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Options Trading Profit Strategies: When to CLOSE OUT Trades - YouTube
Channel: BestStockStrategy
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Closing options trades. Why you should
not close a naked position at 50%.
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Realistically speaking what tastytrade
tells you and I'm not even going to
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mention like option alpha because I
think that they're a complete scam and
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they don't make any money but I do have
a tremendous amount of respect for
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tastytrade and to me it doesn't make
sense and it doesn't make sense
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mathematically why they recommend why
they recommend that you should close out
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both naked and verticals and Whitin
verticals are spreads at 50 percent so
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this is gonna be a little bit of a
difficult video for me because I
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actually have to think and do math in my
head while I'm simultaneously speaking
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to you at a relatively rapid rate so the
fact is that let me just go through some
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of the theory first when you use a
spread you are mainly profiting so for
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example Facebook right now is trading
around 130 132 let's say you would sell
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a naked put option with a strike price
of 120
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If you were going to turn that
into a spread you would also sell the
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120 put and then let's say you would
buy the 110 put so let's say in this
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example you are going to sell the naked
option on Facebook with a strike price
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of 120. So you sell the 120 you
will collect just hypothetically
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speaking let's say three dollars okay
this is a dollar sign then if you buy
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the 110 so you buy this you sell this
this one is gonna cost you $1. So
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if you do the spread you're gonna
collect two dollars if you do it naked
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you're gonna collect three dollars now
what tastytrade tells you is that you
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need to close both of these trades after
you receive a 50% premium decay
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So after this decays to a $1.50 this
is when you should close out the naked
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and in this scenario with the spread
when this trades of $1 then you should
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close it out and you would realize a 50%
gain. Tthe problem with this is that it
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doesn't make
sense mathematically and the reason is
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that even by tastytrade's own math,
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if you close out the spread at one
dollar what that means is that this
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option, the 120, that you sold it's
probably going to decay down to around
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I'd say like a $1.20. And then
this option that you bought at that time
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is probably going to be trading for 20
cents because remember the rate of
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return of the higher priced option is
going to be the one that leads your
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profits. Let me repeat that the rate of
decay of the option that you sell on the
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put side, the higher price option, is
going to be the leading option that is
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going to determine your profits. So in
this situation when you're using the
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spread when you close it out for a
dollar this option which you previously
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closed out for a $1,50 now you're
waiting for this option to trade it a
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$1.20 so when you close out that
trade what you're going to do is let's
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say you sold the spread so you would
sell the $3.00 option you would buy the
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$1 option so you sell the 120 you buy
the 110 that means on a net basis you
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would collect two dollars of net premium
now if you want to close that out you
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would buy back the option that you sold
which is the 120 and you sell the 110
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option so in order to do that you would
buy back this 120 you pay one dollar and
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20 cents per share or $120 per contract
then you would sell this you'd sell it
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for 20 cents so on a net basis this
decayed 80 cents this
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decayed $1.80 cents again let me just
make this clear. Decay 80 cents for the
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option that you bought the 110 put on
Facebook for the 120 point on Facebook
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that you originally sold for $3 that
decay is a $1.80 as a result
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here you would get a total net premium
on the spread that you would keep would
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be $1 as you can see here you would have
80 cents of decay and remember and here
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you would have a dollar eighty in decay
so the difference between this is $1
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which is equal to the amount of premium
that you keep now here's the summary if
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you're waiting for the leading indicator
option to decay all the way down to a
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dollar 20 then you might as well wait
for the naked option to decay to a
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dollar 20 to understand what I'm saying
it doesn't make any mathematical sense
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that you will close out the naked option
and the spread at the same price so I've
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done and run a few simulations obviously
I'm not running like a thousand back
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tests like tastytrade does but I'm
really shocked that they would recommend
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this why is it does just doesn't make
any sense why you can run this with any
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example that you want why you would
close out naked options and spreads at
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the same amount because in this
situation this same option that you're
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closing out that you're proposing to
close out of 50% you will close this out
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at a $1.50 but your risk is in
the put that you're short here with the
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spread you're waiting for this to decay
to a $1.20 so you might as well wait
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for the naked option to decay to a
dollar 20 therefore you would collect
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10% additional premium 10% addition
Premium so 10% additional reunions the
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difference between a dollar two dollar
fifty and a dollar twenty 10% additional
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premium from what they recommend would
