UPDATE 03/01/2016
A few months into the new year I realized that my trading strategy and goals for 2016 had to be changed. My SPX trading didn’t work and didn’t make money. In January I lost substantial money and in February I was going for a large loss too.
I was very close to wiping out my account. I realized that I had to stop trading SPX spreads and return back to my original options trading strategy which worked well before I switched to SPX – selling puts against dividend paying stocks (meaning using dividend stocks as underlying and not the index; I do not own the stocks against which I will be selling the puts).
Below is my updated 2015 review and new goals for 2016 reflecting my trading strategy [with comments added].
In my last post I reviewed my dividend investing of 2015 and set goals for 2016. Today, I would like to provide a similar report on my options trading.
I decided to learn trading options four years ago to create additional income which I could use to buy dividend stocks in my ROTH IRA account (increase savings and contributions) and possibly use that additional income to help our family budget, pay off the debt, travel, etc.
It was a bumpy road, but I thought I learned a lot during that period of time when I started trading in 2011. I learned a lot, but realized I still have to learn a lot. As soon as I thought I knew how to trade successfully and make a consistent income, Mr. Market showed me that I didn’t learn everything I needed to be successful.
If you follow my blog and my monthly investing and trading reports, you can see my trading journey and hopefully learn from it yourself.
I started trading in mid of 2011 with $2,000 account and before the end of the year I worked my small account up to almost $8,000. I was proud of my achievement and I felt as a great trader ever. I quadrupled my account in a few months! What a great trader I was! And what power options trading had to boost my portfolio almost thru the roof.
Having no plan and basically not knowing what I was doing I continued trading. And I traded my account back down to $2,000. At some point my portfolio value dropped below $2,000 and I even lost my margin from the broker. By mid of 2012 I was broke again. For the next 6 months I stopped trading and investing, thinking what to do next.
In many books and on the interned I read that a trader should learn from his mistakes and stop doing them again. I was clueless. I didn’t even know what my mistakes were. I was not able to identify them not even learn from them and find out how to avoid them.
Before the end of 2012 I started saving some cash and started trading naked puts [against underlying stocks] as these seemed worked well for me. And yes, they worked great. Soon I added naked calls to my arsenal of trading tools. [That showed to be a great mistake!] I was trading short strangles selling OTM (out-of-the-money) naked puts and naked calls against low priced stocks such as Taser (TASR) – (my favorite one).
Soon my account skyrocketed to $28,000 equity value and $21,000 net-liq (net liquidation) value. Can you believe it? I worked my account from $2,000 to $21,000 net-liq and $28,000 cash value!
Then the best trade of my live came. I could take a trade where I could make $14,000 in a single trade!
You can guess what the result was, right?
I lost $14,000 in a few attempts of trying to save the “greatest trade of my life ever”. I lost money and every trade I took to reverse the losing streak ended as a disaster. This journey is best visible on the following chart:
Dreadful, right? [Well, it was dreadful and no wonder when I deviated grossly from a trading strategy which worked well before and became greedy!)]
· My 2015 goals review
Because I was still clueless, I wasn’t able to set a meaningful goal for 2015. All I was able to write down was:
My goal for 2015 would therefore be to focus on money management and wealth creation and preservation.
I advise my readers to trade only 30% of available cash and keep the rest in reserves for trade repairs. I was constantly breaking this rule. This year my goal will be to strictly follow this rule.
Well, yea. Great goal! And what about strategy? What is that money management I was talking about and wanted to follow? Trade only 30% of available cash? Not only was I breaking that rule heavily I had no clue how to apply that rule at all! I had no clue and no plan on how to trade, limit losses, and be always on the right side of the market.
The result?
At first the account held the level, but then a free fall started and I was losing money even more and faster than in 2014. And I still wasn’t able to do anything about it!
At some point it looked like that no matter what trade I took, I was always on the wrong side of the market.
