Q & A. Timing the Market

Updated two hours later


On timing- here's a simple style I've had good luck with: When you
"see" a trade, initially execute and things don't start happening as
hoped for (immediately) then it's time for a very simple (usually very
cheap at that point) adjustment: Get out!

I'd be really interested to get your opinion on this admittedly
frequent trader's paradigm (I'm still an option rookie) but from where
I sit it looks like many "adjustments" are a stubborn refusal to be
wrong. And ironically, v-e-r-y smart guys are particularly prone to
this ill fated thinking.

In my supreme option rookie ignorance I must say- timing smells a lot
like predicting direction: Try it when ya have to and be prepared to
change your mind almost instantly.



There is nothing illustrating any ignorance in this comment.  You have hit on something important.

1) I did not mean to use the word 'timing' in the traditional sense.  This post, and the one that follows is concerned with deciding – on an ongoing basis – how long before options expiration is an ideal time to open a position in which we sell option premium.  In other words: is it 'better' to sell that premium one, two, three, or more, months before the options expire?

This discussion includes iron condors, selling put and call spreads, naked options, covered call writing.  These are premium selling strategies.

2) In this context, there is no 'start happening immediately' because what we want to happen is 'nothing.'  We want time to pass without the stock moving against us.

3) Your idea is a good one.  But it's for a very different type of strategy.  It's a directional play – and that applies when you BUY (not sell) option premium.  You are buying, and paying for, positive gamma and that comes with negative time decay (theta).  So, if you don't get the move you want, then your timing is off, and it's often best to exit – and decide if and when it's time to play again.

4) As a general rule, I don't like predicting specific direction by buying options.  It's not that it's such a terrible way to make money, but it involves being able to pick market direction correctly, and it also involves being able to time the market move.  I cannot do that.  I don't believe many people can.  Thus, in my opinion, buying options is a losing game – for the vast majority.

But if you have a proven track record of knowing when to buy and sell, then buying options can work for you.  It's just not for me and I shy away from talking about option-buying strategies.

5) Yes, 'timing' is an important part of 'predicting direction.'

6) I don't look at adjustments as 'refusal to be wrong.'  I see it as:  I already was wrong, and what should I do now?  Sometimes I exit and take the loss.  But when I see an adjustment that reduces risk and still leaves me with a position that has acceptable risk/reward parameters, AND (this is the part most people miss, and do indeed refuse to be wrong) is a position I want to have in my portfolio – then I make the adjustment.  I do not do it, nor do I recommend anyone do it, just to avoid taking a loss – which is what you refer to as 'refusal to be wrong.'

Being wrong is part of the game, and pretending that part does not exist is foolish.


UPDATE: I received the continuation from Dave, so added it to this post.

is no 'start happening immediately' because what we want to happen is
'nothing.' We want time to pass without the stock moving against us"

ummm, when I put on my RUT ICs about 2 weeks ago and nothing
(didn't!) happen immediately I became pretty wrong (immediately)…

understand at that point I could have "made an adjustment" to salvage
my odds of a lesser profit than I originally had in mind when I put on
the trade *BUT* I also need to weigh that expense against the cost of
the get-me-out-now button, AND consider that the trade moved against me
and my thesis (and right out of my comfort zone).

-I spent last week with a real smart guy- math phd etc and self
proclaimed experienced option trader… He's taking a "little break"
from the market now because about a year ago he lost a good portion of
his wealth- hmmm, I think he mentioned a couple hundred grand a week or
so at the zenith, "adjusting" his way out of (?) trouble.

At the risk
of kicking him when he was down I couldn't help politely mentioning my
Golden Rule: never, never- ever let a trade run over 10% against you
and he just chuckled a somewhat condescending; "that's an impossible
rule". I've noticed really smart guys tend to have trouble with really
simple rules 🙂

Sorry for the diatribe… I love your blog.



Thanks.  Tell more people to come visit me here!!

