I had the ultimate pleasure of joining Coach D yesterday for the coaches show. We rocked an entertaining discussion on our recent trades. There were a few questions I wasn’t able to address due to 8 o’clock arriving to spoil the fun. So let’s take a look at the queries for today’s tale.

Why do you take partial profits on a credit spread?

The short answers are because 1) it increases my profit per day and 2) it increases my probability of profit.

Let me use a trade I entered today to illustrate. FCX scored an epic breakout yesterday making me a buyer of any and all dips. This morning’s pullback provided just such an opportunity so I sold the Aug $14 put for 34 cents. Expiration is 23 days a way and the initial margin requirement was $410. That means the potential return on investment is 8.3% (34/410).

Now, if it takes me the entire 23 days to capture the $34 reward then my profit per day is $1.48 ($34/23). I can pat myself on the back for having squeezed every last penny of profit out of the trade, but it took me the entire 23 days. Now, what if I could capture half of the $34 reward in one day? What if, due to FCX bouncing back from this morning’s selloff I could buyback the put for 17 cents? What would my profit per day be then?

You guessed it – $17. Isn’t that better? Is making $17 in one day better than making $34 over 23 days? Sure, $34 is more money than $17, but that’s not a fair comparison. Remember, if I exit the trade today with the $17 then all I need to do over the next 22 days is make more than $17 to have an overall profit greater than $34.

Does that make sense? Let me say it another way. I just took $410 and generated a $17 return in one day (probably due in part to luck). Should I keep that $410 invested in the current FCX naked put for 22 days longer to capture the other $17 (of the potential $34 max reward)? Or, should I close the FCX position, free up the $410, and deploy that money elsewhere in an attempt to make more than $17 in the next 22 days?

I’m pretty confident that I can make more money by closing and redeploying. Incidentally, the FCX put is sitting at 19 cents right now. I have a closing order in at 17 cents, but if it doesn’t hit it I still may exit by the end of the day.

In sum, the first reason why I take partial profits is it increases my profit per day over time. It’s a no brainer if you make a large chunk of the potential profit quickly.

Now how does it increase my probability of profit?

Let’s use Boeing as an example because it just exploded today. Suppose you want to be a contrarian since it’s so overbought and sell a Sep $240/$250 bear call spread for $1.40. To win at expiration you need BA to be below $240. The 240 call has a 23 delta which suggests there is a 77% chance that the call will expire worthless at expiration. That is your probability of max profit at expiration.

But what if my plan is to buyback the call spread for 70 cents? That would be 50% of my max profit. If there’s a 77% chance that the call spread will drop in value to zero, isn’t there a greater than 77% chance that it will drop in value from $1.40 to 70 cents at some point between now and expiration?

The answer is yes. Maybe it’s 80% or 85%.

And that is why I like to take partial profits. It increases my win rate.

Capisce?

Financial freedom is a journey

The Tales of a Technician series is brought to you by Tackle Trading.

Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.

# Sign up now for a 15-DAY FREE TRIAL #

Legal Disclaimer

Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.

All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.