Any time I opened a bullish trade, the market fell. When I opened a bearish trade, the market went up. I was like a small ship in the middle of the ocean being tossed around by a storm and having no sails and steering wheel available to navigate the ship. The market literally did whatever it wanted with me. At some point I was so depressed that I wanted to stop trading at all. I was hopeless, clueless, and mentally down. I started to believe that trading options is a sucker’s game and all those winning traders out there are liars. You cannot win!
But, no matter how depressive and bad my trading was, it had some benefits to me. Here is what it helped me to do:
1) I was able to define my trading strategy [That was a lie I was telling to myself.]
This was a good step towards successful trading. [No, it wasn’t.] I finally defined my trading strategy. I now know what I want to trade, when to trade, and how to trade it. That’s a good start. I now understand my trades and what to expect from them and be finally on the right side of the market. [Yes, once I realized that my strategy was totally wrong I updated it along with this update.]
At the beginning, I was trading options against regular stocks and dividend stocks as well as $SPX (S&P 500 index). But I had to deal with earnings, turbulences in stock volatility, and mostly assignments. [Later I learned that this was just an excuse and a lie to myself for actually being greedy and deviating from my original plan.] In a few occasions I lost money because one leg of my spread got assigned (usually the leg which was against me) so I couldn’t give the stock enough time to grow back above the endangered strike, for example the recent stock I got assigned was a spread against AGU. The result was $1,500 dollars loss due to forced liquidation of unwanted position (I also received a margin call for that trade). [But this was my original plan from day one! This was the strategy which turned my account from $2,000 into $21,000! I wanted to get assigned! But as soon as I overtraded my account and tried to do whatever it took to avoid the assignment, the troubles occurred and I started losing again.]
I stopped trading spreads against stocks or any American style options. From that time on I only trade spreads against $SPX which cannot be assigned early (European style option). It also has a tax benefit as trading options against SPX is treated under IRS 1256 Contract with a 60/40 rule which is better for short term trades, where 40% of all trades are treated as short term capital gain and 60% as long term capital gain. You won’t get this advantage with stock options or non-index options. If you hold any other option contract less than 35 days it is automatically treated as short term capital gain and you pay heavy taxes on your gains. With SPX trades you do that only on 40% of all your trades and the wash rule doesn’t apply with SPX either. [This actually showed up as the biggest mistake I made. It was a wrong strategy and it didn’t work no matter how much I tried to excuse it, defend it, modify it, or re-learn it.]
2) I was able to learn from my mistakes [Another lie!]
Although I defined a strategy, I still continued losing money. I was still desperate and depressed. I couldn’t understand it. I had a great strategy, I was able to open a trade so far away from the market that I would never be affected by the market’s fluctuations and never be on the wrong side. I felt invincible.
Yet, there was a catch. I thought that if the market falls hard, there would be a fast recovery too, because to fall this hard and deep it would be a flash crash or similar thing and from such oversold market it must recover quickly.
It doesn’t have to. It can be down long enough to break your neck. And I learned this lesson in August 2015 when the market fell hard and I ended up with 5 losing trades which were more than I could afford to lose. By creating a weekly ladder I exposed myself to bigger loss than I could handle. Panicking at the scale of potential losses I tried to save the trades, roll them, reverse them.
It worked with only 1 trade out of the 5 endangered ones. See the chart below:
This was a lesson I was finally able to learn from.
[Everything you just read in the paragraphs above is a bullshit. Lie, lie, lie, and a lie. I was deceiving myself to make myself look like a great trader.]
3) Still refusing to take a small loss [This didn’t work either!]
In trading there goes a saying: “if you are not willing to take a small loss now, you will be forced to take a mother of all losses later.” I still believed that if a trade goes against me I can manage the trade by rolling it away in time, or roll it away in time and higher, or even convert a bullish trade into a bearish trade.
