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Adjustment Woes

Hi Mark have been trading iron condors for awhile but always get burnt when time comes to adjust

Hello Kaye,

Adjustments prevent getting burned. So let me make a few observations:

    –If you wait too long and have already lost too much money by the time that you decide to adjust the position, then all the adjustment can do is help you not lose too much additional money. It is unlikely to produce a happy overall outcome. I understand that we don’t like the idea of adjusting too early because the market may reverse direction. However, there is a good compromise that depends on your comfort zone. I hope that you can discover that compromise. Consider adjusting in stages.

    –If it is the adjustment trade itself that produces the poor results, then there are alternate adjustment strategies. Rolling is not the only choice. And if you do roll, I urge you not to increase position size by more than a modest amount. It is okay to roll from 10 spreads to 12, but increasing size to 20-lots is just asking for trouble because some trades get rolled multiple times and positions can become var too large.

    –It is easy to get burned when you sell extra put spreads (on a market rally) or sell extra call spreads (on a decline). It the scheme of things, it is very important to prevent risk from escalating. Translation: If you must sell new put spreads on a rally, please cover the already existing put spreads — just in case we see a market just like the past week. The rising market reversed direction suddenly and made a bit move lower. There is not enough residual profit potential in that original put spread to risk leaving it uncovered. That is the reason it pays to cover when selling a newer spread.

    –If you are trading with a market-neutral bias, then the adjustment should return your position nearer to delta neutral than it was before the adjustment. In other words, when you do not have a market bias, try to avoid using the adjustment to recover lost money. Don’t suddenly decide to trade an iron condor that tries to take advantage of the current market trend. In general, iron condors are not suitable for traders with a market bias (unless it is a small bias).

    –If none of those situations apply, if you provide an example or two that describes what went wrong, I will try to provide some insight on your trade. Remember that every losing trade does not mean that the trader made any mistakes.

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Trader Mindset: The Cost of an Adjustment

The setup

A trader buys (or sells if you prefer that terminology) an iron condor, collecting a cash credit of $250. The market moves against the position and the trader decides that he/she is no longer satisfied with the trade. Something must be done. Keeping this discussion simple, let’s say there are two choices.

    a) Close the trade, paying $400 per iron condor. Net loss $150 per
    b) Adjust the trade

  • Define adjustment: Change the position to reduce risk
  • Necessary condition: The new position is ‘good.’ The trader wants to own it
  • The adjustment is NOT made to avoid taking a loss. It is made to reduce risk

Adjustment cost

When the adjustment requires a cash outlay of $50 to perhaps $200, most traders are willing to protect their remaining assets by making the risk-reducing adjustment.

However, if the adjustment requires paying $300 – $350, there is resistance to the idea.

One of the Gold Members at Options for Rookies Premium made the following comment regarding such an adjustment:

I’m not sure I could spend more on my adjustment than I received; that might be tough.

A significant quantity of traders are predisposed to some ideas (mindsets or mental blocks) because they seem so obvious. The logic behind their reasoning appears to be so impeccable that it ‘s essentially inconceivable that the ‘obvious’ belief can be erroneous.

The quote above represents one such example.

The truth

Without an adjustment, the risk of losing too much money has become unacceptable for this trader.

These are the facts, although not everyone is willing to accept them:

  • The iron condor is no longer priced at $250. The current market value is $400
  • Making trade decisions based on the $250 price cannot be efficient because it is not a realistic price

Additional facts, based on the trader mindset:

  • Trader is willing to spend $400 to exit the trade
  • Trader is unwilling to spend $300 to make the trade, even though the new position would be:
  • Safer to own, with risk of additional losses significantly reduced
  • Less dangerous to own because amount that can be lost has also been reduced
  • Good enough to own. That means the trader would be comfortable establishing it as a brand new trade

Bottom Line

Trader is willing to exit, spending $400 because taking losses is sometimes necessary.