It's not a diatribe.  It's conversation.

You hit the nail on the head.   If the trade moved right out of your comfort zone, your decision is 'HOW' to move back into the zone.  Exit, adjust…doesn't matter.  As long as your zone does not remain violated.

And here's a bit more of how I think, which may not apply to you.  The original plan for how much you intended to make is 100% irrelevant.  You own the position at the new price after RUT has moved against you.

The easiest, and often the best, solution is to exit the trade and perhaps find a new trade.  But – and I do not think this is being stubborn – if you can satisfy the conditions of

a) reducing risk to move back into your zone  AND

b) If the adjusted position is one you would open right now – in other words, is one you want to own – then adjusting is fine.

But too many people – intelligent or otherwise – refuse to accept a loss and make adjustments they do not want to own.  They make these trades in an attempt to 'get even' on the trade. 

That is contradictory to my philosophy.  I do not care about getting even (honestly).  If I lose 10 grand – I want to make 10 grand.  That's normal.  But – I DO NOT CARE from whence that profit comes.  It can be the old position adjusted, or it can be one (or more) new trades.  I have no need to try to salvage the old trade.  My goal is to profit today and tomorrow.  To do that, I MUST own a portfolio of good positions, not positions adjusted with 'hope' as the driving force behind the trade.

As a side comment:  Options are not like stocks.  If you buy stock and it drops 10% – or some other number, exiting makes lots of sense.  But an option trade is different.  A change in implied volatility can easily produce a 10% loss.  To me that's not a reason to exit.  It's a warning not to double the size of my trade, but if the Greeks (which are used to measure risk) are acceptable, I'm not exiting.  I don't want to suggest you do the same, but recognize that options are traded differently.

My guess is that your friend rolled down and out, in a plunging market.  He moved the position to lower and lower strikes, with longer times to expiration.  And he probably also multiplied the number of contracts so that he could 'roll' the position for even money or a cash credit.

That's a common strategy.  And perhaps it ok to add a few extra contracts ONE TIME.  But increasing size and continuing to sell vega in a market in which IV is rapidly rising is a very desperate, and risky strategy.  Very.

If the market had stopped going down in time for him to survive, and if IV had stopped rising, he would have survived.  But, apparently that did not happen in time for his gambling methods to become profitable.  Yes, even math PhDs who know that gambling is bad – make losing decisions.  I agree he was unlucky – and that the outcome was far against the odds.  But there must be a limit as to how much can be lost in a single trade (or entire portfolio), and he violated that limit.

Doubling the bet again and again in an attempt to get even is something that wins most of the time.  But when you lose, it can take all your money.  How can that be a reasonable gamble?  It cannot.

And don't forget this John Maynard Keyes gem:  "The markets can remain irrational longer than you can remain solvent."

Thanks for this discussion.


11 Responses to Q & A. Timing the Market

  1. Dave 08/01/2009 at 1:09 PM #

    “there is no ‘start happening immediately’ because what we want to happen is ‘nothing.’ We want time to pass without the stock moving against us”
    ummm, when I put on my RUT ICs about 2 weeks ago and nothing (didn’t!) happen immediately I became pretty wrong (immediately)… I understand at that point I could have “made an adjustment” to salvage my odds of a lesser profit than I originally had in mind when I put on the trade *BUT* I also need to weight that expense against the cost of the get-me-out-now button, AND consider that the trade moved against me and my thesis (and right out of my comfort zone).
    -I spent last week with a real smart guy- math phd etc and self proclaimed experienced option trader… He’s taking a “little break” from the market now because about a year ago he lost a good portion of his wealth- hmmm, I think he mentioned a couple hundred grand a week or so at the zenith, “adjusting” his way out of (?) trouble. At the risk of kicking him when he was down I couldn’t help politely mentioning my Golden Rule: never, never- ever let a trade run over 10% against you and he just chuckled a somewhat condescending; “that’s an impossible rule”. I’ve noticed really smart guys tend to have trouble with really simple rules 🙂
    Sorry for the diatribe… I love your blog.