This strategy worked with some trades, but not with all of them. At some point I had trades where I could take a small loss of $50 or $100 dollars, instead, I decided to wait hoping that the market will go higher and expire worthless and I make thousands of dollars I collected in premiums.
Yes, I collected a lot of credit, but I also increased risk. An original trade was risking $900 dollars, the final version of that trade after all the conversions, rolls, and adjustments, risked $4,000 dollars. What a foolish idiot I was!
As you can see, this cost me a lot when I reached a point when I was no longer able to convert a heavily losing trade. Of course, it could cost me more, as you can see in the table above, I risked $4,465 for a trade which ended up with $2,965 loss at the end. So better than $4,465 loss. But at one point all I saw was the credit of $1,500 dollars I collected and hoped to keep it. I had to give up more than that.
I realized that salvaging a trade is a dead end and decided to stop doing it anymore.
[This is good one (BS). Yes, I stopped taking a big loss, but I continued taking many small losses wiping my account further down. Don’t believe anything I just said in the paragraph above. It was that I again thought I was a great trader and finally got the edge. All I got was depression.]
I spoke with some other traders over Twitter, Facebook, or Stocktwits and one trader told me that he never rolls spreads. He either lets it die or close it early for a small loss. But fixing a trade is a nonsense.
4) My capital gains/losses in 2015
From my trading operations only (overhead and other gains or expenses excluded) I lost -$7,895.08 (adjusted for 2015 year only). That represents 67% of my portfolio value. However, due to some trades carried over from 2014, my total net-liq loss represented -$9,166.86 or 78.31% portfolio value loss.
Here is a table of my monthly records. Some trades prior to adjustment may not be recorded also some carry-over trades may be missing as I started creating this chart later and some trades I back-added. My 2016 year should be already accurate as I developed a method of effectively recording those trades without mistakenly omitting some or misreporting others.
(Click here to enlarge)
Note the discrepancy between total loss in the table and reported loss from my account gain-keeper software. It could be because of back dating some records into the table and I might have missed some trades.
· My 2016 goals
Here is my new [(old)] trading strategy for trading during 2016.
Based on this new strategy, I am also updating my goals (see below).
1) I stopped trading the “ladder”.
I no longer trade a ladder. It cumulates trades and if the market gets into longer term trouble I end up with several trades in potential danger and bigger losses than if I only trade one trade at a time.
I will only trade one trade at a time based on Bollinger bands (BB) and 50% regression channel. If the prices of the market go down to the lower BB band or regression channel I will start adding put spreads upon trend reversal. If the market goes to the upper BB band or regression channel, I will start adding call spreads upon trend reversal.
2) I will trade 45 > DTE spreads as well as < 4 DTE spreads
I will be trading one contract at a time using longer term options with 45 > DTE (day to expiration) as well as one trade with < 4 DTE. With the loss limiting protection set forth below I feel comfortable to take such short trade.
3) Portfolio risk limit in 2016
I will trade spreads and open as many contracts as possible to only risk 10% of the entire portfolio at a time. Because I lost substantial money last year and current portfolio value wouldn’t allow me to trade basically anything, I will trade:
1) One trade/contract with 45 > DTE with max risk $1,000 in 2016 and
2) Two trades/contracts with < 4 DTE with max risk another $1,000 in 2016.
I will be trading this structure as long as the portfolio value grows enough to allow me to increase the number of contracts (which I do not expect this year at all). However, this can be by-passed when trading Iron Condors for example. I will maximize the margin available with Condors. If for example the market falls from highs and I open a bear call spread and the market falls down to a support and then reverses back up, I can add a bull put spread creating an Iron Condor which will not increase the risk of the portfolio and margin. With Condor, you can never lose on both side only one side.
4) Defending my trades 2016
Although, the maximum trade risk set up above is $1,000 per trade I will never let that risk to be converted in a full loss anymore. I will not roll any trade and I will use delta of the short strike to liquidate the trade if it goes against me early.
