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The Three Most Common Adjustment Mistakes—and How to Avoid Them

by Uncle Bob Williams

Options trading requires adjustments from time to time. With a High Prob Condor, you can go most of the year without any adjustments, but 1 or 2 months will require an adjustment. That's a normal part of Options trading.

All adjustments have costs. There's isn't any way around that fact. The key to good adjustments is minimize the cost and to maximize the chance of success. You can accomplish 99% of that goal by avoiding the 3 most common adjustment mistakes.

The Three Most Common Adjustment Mistakes—and How to Avoid Them

1) Waiting too long to exit.
If your position hits the adjustment point, exit. Don't wait. Don't rethink things. Don't try to rationalize that the Market will reverse. Just exit and move on. There is a time and place for optimism. This isn't it.

Our early adjustment point on a Condor is when the Delta of our Short Strike hits 0.16, and usually the cost to exit is around one month worth of profits. Our aggressive adjustment point is when the Delta of our Short Strike hits 0.30, and usually the cost to exit is around two months worth of profits.

If you wait until the underlying hits the Short Strike, your cost to exit can cost around 4 months of profits or more. Ouch!

It can be difficult to recover from that size loss. Too often, beginning traders will hold on until the end — praying and hoping in the face of all the warning signs, losing sleep all the way up to when they suffer a large loss. That can be enough to put an end their Options trading career. Which is unfortunate because this scenario is easily avoided by "biting the bullet" and exiting when the adjustment point is reached.

2) Using "Traders Vision"
"Traders Vision" occurs when a position starts to go bad, and the Trader starts to see all the "signs" that the Market will correct and their position will be OK. This technical indicator, or that commentator or that trader or this newsletters says... Soon you are convinced you're right and things are going to turn around. Everything you see will start to reinforce your view of the direction that you want to the Market to move. This is a fool's game. No one knows the future, and the fact that the Market has or hasn't done this or that particular move is ultimately meaningless. The Market will do whatever it will do. If the Market was predictable, we wouldn't be able to profit from it. Don't fall prey to these head games. If you reach your adjustment point, exit and move on.

3) Making bad adjustment trades
People get nervous at adjustments, or anxious about a possible loss and they end up placing trades that are overly aggressive to try to limit the loss. An overly aggressive trade means a trade that has a higher risk, and a higher risk means a greater probability of loss. Which can put traders into an even worse situation than they are in now. Sometimes you have to take a loss, and that's a normal part of Options trading. If you make an adjustment trade, only make a great trade.

Let's look now at the range of possible adjustments:

A) Leave the position on, ignore the adjustment point and pray that things will turn around.
You may get lucky, but if things continue the wrong direction your losses will keep growing. Don't. Repeat — Don't do this.

B) Exit and accept the loss.
This is the adjustment that we normally prefer. The Market will go against you sometimes, just accept that as part of trading. We usually exit at the early adjustment point, take the small loss and move on to a new trade. As long as you make trades where the probabilities of profit are far in your favor, this strategy will keep you profitable and trading for a long time.

C) Roll It.
If you take a more aggressive adjustment point, and you have a large trading account, you can often roll your position. You can roll out to a further strike in the same expiration month and increase the size of the position, or you can roll out to a further expiration date which will give you more room with the same position size. You can also do a combination by rolling out and increasing the position size. The cost of this adjustment is extra capital and/or time that you will be in the trade, both of which reduce the yield on the trade. There is also the additional risk of further adjustments / losses if the Market continues against the position.

D) Manage it by the Greeks.
If you have a large trading account and a lot of trading experience, you can manage a position that's gone bad by "managing by the Greeks." This means that you put on additional positions and spreads to bring the overall portfolio of positions to "Delta Neutral" (this will minimize the effect that price changes have on your position) so you can let the time decay work away until you get back to profitability.
Warning: This is not so easy. You have to make sure that your portfolio of positions is Theta positive (they move back towards a profit with each day that goes by), and you have to make sure that the Vega stays in a reasonable range so that you don't get hammered by a change in volatility. If you've ever heard of a $5,000 position that's gone bad and turns into a poor $50,000 position, you have the idea of what happens when "managing by the Greeks" gets ugly.

Yes, it's true that sometimes managing by the Greeks can work out great, but it requires a lot of attention and a lot of effort to structure the positions and to stay on top of them. You also have to cover all the additional commission costs as you add and remove positions. If you are a full time trader with a big account, this can be a serious adjustment possibility.

Of course, you can always mix the adjustment strategies, like removing part of a bad trade and then rolling the rest. But this game should only be played by pros. Don't try this at home.

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