  2. Mark Wolfinger 08/01/2009 at 2:07 PM #

    Reply used as update to original post.

  3. Jimmy J. 08/01/2009 at 7:31 PM #

    Mark, thanks for the previous answer. I have another question, if you don’t mind. When the strike price is BELOW the underlying market price, and DEEP in the money, why
    wouldn’t a buyer exercise that option immediately and get a swell deal buying stock at that price?? Why are strike prices EVER offered deep in the money? I’m missing something big here.
    Also, how can I as the buyer compute a breakeven or even profitable choice of option. I’m soooo confused.
    Thanks for your patience!

  4. Trader 08/01/2009 at 9:56 PM #

    Another thing that makes the 10% and out approach hard to implement when using options strategies, is that due to bid/ask spreads and commissions, it is not uncommon to be 10% down immediately upon entering the trade. Even when things go ‘well’, it is not uncommon to be at break-even for quite a while before a ‘sell-premium’ strategy becomes meaningfully profitable.

  5. Trader 08/01/2009 at 10:07 PM #

    Jimmy J.
    It makes no sense to exercise an option, even when deep in the money, if there is any amount of time premium left. For example, lets say a stock is trading at 50 and lets consider a 20 strike option trading a couple of weeks before expiration; if the trading price of the option is even a few pennies above $30, few people would be willing to throw the extra pennies away by exercising early.
    Another thing to consider is why would someone buy (as opposed to sell) a deep in the money option; it may be that they like the leverage and don’t want to deal with decay, thus going for a delta of 1; in that case, one would keep the option as long as the underlying direction moves their way, and if not, they would simply sell the option, without having to exercise it. Another situation may be that a stock has risen so much that an option has become deep in the money; again, selling it, rather than exercise makes more sense.
    There are a two cases when exercising early makes sense, something that I have done (or have done to me) in the past; 1) owning a non-liquid option that has such a wide bid/ask spread and for which the market maker is not willing to pay ‘fair’ price. I traded some options on an oil trust and with a month to expiration the options where $20 in the money but the bid/ask spread was $2 and I could not get a fill at par (i.e., exactly at the stock price). I exercised and got fair value. Another time I had options I sold exercised was right before the dividend x-day; clearly the owner wanted to collect the premium, so they called the stock before that deadline.