This was my biggest hard thing to do. I always feared that once I close the trade the market reverses and will go up (or down if call spread is the touched side) and I will take unnecessary loss. Well, look at it this way, we can always go back into that trade should that happen, right?
The maximum loss occurs only if the price of underlying stock, in this case SPX index goes thru both of the strikes at expiration. Even if this happens a few days before expiration, you will not see a full loss. For example I had a trade with total risk $1,500 per trade which went completely bust. Even 7 days prior to expiration it was trading for $1,470. So the full loss really happens at expiration. Anything prior to that there will be some value in the option spread (usually a time value).
In 2016 I will use delta 30 as my limit. If the price reaches any short option strike of the spread I will close that trade (at some occasions I may choose to deviate and set a different delta, for example I had a trade where I was so close to the market that using delta 30 would mean closing that trade almost right away after opening it, so I decided to use delta 40. The potential loss at that delta for that trade was only $40 dollars, so such adjustment was justified even by potential loss amount.)
There will be no questions, hesitations, or excuses to this rule. Even if the market reverses and continues back up higher after I was stopped out (or I can think that something like that may happen after I close the trade), I will still close that trade. I can put the trade back up if the market reverses and eliminate or lower the loss by a new trade. Should the market continue lower, by doing that I saved the trade, and I can always put a new trade back on once the trend reverses. A new trade would also help eliminating or minimizing the loss.
This was my biggest dilemma and I wasn’t able to handle this, ever. I always had a fear of losing the gain potential if I closed a potentially dangerous trade. What if it turns up and goes up without me. This weird fear of lost opportunity forced me to try to save a trade instead of closing it, taking the loss and move on.
The short term trades will be closed upon a touch and not delta value. If the market touches the short strike, I will close 1/2 of the trade and let the other half run until expiration if the price “dances at floor” (meaning stays bouncing at the strike price, or be ATM – at-the-money). Should the price continue rapidly down so it would endanger the protective option strike, the other half will be closed immediately too. If I have only one contract instead of two, then the entire contract will be closed upon a touch.
5) My capital gain goal for 2016
I have two expectations and goals for 2016 as far as profit expectations.
For the < 4 DTE trades my goal is to achieve a consistent 6% – 8% gain per week. This is not a gain per portfolio, but per trade! Per portfolio it would be approx. 1.2% gain per week.
If we open a spread with $500 dollar max. risk/spread width and collect $30 dollars premium, our total risk will be $470 dollars and our potential gain 6.38% ( 30/470 = 6.38%) if the trade expires that week.
For the long term trades I will use 50% credit capturing strategy (meaning that once the spread loses value enough to buy it back and keep at least 50% of the collected credit, I will close the trade). With trades, where 50% collected credit would be less than $30, I will place a buy back order so I keep 50% or $30 dollars minimum credit.
With this strategy, the average holding time of the open trade seems to be 23 days (but December 2015 it was only 6 days). From the last year records it appears that I can achieve a gain of 3% per month (or 23 days) average gains. So in 2016 my goal will be to achieve a consistent 3% gain per month on the longer period trades.
[My goal for 2016 is to rebuild my trading account back to the level prior to losses and end up with $21,000 Net-Liq value. I know, it is a very bold plan, but I did it once, I will do it again.]
[My second goal for 2016 is achieve min. $1,000 income monthly from options by the end of the year.]
6) Posting my trades in 2016
I will continue posting my trades in my closed Facebook Group for others to see how these trades are doing and how I am following this plan. Eventually, you can learn from those trades too! The group is closed and limited to 50 members only. The new members will be accepted only if any old members leave the group.
I believe, that this is a solid plan with a solid strategy on placing and protecting the trades. Losses or losing trades will happen, but with the strategy laid out above we can minimize them and reverse the money losing streak. What do you think? If you are an experienced trader, let me know your opinion
We all want to hear your opinion on the article above:
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