Trader prefers not to spend $300 to build a better position that offers a good return in exchange for the risk involved.

Why? Because spending $300 results in a owning a position when the bookkeeping says it can never be profitable (based on the original entry price). The excellent chance of earning money from today into the future is ignored.

When thinking about the cost of adjusting, that decision should be made between the current choices, and has nothing to do with the original price at which the trade was entered. The choice is: exit and pay today’s price; or adjust and pay today’s price. Make the better choice by making the better trade.

That’s the path to success.

995

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Position Adjustments are Essential

Mark,

Let us take two traders (A and B) trading ~90 day index ICs (or credit spreads) with a preference to exit the market 20-30 days before expiration. These traders make exactly the same trades and have the same comfort level and same trading philosophy, except when it comes to making an adjustment:

Trader A always uses the same adjustment method: close all positions at the same time or close in stages.

Trader B sometimes closes his positions and sometimes he uses other adjustment methods depending on his analysis in each situation.

In the long run, and under all kinds of different market conditions, I think trader B will achieve better results (higher annualised returns). The question is how much better?

Obviously, I am not looking for precise figures here, just some kind of rough data/information/comments that could help me decide for myself, if it is worth it (for me) to spend the necessary time to “master” one or more of the available adjustment methods.

Thank you,
Dimitrios

Good question. However, the problem is not with ‘learning’ something new. Nor does it have anything to do with your ‘mastering’ anything special. We must look at ‘adjusting’ differently.

As to the final question, I believe that knowing how to ‘fix’ a good, but risky, position is a powerful earnings source. It remains important to exit trades that are not worth salvaging.

An Alternative Perspective

I often refer to ‘risk management’ as if it were separated from ‘regular’ trading. We enter into a trade as a first step, then when necessary, the original position is changed or adjusted.

Consider this perspective:

You own a blank portfolio – with no current positions. No risk. No possible reward.

Next, assume adjustment to that portfolio is made. Deciding that zero risk/zero reward is not what you want to own right now, you buy an iron condor. That trade adjusted (changed) the portfolio. You made a voluntary trade and added an acceptable level of both risk and reward potential.

    I’ve described adjustments as having one purpose: risk reduction. In this scenario, the risk of having no earnings potential was reduced.

Two weeks later, you make another portfolio adjustment by opening a new position. Perhaps it’s a butterfly spread this time. This is another voluntary portfolio adjustment.

Most traders think of an adjustment as involuntary. In other words, they prefer not to make that trade. That is not a good mindset, and only applies when the trader has waited far too long and now has no alternatives, other than exiting the trade. I suggest looking at an adjustment (as it is usually defined) as a voluntary trade. You want to make this trade because it reduces risk and transforms the current position into another that you want to own.

From this perspective, making a position adjustment is NO DIFFERENT from opening a new trade.

When the adjustment is complete, you own a position that you want to own. Isn’t that exactly how you feel when making a new trade?

Thus, you do not have to ‘master’ anything. You only have to know when an adjustment is needed and recognize when a new trade is going to give you an improved position. I believe those are reasonable goals for any trader. Think of ‘adjusting’ a position as working on a partially painted canvas, whereas adjusting a portfolio by adding a new trade is working on a blank canvas.

Just as you make an effort to learn more details about trading your chosen strategies, so too will you learn a few possibilities for ‘fixing’ a troubled trade. There’s no need to be any more of an expert in making these trades than there is in making the original iron condor trade. It may be more fun to open a clean trade, but you will discover that the money is made by improving your positions. I do not believe there is any special edge in initiating iron condors. The edge has to come from good decision-making, and trade execution skills.

As you understand more about options, you gain a better intuitive feeling (but do NOT ignore the risk graphs or the greeks) for which trade type provides needed (even if not the absolute best) risk-reducing, profit-enhancing protection. It is worth the effort.

