The term “managing winners” refers to closing a trade prior to expiration and prior to max profit. We tend to close our winners when we reach 50% profit, or lower for certain strategies like
We have found that managing our winning trades prior to expiration can improve our probability of success. If we consistently enter trades with a probability of profit of 70%, but we close them when we reach a certain percentage of profit, we can increase our overall percentage of winning trades higher than 70%. This is because we’re taking risk off the table and we’re also decreasing the time that we’re in the trade.
Another reason we prefer to manage our winning trades is because of the risk/reward shift that occurs when we start to see profits. Let’s take an example of selling a call for $1.00. The maximum profit is $1.00, and the losses are undefined. Ten days go by and implied volatility contracts, which results in the option being worth $0.50. Since our maximum profit is the credit received for this trade, we have to reevaluate the risk/reward. In the current position, we can only make $0.50 more, while still holding all the risk of the position. Not to mention the fact that we can also lose the unrealized gains we’re seeing in the open position!
As we get closer and closer to maximum profit, our risk starts to outweigh the potential reward of holding the position. We’ve found that the target of managing our winning trades at 50% can be the sweet spot over the long run for most trades.
The main benefit of having a lower time in the trade is the fact that we can redeploy capital elsewhere in a new trade, and likely collect more. In the same example above, instead of waiting until expiration to hopefully make that extra $0.50, we could probably take the trade off and look for a different underlying to trade to collect even more than that. This aspect of managing winners can help improve P/L per day over the long run.
There are not many downsides to managing winners early. One thing to keep in mind, however, is commission costs. We always want to ensure we’re covering commissions and not managing too early. We wouldn’t close a trade for a $0.10 winner, as that would likely inhibit our ability to profit after commissions.