risk reward doesn’t warrant it, is a good way to end up with virtually nothing and in some cases, turn a good winner into a loser.

Locking The Profit Based On Remaining Risk Reward

So, how was the 2.20 profit locked, with the remaining risk reward potential, as described above?

Options Trades Profit Locking

This was done by buying a call and selling a put, when the underlying went to 72.00 – look at the profit graph for buying the call:

  • A 72 call could be bought for .85
  • You would lock in a profit of 1.50 instead of 2.20 – and could make 3.50 at 70.00 instead of 4.35
    • But note that you would make 2.50 at 71.00 instead of 3.20
    • If support was 68.00 instead of 70.00 and I had more time – I could see closing 50% and holding the remaining
    • To get the lock described above, I also sold a 71 put at .70
      • And now you can see the 2.20 profit lock, with the 3.20 potential at 71.00 and lower

Apple Computer Put Profit Locking Video

The second video on the page discusses an apple computer profit lock trade that was done.  After buying a 695 put for 1.22 – I asked the question:

  • If I sell a 690 put 1.45 and buy a 690 call 2.00 – how much money could I lose?

Apple Put Profit Lock Trade

Do the math for this profit lock trade [you have around 3.10 profits at the time] and compare it to expiration profits at stock prices of 690 688 692 – would you do the trade or take the profits and close the long put instead?