If you believe than an adjustment is another profit-making opportunity and not a nuisance that locks in a loss, then the whole idea of adjusting becomes so much less frightening and burdensome. It’s just an ordinary trade using options = to do what options do best: reduce risk and (if you elect not to exit) increase the chances of owning a winning trade(defined as making money from the time the adjustment is made).

990
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Managing Iron Condors: The Worst Adjustment

My oft-stated belief is that it is almost impossible to become a successful options trader without becoming a skilled risk manager.

When it comes time to decide how to reduce the risk of holding a position, there are many choices. The alternatives are too numerous to describe, however, the basic choices are

  • Do nothing. This is not risk management. This is wishful thinking
  • Adjust the trade to reduce risk
  • Cut position size by exiting all or part of the position

The best decision

making a decision

I believe that adjusting the trade represents the best choice, with the following stipulation: Once the position has been adjusted, the trader likes what he/she owns; believes it is likely to earn profits going forward; is no longer too risky to own, and satisfies the psychological needs of the trader. That last phrase simply means that it is comfortable to own the position and is not being held for the sole purpose of recovering a loss.

When it comes to adjusting, there are always going to be alternative trades from which to choose. Today I want to discuss one specific type of trade. I know that many traders like to adopt the example that I’ve chosen to highlight Despite that fact, I believe it is the worst possible choice.

The worst choice

    Assumptions: We opened an iron condor position and the market has declined to a point where the put spread has become worrisome. For this discussion, it doesn’t matter whether the put spread is 5% OTM (far too early to be concerned in my opinion); 3% OTM or ATM. The point is that the underlying asset has moved to a point at which the specific trader who made the trade is uncomfortable holding the position as is, and wants to make an adjustment.

    Let’s assume that the position is long 300 delta.

There is one adjustment method that I avoid discussing – just to minimize the possibility that it would occur to any reader to experiment with this trade idea. Keep in mind that the ONLY reason for making an adjustment is to reduce risk – as long as the new position is worth holding. We do not reduce risk to crate a position that we do not WANT to own.

So what is this adjustment that I think is so terrible?

It’s the sale of call spreads to add some negative delta to the portfolio. (Or put spreads when the market has been rising and the portfolio is delta short.) Selling call spreads accomplishes some noble goals: It move the position nearer to delta neutral. When trading with no market bias, that’s a good thing. It also adds more cash to the trader’s account, increasing the potential profit, and we all like to earn more money.

One other benefit of adopting this strategy is that it seems to work so often. Much of the time the market continues to drift lower, making this adjustment profitable. Of course the put situation has gotten worse. That’s not a real problem when the trader is on top of the situation and is taking steps to manage risk. However, all too often the steps taken include the sale of even more call spreads. Once again, taking in cash and reducing the immediate delta risk.

I must admit that this strategy works very nicely when it works. Sometimes the cash from the call sales is sufficient to cover all losses from the put side of the iron condor and the trader may eventually earn a profit. Sometimes the market stops moving lower and the trader not only earns the original cash collected when initiating the iron condor trade, but is rewarded with extra profits derived from the call sale.

That’s the good news.

However, the primary (if not the only) purpose of making the adjustment is to reduce risk. This method does reduce delta risk (temporarily), but it adds negative gamma and a significant downside risk. when selling those additional call spreads, too often the trader sells a cheap spread (so it is reasonably far OTM). That does notr add very much cash to the kitty, and adds major risk of loss – if the market turns – for very little cash. If the trader makes the better (but still terrible) choice of selling calls spreads that generate a ‘decent’ amount of cash, then there is at last a reward worth earning for taking the risk.

But that’s the point. Adjustments are risk-reducing trades (or should be). The idea that lessening delta risk makes for a good adjustment is not the way a successful or experienced executes adjustments. I understand how powerfully profitable this plan looks. But it only takes one large and sudden market reversal to blow up an account with far too much loss exposure.