  6. Mark Wolfinger 08/01/2009 at 10:08 PM #

    Patience is not one of my strong points, but somehow, when replying to basic questions I seem to have enough. At least I hope so.
    1) Just for future clarification: In your question, you never mention whether you are talking about a put or call. That’s a serious omission. In this case, it’s obvious you are writing of a call option.
    2) Because there is no ‘swell deal.’
    Example: Stock is 40 and we are speaking of a call with a $25 strike price. What do you think you have to gain by exercising the call? Sure, you pay $2,500 for $4,000 worth of stock. Is that what you call a ‘sweet deal?’
    When you exercise the call, that option no longer exists. In other words, it’s worthless. Before you exercised, the call was worth at least $1,500 (it was $15 points ITM). Now it’s worth zero.
    You made a ‘sweet deal’ on the stock, but you made a very bad deal on the call. Net result, nothing gained. Nothing – unless the stock is about to pay a big dividend. That’s the ONLY time you want to exercise a call option before expiration.
    3) When new option series are issued following an expiration date, DEEP ITM options are not offered. But once an option is listed for trading, it can never be delisted as long as there is an open interest above zero. So if the stock is 80 and 75-strike options exist, when the stock moves to 200, those options still trade. They cannot be removed just because they are deep ITM.
    Here is something I have mentioned several times, but some people just don’t get it. So you are not alone: It is very (pardon this impolite word) stupid to exercise a call option any earlier than necessary. Here’s why:
    1) Cash. Why pay for stock – at any price, when it costs cash to exercise? You will have to pay interest to own the shares, or cease collecting interest if you have the cash. Interest rates may be low, but they are not zero and exercising costs that interest.
    And don’t tell me you are going to sell the stock immediately. Instead of exercising and selling stock, just sell the call.
    2) RISK. RISK. RISK. When you own a call option that is $10 ITM, if there is a disaster and the stock plummets, all you can lose is $1,000.
    But when you own the stock you can lose a whole lot more. Unlikely? Sure it’s unlikely. But it’s just plain ridiculous to take that risk when there is nothing to gain. Nothing to gain. No sweet deals. Don’t exercise call options any earlier than necessary.
    Please tel me that you understand and agree with this. I just don’t get it. I don’t know why this is so difficult for some people to grasp – but it is. That’s why I’m asking.
    3) Computing break-even is a very foolish undertaking. Why do I have something harsh to say about that? Here’s why:
    a) A break-even calculation involves holding the option to expiration. That is a bad idea. When you buy an option, you have an objective in mind for the stock. But it costs time decay – every day that you continue to keep the option. Thus, one of your objectives is to sell the option at some point – hopefully after the stock does what it is you were looking for it to do. Thus, in my opinion, break-even ‘thinking’ is ‘money-losing’ thinking. You really do not want to lose every cent of time value in the option.
    b) here’s the real break-even: When you pay X for an option, any time you can sell that option for X, that’s your break-even point. Sell at a higher price for a profit, sell at a lower price for a loss. That’s pretty simple.
    c) To reply to your question – although I would prefer you never think about this – the break-even point for the underlying stock is the strike price of the option, PLUS the price you paid for the option. Pay $1.43 for an Oct 30 call, and the break-even price is 30 + 1.43, or $31.43. If the stock is ata that price when expiration arrives, you break-even.
    This is not confusing. Please take the time to think about this. Don’t get overwhelmed. Take it one step at a time.

  7. Mark Wolfinger 08/01/2009 at 10:20 PM #

    The power of options…Let me repeat that: The POWER of options is that risk can be measured. That means it can be reduced, eliminated, or neutralized. It can be eliminated. When you trade options, it’s a very good idea to use the Greeks to h measure and handle risk problems. Using a percent move or loss avoids the Greeks. That destroys the POWER of options. Bad idea, in my opinion.
    Options are not stocks and that concept is known by everyone. But rules for trading stocks are often applied to trading options. Dave’s rules work for him. Good. I’m glad to hear that. But I believe a different set of rules is needed to trade options, and percent loss is not one of them.

  8. Dave 08/01/2009 at 11:25 PM #

    OK 10%-
    I’m just an option Rookie feeling my way, I’ll certainly consider what the Greeks have to say before I cut my next loss at 10% however…
    With all due respect– you’d have a real hard time convincing me many MANY stock trading techniques aren’t at the very least worth considering during an option trade…
    Do the Greeks know where support and resistance levels are? Can they use them (or ignore them) to identify what is surely one of the very most critical aspects of almost any trade– the entry?
    Can they predict the next moment Obama Bernanke or Geithner will pop on TV with some new rule-changing-save-the-day new program?
    I appreciate love and believe the math, but I think there’s also a bit more to consider, why limit your thinking? It’s not an options -vs- stock trading issue.
    With super-careful entry consideration which includes asking the Greeks their opinion I’ve found that my 10% rule is v-e-r-y doable. Do I get knock out of trades? Of course– all the time! And if the conviction strikes me I can get right back in. It really all just reinforces the absolutely critical importance of proper entry.
    Simple question: If you’d cut all losses at 10% the last 2 years would your account be in better health?

