How to Take Profits and Cut Losses

A low-priced call option or put option can turn into a profit almost overnight.

But just as important, this volatility makes it doubly important to take profits when you have them.

When we say "take profits," we mean that you should close half of your position when the option hits its target price.

Then, if an option you are "riding" begins to lose value, immediately close the position and take the rest of your profits.

The easiest way to monitor this is with the underlying stock. If the stock reverses direction by 3%, close your position. You should also do this with options that have gains but have not hit their target prices.

Cutting Losses
As important as riding your winners and aggressively protecting your profits is to cut your losses when you have them, too.

In fact, cutting losses is more important, because when you buy options you will likely have more losers than winners.

The big hits that you get with your winners should offset your losses. But they will only do this if you keep your losses as low as possible.

For some reason many, if not most investors have a hard time taking losses. But this is what separates professionals from amateurs. It also separates amateurs from their money.

A losing option position will eventually expire worthless. To keep this from happening you must take the same kind of "mechanical" trading approach to losses as you do with winners.

The bottom line is this -- when you are involved in short-term trading, and options certainly fit that description, you must take a completely mechanical approach to your trading.

Take profits when you have them, and take your losses when you have them, too.

Any other approach is doomed to failure.