But there are two potential disasters that await. I believe that the sole purpose of adjusting a position is to reduce risk – not to seek extra profits. [I am not against earning extra profits, but the primary purpose is to make the current position safer and worthwhile to hold.]
When extra call spreads are sold,nothing is done to reduce the risk presented by those put spreads.

Problem number One: If the market continues lower, the loss form the puts is going to increase rapidly. The sale of call spreads is not going to generate enough cash to offset these losses. Thus, the primary purpose of making an adjustment – to keep risk of loss at a reasonable level. Once those puts move into the money, it becomes far more difficult to manage the entire position. Not only are the put spreads problematic, but the continuing sale of call spreads can result in blowing up the trading account if there is a sudden market reversal.

Problem number Two: When keeping risk in line is not the MAJOR (it should be the only) consideration when making an adjustment, far too often risk builds and goes unnoticed. The type of trader who employes this ‘sell more calls’ method of risk management seldom bothers to buy back those now, far OTM call spreads. It’s bad enough to create downside risk – where none existed before – but to not buy back the cheap options creates a scenario in which a traders account can disappear overnight.

This is unacceptable risk (Obviously an pinion and not a statement of fact). But it is a tempting methodology. It works most of the time. It can lead to extra profits. It’s easy to fall in love with this strategy. But good luck does not hood forever. Markets do get volatile again, and despite promises that the trader makes to him/herself to act in plenty of time – f necessary – the personality that sells those extra spreads to bring in more cash – is not the right personality type to be able to rush in to cover those call spreads when the market turns. In fact he sale of additional put spread would probably be the trade of choice.

This is a disaster waiting to happen. I feel it is the worst possible adjustment chocei and would go as far as to say that if you are considering this play – selling more calls without buying back the original call position – it’s better to exit and take the loss, rather than to build risk to unacceptable levels.

974
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Iron Condors: Introduction to Risk Management 02

Today’s video continues the introduction to risk management, especially as it is applies to trading iron condors. As you have no doubt noticed by now, I believe in detailed discussions.

My primary job is to be certain that everyone who wants to come along on this ride learns at least enough about trading and risk management to give that person a good chance to succeed. The bottom line remains unchanged. Most people who try to earn good money from trading fail. Trading is not as simple of a task as many believe it is.

It requires no skill to buy index funds and put them away forever (buy and hold) with the hope that the markets will cooperate and provide you with enough money to meet your future needs. It’s another to actively make trade decisions, including how to manage risk and minimize losses. This is not a simple task.

That’s the reason I place so much emphasis on the details. If you make the attempt to earn money as a trader, I believe that the better you understand what you are doing and the decisions that must be made – then the better your chances of making good trade decisions. It is obviously my belief that good decisions are necessary for success.

These videos move slowly, but my goal is not to complete a course in a few days and send you out to trade. It’s to do the best I can to give you a better chance to make it as a trader. If you understand the basics, then you will be prepared to tackle more advanced trading techniques and theories.

These videos are targeted to traders who believe they still have much to learn. That should include almost everyone. Yet, these are definitely at the elementary level. If that sounds right to you, then welcome aboard.

Introduction to risk management. Part 2

13 minutes


FreeVideoCoding.com

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Adjusting a position: Using the underlying II

Three comments/questions from Joe raise a valuable point for discussion:

Hi Mark,

I have been trading option spreads on RUT and have now begun looking into trading options on the ES (S&P emini) or NQ (Nasdaq emini). I would like to know what you think are some of the pros and cons and your overall opinion?  Comment oneClick to read reply.

 

How I see it so far is that with the eminis I would get better leverage and be able to hedge with the ES emini contract.

What I like most about the S&P emini is the possibility of being able to adjust with the underlying, even outside of regular market hours. I imagine this could provide a great benefit for hedging ICs, if anyone trades this way i would appreciate any imput. Comment two. Click to read reply.

 

is it not viable to just short or long the SP when the short strike is hit? Thus enabling the trader to be fully covered at expiration? Comment three.

