knowing when to get in and when to get out

Lately I’ve been spending a lot of time evaluating potential investments, both in the stock market and new businesses. As a part of this process, I’ve been struck with the importance of knowing when to get in, and when to get out. In my opinion it is critical to have a clear entry and exit strategy for any investment you choose to undertake, no matter how large or small.

For example, lets take an option trade… Heck, lets take my latest position on the Russell 2000. So the position is an Iron Condor and will expire in the month of March. The inside strike prices are 670 and 780, so it makes some sense that I would want to be out if the underlying gets to 670 or 780

For those that are not familiar with an Iron Condor, basically it is a complex option position consisting of 4 different options. For this particular Iron Condor the following options are used March 660 RUT Put, March 670 RUT Put, March 780 RUT Put and March 790 RUT Put. To setup Iron Condor I typically buy/sell two vertical spreads. In this case, the 660/670 Put spread was sold first, then the 780/790 Call spread. In the end you are long two options and short two options. When selling the condor, you are short the inside strikes and long the outside strikes.

If the position is held till expiration, you are only risking the difference in each vertical spreads strike price. In the RUT example, my risk is $10 (the difference between 660-670 or 780-790). The risk is not $20, because you can’t be wrong on both sides! If you have a good broker, you will only have margin held for your max risk ($1,000 per contract). Remember, options work in multiples of 100: 1 Contract = the right to buy or sell 100 shares

So if you want to be out no matter what when the position hits 670 or 780, then it stands to reason that you would want to get out at some defined time/price before you reach the get out now prices. To be honest, I don’t have a clear system defined for this yet. For me its more a feel thing on the position, suffice to say, if the position is moving quickly towards my get out now prices I get out! For this Russell position here is my criteria:

If the Russell trades at or above 770 on or before March 10th, I’ll get out.

If the Russell trades at or above 775 on or before Expiration, I’ll get out.

Depending on the market during the week of Expiration, I’ll evaluate closing the call spread. Due to the small credit taken in to open the position, it may not be viable to close the spread. This particular position will likely not be closed unless it is in danger; I plan to just let this expire worthless

If the Russell trades at or below 680 - I’m out. If the Russell can fall over 50 points in two weeks - I’ll run!

So now there is a defined exit strategy, but what was my entry criteria? In this particular trade, I was looking for a position that had a nice short term ROI while maintaining minimum risk. Given that there isn’t a lot of premium available in the markets lately, anything in the 5-10% for 3 weeks was good enough for me. If my money is going to be on the line much longer, the ROI will need to move much closer to the 10% range. For this Russell position, I defined minimum risk as at least a 90% change of success.

So there you have it, entry and exit criteria for a trade. Now the key is to simply follow the rules and let your emotions go by the wayside!

Later this week I’ll write about my thoughts on larger, longer term investments. Currently I’m evaluating the potential formation of a franchise business, so I’ll dive into what my thoughts are on this as well.