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What is a Maximum Entry Price (MEP) and how do I use one?

Apr 17, 2020, 08:21 AM

One of the most common reasons that options traders suffer losses is because they purchase options at too high of a price.  Sounds obvious, right? But it's more a matter of discipline.

When analyzing an option opportunity, an investor should calculate the maximum price that he or she is willing to pay for the option.  Frequently, options traders get caught in rising options prices and end up paying too much for the option because they didn’t want to lose out on the opportunity. 

To illustrate this concept, let’s take a look at the pre-commission past track record of one of our recommendation services.  The maximum entry price recommended and its correlated profit (loss) is listed in Table 1

In 
Table 2, we illustrate the effect that the investor would have had if he or she “chased” the recommendation and paid 1/8 of a point more than the maximum entry price.  Please note that the recommendations that are marked with an asterisk had half of the position closed out at a double (+100 percent) in order to lock in a profitable position.

MEP graph table

* Indicates that 1/2 the position was closed out for a 100% profit.

As this illustration shows, the investor who paid 1/8 of a point more received a profit of almost 120 percentage points less than the investor who followed our maximum entry price guidelines. 

Clearly, chasing the market and paying an extra 1/8 of a point drastically reduces your profit potential and increases your risk/reward ratio.  In addition, by paying more than the maximum entry price, you are encouraging market makers to ratchet up the price of the option.   Therefore, it is important to always follow your maximum entry price guidelines.

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