Joe

***

In my experience, that is a commonly used, but ineffective, adjustment method that leads to much unhappiness.  Just last week I posted a lengthy discussion of why I believe it's a poor idea to adjust a negative gamma position with stock or futures

 

The exception

1) Joe, when the markets are closed, it's fine to use whatever you can to make an adjustment. There is no sense getting pummelled and just sitting patiently, waiting for the market to open. If you are a true believer that getting that delta risk removed as soon as possible is important, then it is good to have the opportunity to trade futures before the market opens in the morning.  If you can set it up with your broker, you may be able to trade futures overseas.

Once the market opens, it is my belief that – over the long run – you will achieve better results by unloading those futures and substituting appropriate options to make the adjustment.  And that includes the possibility of accepting the fact that you have a loss, and closing the entire trade.  As I said, my opinion.  If you are comfortable with owning stock or futures, then do not let my opinion influence you.  I can only state that I had poor results by adjusting with underlying shares.

 

Fully covered

2) This is the part of your question that is most important, and troublesome:  "enabling the trader to be fully covered at expiration."

If you buy the correct number of futures when a call moves into the money, yes – you will be fully covered at expiration.  Yes, you can deliver those futures when assisgned an exercise notice on your short calls.  And if the market continues to rally, it's a bonanza for you:

a) Your long calls may also move into the money

b) Your long futures/short calls are now 1:1 and this is a long, bullish position all by itself.  It doesn't even consider the extra calls you own.

Why it is 1:1?  Because you said that it allows the trader to be fully covered. Fully covered means 100 shares per call option, or the appropriate number of eminis per contract. 'Fully covered' does not mean 'delta neutral.'

If you were to buy only enough futures to be delta neutral, then you would not be fully covered.  Far from it.  You would cover only a portion of those short options, with the quantity depending on how far ITM your shorts moved (and its delta).  Don't ignore your long calls. They now have significant delta, requiring the purchase of fewer futures contracts (this assume you are seeking delta neutral and not being fully covered).

3) i suspect that being 'fully covered' is not the trade you would make in the real world.  That's such a hugely bullish play, that to me it is an attempt to go long and 'get back' the money lost on the gap opening.  But more than that, it leaves you exposed to an even larger loss should the stock go back to where it was trading prior to the gap.

4) The real problem with your plan is that it depends on the underlying continuing to move higher.  Why would you expect that to happen?  Just look at yesterday's example.  AAPL opened much lower and then rallied.  If you had sold 100 shares for each short put in your portfolio, you would have been clobbered on the rally – in addition to the big loss suffered on the original decline.

This is not a trading technique that you should want to adopt on a regular basis.  However, my usual qualifier applies:  If it suits you, if you understand the risk and reward potential, it you would be comfortable holding the position knowing that a market reversal is going to be very expensive – then this method is suitable for you.  As I said, it's a very popular method for delta adjustment.  But it completely ignores gamma – and that's the greek that caused the loss in the first place..

878

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Adjusting a position: Using the underlying

Mark,

I have maybe a naive question. Is it possible to make adjustments to already open positions, that might be 'in danger' of losing money, using stocks (or indexes if applicable) instead of options?

From "The Rookie's Guide to Options" I know that it is possible to create 'synthetic' positions and sometimes it makes sense to trade them.

One example: A put spread where short side is ATM (or very little out), probably too late, but at this point the put should be bought back.  Instead one might short the stock and buy a call to protect from a big upside move.

Could you please explain what are pros and cons of such adjustments.

Thanks,
Robert

***

Good question.  Let me reply by making some points

1) Yes, you can use stocks or futures or any underlying asset for adjustments.  Remember that these adjustments provide only delta (positive or negative), and do not reduce gamma, vega, or theta risk

2) Any trade that reduces risk and leaves the trader feeling comfortable with the adjusted position – is a satisfactory adjustment.  That is one of the goals of risk management.

