Important, Before we get started:
As with any trading strategy, I highly suggest using your platform to paper trade it before you use real money.
This allows you to not only fully understand the strategy, but to work out any kinks with knowing how your platform works, which buttons to push, and so forth.
Now on with the show…
A few days ago, I wrote a tutorial on the Bull Put Spread for you.
If you read that article, you already know that the bull put spread is a powerful tool that lets you collect credit upfront and potentially profit whether the stock goes up, stays flat or even dips a little.
In that article, I talked a little bit about setting a “trip wire” to protect you in the rare case that the trade starts working against you.
But like any good adventure, every trade needs a solid exit plan, so today I want to talk in more detail about how to strategically exit your bull put spread if it starts working against you.
Know When to Fold ‘Em
The beauty of the bull put spread is that you know exactly how much you can lose before entering the trade. It’s the difference between the strike prices you choose minus the credit you receive.
But unlike buying a single stock, exiting a spread can involve multiple decisions.
Here are a few general exit strategies to consider, keeping in mind these are just starting points, and you should always adjust your plan based on your specific goals and risk tolerance:
- Exit at Expiration: If the stock price stays above your higher strike price by expiration, you keep the full credit you earned and both options expire worthless.
This is the ideal scenario and, in fact, it is what happens most of the time when you’re doing the proper research before you place a trade. - Early Exit for a Profit: Let’s say the stock price shoots up after you enter the trade. This is a good thing, right? Absolutely! The spread that you (for example) collected 10¢ on might now be worth 2¢.
In order to eliminate the possibility that the stock crashes back down by expiration, you might choose to close both legs of the trade. Sure, you won’t keep the full 10¢, but you’ll keep most of it and eliminate any possibility of losing the trade. - Close the Trade if the Stock Dips Below Your Comfort Zone: Remember, even with a bullish outlook, the stock price can always move against you. It’s just the nature of the market.
This is why I discussed the idea of having a trip wire in my original article. A trip wire lets you set a level at which you’ll close the trade. You could, for example set the trip wire price 10 or 20 points above you upper strike price.
That way, if the stock price starts getting too close for comfor, you can exit the trade. Doing it this way could help you minimize potential losses or possibly even exit at breakeven.
No One-Size-Fits-All Exit
The best exit strategy depends on your individual goals and risk tolerance. Here are a few additional tips:
- Consider taking profits off the table if the trade moves in your favor quickly. There’s no shame in locking in some gains!
- Don’t be afraid to adjust your trip wire as the trade progresses. Let’s say you had a trip wire set to close out the trade at $1275 (above your higher strike price). But then the stock shoots up after you place your order, exceeding your initial bullish expectations.
You might think about raising your trip wire to a higher price point, say $1285. This gives the stock more room to breathe while still protecting you from a significant downturn. - Stay informed about the stock and the overall market. Breaking news or market shifts might influence your exit strategy.
Practice Makes Perfect
Before risking real money, experiment with different exit strategies using paper trading on your platform.
This lets you get comfortable with the mechanics and develop a plan that suits your trading style.
The Final Word
Exiting a trade strategically is just as important as entering it.
By having a plan in place before you ever enter the trade, you can manage your risk and potentially maximize your profits with the bull put spread.
So, buckle up, understand your exits, and get ready to put this powerful tool to work in your trading toolbox!
By the way, there are other, more advanced exit strategies out there.
But for now, this should give you a solid foundation for exiting your trades with confidence!
Trade well,
Jack Carter