mean that you would close the nican
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option at sixty percent of the premium
received and you would close the
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vertical at fifty percent so that's the
conclusion that I get and all of my
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analysis and the iterations that I've
gone through proposes you should always
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close out naked options at 60% to
65% of the premium
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received and you should close out
verticals at fifty percent and the
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entire reason again it's I'm gonna make
this very simple is that when you trade
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a spread your profits are dictated by
the option that you sell so in this
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situation when we sold the one twenty
put we collected three dollars
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you're still when you do a spread
selling the same one twenty put and
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collecting three dollars but with the
spread you're waiting for it to decay
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and value to a dollar twenty and here
you're only waiting for it to decay and
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value to a dollar fifty so you might as
well because this put that you sell
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determines your profit you might as well wait
for this same option that you're selling
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to decay in price to a dollar twenty as
a result a dollar twenty you will keep
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you will sell it at a dollar twenty you
will keep a dollar eighty all right so
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here you will collect and keep thirty
cents more premium that's ten cents ten
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percent more premium so a rule of thumb
is you should always close out naked
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options at sixty to sixty five percent
of the premium receive for verticals you
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to close them out at fifty percent I
don't understand why tastytrade tells
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you that you should close out naked
options and spreads at the same amount
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at fifty percent because mathematically
it just does not make any sense
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whatsoever. Seriously it doesn't like the
put that you sell is the leading
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indicator of your profitability so if
you're gonna wait for it to decay this
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option to decay down to a dollar twenty
you might as well just sit wait for this
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to decay to a dollar ten to a dollar
twenty and collect ten or 50 percent
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more premium
so for example if you wanted to put
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let's say you were selling I'm gonna use
another underlying I'm gonna use
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Lockheed Martin let's say you wanted to
sell a 250 put in Lockheed Martin and
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you were going to do it naked and you
were gonna collect let's say $2 okay
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the second that this trade fills you
would then close out this trade for I'd
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say around 80 cents let's say 75 to 80
cents alright so you would sell the put
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with the strike price to 250 then
immediately you would set a buy to close
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good to cancel order with a strike price
of 75 to 80 cents as a result this would
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allow you to keep around 60% to 62.5% of the premium all right so
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70 to 80 cents that way you'll keep 65
to 60 to 65 percent so this would be
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this will be the amount that you buy it
back so again just to reiterate you're
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selling a put on Lockheed Martin with a
strike price at 250 once it closes you
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immediately submit a buy to close order
with a limit price good to cancel of
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anywhere from 70 to 80 cents whatever
you feel comfortable with if you want to
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do 70 cents and you want to be more
aggressive fine if you want to do 75
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cents that's fine if you want to do 80
cents that's fine but this will
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automatically give you anywhere from 10
to 15% more premium over what tastytrade
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recommends now if you wanted to do a
spread and you wanted to sell this same
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250 put what you wanted to buy the 230
and then you collected two dollars here
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and then one dollar here that will mean
that you will collect one dollar of net
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premium for doing a 250 by 230 spread in
Lockheed Martin and you collected one
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dollar in net premium that immediately
once this trade fills you
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would submit a buy to close order that
would have a limit good to cancel price
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of 50 cents. So here you
would collect when you do the spread of
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Lockheed Martin the 250 and 230 you will
collect $1 of net premium for the spread
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and then you would submit a good to
cancel closing order for 50 cents and
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therefore you would keep 50 cents but
when you're going to do it naked and you
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would sell it at $2 immediately once it
fills you would submit a buy to close
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order with a limit price of either 70 75
cents or 80 cents so again I just want
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to make this clear that when you close
out options trades it does not make
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mathematical sense for you to close out
naked options and spreads at the same
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price closing them out at 50 cents at 50
percent just does not make mathematical
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sense because in options trade and if
it's a naked option versus a spread they
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are not the same you're still assuming a
substantial amount of risk because
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you're way on the spread because you're
waiting for the option that you sell to
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decay even more in value than it would
if you had the naked option so you might
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as well collect an incremental 10 or 15
percent of premium with the naked option
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and wait for it to close to trade down
to the same exact level as it would for
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the spread in order for you to close out
that spread at a 50 percent profit so
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this is David Jaffe from BestStockStrategy.com if you have any questions let me
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know
you can go to BestStockStrategy.com
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enter in your email address and
receive over 50 percent over $400
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