3) Buying or selling shares is a very appealing adjustment method, but in my opinion, it's a poor idea.  Many traders use stock as their adjustment of choice, believing that 'fixing' delta is all that is needed to make a satisfactory adjustment.

Think about why the position is in trouble in the first place.  The ATM put contributes significant negative gamma to the position.  Buying, or in your example, selling, stock does nothing to reduce that gamma risk.  It does take the immediate delta risk out of play.  And that's good enough for some traders.

The advantage of using stock is that the trader doesn't have to pay for any gamma and does not have to sacrifice any theta (time decay).  After all, thinks the trader, I'm in this position to collect theta, so why would I want to make a trade that cuts my positive theta?

Answer: Because buying gamma comes with negative theta. And reducing both delta and gamma is going to make the position safer than only reducing delta.  If you – an individual decision – are comfortable with maintaining the negative gamma position, then by all means – adjust with stock.  However, I feel more comfortable reducing delta and gamma risk, rather than delta only.  There's no right or wrong here.  It's a personal choice.

There is also risk of getting whipsawed.  Although that possibility exists with any adjustment, it is especially painful when the adjustment was made with stock becasue it results in a buy high, sell low scenario.

My recommendation is that it's okay to adjust with stock when you cannot figure out what else to do – but the adjustment should be temporary.  As soon as you have the chance to unload the stock position and replace it with a positive gamma trade, that will give you a better position.  'Better' from the perspective of less risk in the future.

4) Consider your example.  You are long delta because of a short put spread.  Apparently you don't want to buy any puts, but you are considering selling stock short and buying calls to protect the upside.

Ask yourself: Why don't you want to buy puts?  Is it that if you buy the put you sold earlier that you would be locking in a loss?  Is it that puts seem to be too costly?  Is it that you hate paying the time decay present in the puts?  Is it that it feels more 'professional' to make an adjustment, rather than closing the position?

None of those is reasonable.

When you short stock and buy calls to protect the upside, you are buying synthetic puts.  Stock plus a call is the same as owing a put at the same strike as the call.  If you make the suggested trade, you are complicating a position (and raising margin requirements) for no good reason.  Buying the synthetic put is the same as buying the 'real put' – and if determined to make the stock plus call play, then I strongly recommend buying the appropriate put instead.

To answer, I cannot think of a single 'pro' for making that play , only 'cons'- unless the prices of the options are so far out of line that buying stock plus puts is a lot cheaper than buying the call (do not forget that it costs money to own stock).  The 'cons' have it.

Robert – just because you can trade a synthetic (or equivalent) position, it does not follow that it's always a good idea.  Here, buying protection in the form of puts makes the most sense (unless exiting makes you feel better).  As an aside:  DO NOT refuse to exit this trade to avoid locking in a loss.  If this position no longer feels right to hold, then please don't hold it.  On the other hand, if you like the adjusted trade and want it as part of your portfolio, then adjusting is the better choice.

875

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Follow up: Real Life Iron Condor Trade

Mark,

Great post as always. I know this would be a bit labor intensive, but is there any way to show a cumulative P&L and risk vs. return for this group of trades?

Thank you Burt, but I have no way to collect the data.

Risk vs. return does not apply. There is no 'return' to measure.  The P/L for one day's closing prices bears no resemblance to prices you get when making real trades to exit.

Neither is there risk to measure. I assume it can be done, but I have no idea how to determine risk for holding a position for a few days or weeks.

For educational purposes this is probably one of the best posts I've read. It provides one with a lesson on how complicated from a risk perspective and number of trades to maintain a position one might want to get. It also makes me wonder whether the opportunity cost (not to mention the trading costs) associated with so many adjustments is worth it relative to a risk-adjusted return.

I don't understand what you mean by 'opportunity cost'.  When you make the original trade, you have no idea what lies ahead or how else the money might be put to use.  I see zero opportunity cost.

You have money to invest.  Then you must select your trade(s).  How else can you operate?  If you don't like the idea that managing iron condors involves serious work, then don't trade iron condors.

