Chris calls out the "magic words' below:
"... the long-term money is made and lost through managing risk. Until a
trader learns how to effectively manage risk, their trading will
be marked with painful equity draw downs..."
How's this for a new year's/decade'
what techniques, rules, principles or whatever do you follow to stay out of
trouble?
For me it's all about position size and "de-localizing" risk.
with my style, I know I will inevitably grow a trade (i.e. max dollars at
risk) over the life-cycle of the position. so that means starting almost
infinitesimally small - I start each expiration cycle with a one-lot limited
risk spread (usually a long otm vertical). I watch the max risk throughout
the trade and try to keep things ideally maxed around 1%-2% of total capital
(though I will undoubtedly blast through this a couple times a year and have
as much as 20%-25% of total capital at risk on my net positions). The point
about position sizing for me is that no matter what happens - even in the
worst case - I can live to trade again. If I am vigilant about position
size, everything else falls into place: no need to "cut losses short" or
have any such artificial line in the sand where I admit I'm wrong; I ASSUME
I'm wrong from the get go by staking and maintaining the position size.
The other real risk management practice I follow is to constantly shift
where my max risk is a trade or de-localizing the max loss point. I do that
by shoving the risk away from atm strike - however I can make that happen -
while still giving myself a chance to somehow make money on the trade.
As Chris notes, there is no all-weather vehicle (strategy) for trading so as
long as I follow the "nudge the risk away while keeping max risk acceptable"
practice, I've taken care of business.
-----Original Message-----
From: OptionClub@yahoogro
Behalf Of TheOptionClub
Sent: Sunday, January 03, 2010 1:13 PM
To: OptionClub@yahoogro
Subject: [TheOptionClub.
There is a dynamic that has existed among options trading circles for as
long as I have been trading. That dynamic is a perpetual quest for the
"all weather" options strategy. In other words, there seems to be this
irresistible pull toward the notion that we can trade one strategy and
profit in all markets.
All options traders know that it is possible to make money in up
markets, down markets, flat markets, volatile markets, or any other type
of market you can imagine. After you've been around a while you also
come to realize that it is possible to make money with any given options
strategy if it is properly applied in appropriate market conditions.
Covered calls and naked short puts are no different. They work really
well under the right conditions. The trouble is, and this is true of
all options strategies, is that the market will not consistently provide
the right conditions and we won't know whether conditions were suitable
until after the trade is closed. If we could know that before opening
the trade, we would be infallible..
Here is where most of us, including the "professionals,
figure that we can "build a better mouse trap" or develop a bullet
proof, i.e., market proof, strategy that will deliver profits all of the
time. Of course, it's a fool's errand to go down this path but it is
surprising to see how many very smart people go running off on this
errand.
Covered call strategies can be very effective. We get into trouble with
them because we rationalize our way out of applying sound risk
management. We fail to control losses. All stocks go down at some
point, but we often simply assume that if we hold on to them they will
again move higher. Often, the do. Sometimes they do not. You must
have a plan for exiting trades that are not working.
Another area where we get in trouble is with adjustments. The covered
call trade is opened and then the market begins trading lower. The
short call loses most of its value so we roll lower to bring in more
premium, but in the process we also take on the obligation of selling
the stock at a price below our purchase price. The market rallies and
we're called out of the position at a loss.
Personally, I like covered calls and naked puts. I use them as part of
a long-term investment strategy. It's a nice way to effectively "buy
low and sell high," while generating income. Everyone one of those
trades as a stop, though. Once the market stops behaving in the way I
had anticipated when the trade was opened I want to get out even if that
means taking a small loss. It is far better to take a small loss than
to hold onto a trade that ties up capital for months or years.
Whether you trade covered calls or any other variety of options
strategy, the long-term money is made and lost through managing risk.
Until a trader learns how to effectively manage risk, their trading will
be marked with painful equity draw downs.
Christopher Smith
TheOptionClub.
------------
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