Even if you don't go through the P&L, what is your sense of the cumulative risk relative to the after tax and trading cost return?

After tax?  I don't see that either.  All earnings are taxable.  That is independent of the trade.  All I am saying is that I have no idea what you are asking about taxes. 

Burt, there is no way to know the return or the costs before the trade is over.  And the next trade will be different.  My sense is that if you are a good risk manager you will like the return to risk.  If you don't want to bother managing risk, you will fail.  That's my opinion.

Trading costs should never be a consideration when trading.  If they are, you have the wrong broker or are choosing the wrong strategy.  Managing risk is far more important. I cannot imagine failing to make a needed risk adjustment because the commissions would be too costly.  When this trade was opened, our trader had no idea that he would be making so many trades or using as many commission dollars as he did.  Thus, risk does not change.  The risk associated with opening the trade is what matters. Sure tack on some extra dollars to the maximum loss to allow for expenses, but you never know the future.  At any point that risk/reward is no longer satisfactory, that's the time to adjust or exit.

Of course, "complicated" is a relative term. As a former market maker, this "trade" may seem rather rudimentary to you. Would you be able to tease out how "advanced" this number of trades appear to you. What I mean is that a true option rookie would not be likely to handle all the various decisions required. But with experience might approach the amount of adjustments that occurred. Where along the line of rookie to experienced trader would you place this trade?

Burt, there is nothing really complicated about any of the individual trades, and that's how we trade: One step at a time.

Nonetheless, I don't consider this entire series of trades to be suitable for the rookie. That said, if that rookie plans to trade iron condors, then it's important to have some idea of how to make adjustments, when to make them, and some ideas for possible adjustment trades.  This post offers that to any trader.  One cannot just open an iron condor trade and allow it to run to expiration.  There is almost no chance of avoiding blowing up a trading account if a trader adopts that methodology.

For the rookie, this post offers an opportunity to see adjustments made by a real trader.  The rookie can try to discover the rationale behind each move and think about whether that seems logical or misguided.  If unable to make that judgment, then it's a perfect excuse to paper trade iron condors and practice that (or any other) adjustment type.  The rookie is not born as a trader.  there is no substitute for experience.

The whole point behind a post such as that is to enable new traders to understand why the trades were made, how they reduced risk, and whether that specific adjustment is one that suits the individual trader's way of trading. 

There is nothing gospel about the traders choices.  Some traders, not fearing the downside, would have sold more puts when exiting current puts.  Another trader would wait, and then pay less for the puts.  Someone else might buy different insurance  when the trade was initiated.  Following someone else's trade is just an opportunity to see some trades in action and think about them.

To get the most out of this post takes a certain level of understanding about risk management.  That takes experience.  But this is the key point:  Even if your risk management skills are not yet well-honed, even if the idea of managing risk has never previously occurred to you, the idea that it's important to take some action to reduce risk is the idea that must be transmitted.  The rookie trader may not yet make the most appropriate or efficient adjustment, but any adjustment is better than none.  If the rookie learns that doing nothing is unacceptable, that's lesson enough.

So Burt, some of this is for advanced traders, but the concepts can help the rookie trader get a foothold into the idea of risk management and how important it is to survival.

Thanks as always,
Burt

***

You ask about cumulative P/L.  To me it's immaterial.   When you have a position – you have two choices: hold it or don't hold it.

How can it possibly matter whether the position is profitable?  You want it in your portfolio (good risk/reward from right this minute into the future) or you don't.  If you don't want it, exit the trade.

If you keep a position in your portfolio just because you do  ot want to exit and record the loss, then you are going to have a portfolio of high risk trades.  Why would you do that?  When you do not like the trade for any reason (perhaps you have already earned 90% of the maximum profit and are happy with that), get out.  Eliminate the risk and find a better trade.

You can agree or not.  It is gospel in my book.

854

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