  9. Mark Wolfinger 08/02/2009 at 12:55 AM #

    Simple answer: No. More detailed reply below.
    Any technique that helps you reduce/eliminate risk is worth considering, but that does not mean they will pass the test. Some must be discarded.
    I never said anything about ‘MANY stock trading techniques,’ and am disappointed that you believe I did. I said: stocks are different from options and must be traded differently. That does not mean there is ZERO overlap in trading techniques. Obviously one buys and sells both. One looks at the bids and offers when trading. An trader enters and exits. Obviously there is some overlap in methodology.
    What I said can be translated to mean that there is FAR FROM 100% overlap and if you blindly follow all of your stock methods when trading options, it is my opinion that you will not succeed. NOTE: My opinion is based on my experience. Because your experience is not the same, you have drawn different conclusions. Nothing wrong with that.
    Being new to options, I am suggesting you consider my opinion that options and stocks trade differently and require different thinking. Then make your own decisions. I am NOT telling you that you are wrong. But you appear to be telling me that I am wrong.
    Volatility is crucial to options pricing. It can turn positions into big winners or big losers in a heartbeat – even if the stock price does not change. That cannot happen with stocks. Thus vega risk is an important consideration when using options. How does an ‘X% and out rule’ account for changes in implied volatility? That’s why your math friend told you that your idea is not really applicable when trading options.
    Take stop-loss for example. A very attractive technique for stock trading, but essentially worthless when trading options – especially spreads.
    If you use the ‘last trade’ to set your stop-loss price, you may find your specific option doesn’t trade until it’s well past the stop-loss price.
    If you prefer to use the bid or ask price to set the stop loss, which should it be? If you choose the bid price and the market makers get permission to widen the bid/ask spread, – as they frequently do – it’s a disaster for you. When the market is $1.20 bid/ $1.40 ask, and then suddenly changes to $0.60 bid/$2.00 ask, the stop-loss is triggered and you sell at 60 cents? Pretty disgusting, right? And if you use a limit order, how do you set that limit price?
    If you have a spread, what do you use to set the stop loss price? Sometimes that market for the spread may disappear from the trading screen. If the computer reads that missing bid as zero or the missing offer as a huge number, you can get stopped out at a horrible price. You cannot place the order on the bid/ask of the spread. But, spreads don’t always trade as spreads, so how can you place it on ‘last?’ You can’t, and stop-loss is just something a spread trader cannot use.
    This is one stock-trading idea that does not work with options. I don’t believe my statement requires me to prove that each and every technique used to trade stock cannot be used to trade options. You can use some. You cannot use all. I’m giving my opinion that there are enough differences that if an investor tries to move from stocks to options, using a vast knowledge of how to successfully trade stock, the chances are high that he/she will fail.
    Support/resistance? If you use those, then presumably you chose your strike prices accordingly and should not have to worry about S/R any further. But do the Greeks ‘know S/R? Of course they don’t.
    But the Greeks allow you to measure various risk factors – and you cannot do that with stocks. If you choose to ignore the Greeks when trading options, you may succeed. But you negate one of the very best reasons, if not the best reason, for using options in the first place.
    As I say over and over – I am giving my opinions in this blog. I am not preaching gospel. If you read what I say, think about it, and disagree, that’s a good thing. You have lost nothing by thinking things through, and should have even more confidence when sticking with your original ideas. That’s advantageous to you. My job is to help readers think and learn. I do not want to convince everyone that what I do or suggest is best. It works for me as I am sure what you do works for you.
    I don’t even know what you mean about ‘super careful entry.’ I don’t make any special effort to time entries, other than being able to obtain an agreeable price for my position. I make no pretense of being able to successfully time entries. If you have a good track record, then by all means, time entries. But I know, from more than 30 years trading experience, that I cannot do it. So I no longer try.
    I don’t believe ‘timing entries’ is a fair example. Every trade must have an entry. Why would you be more ‘careful’ with options than stocks? And if you are that good with entries, why aren’t you a billionaire?
    Every trade must be entered through a stock broker. So what? That has nothing to do with my statement that stocks and options must be traded differently (allow me to add to the statement) in order to achieve success when trading options.
    Regarding Geithner and Obama – that’s why options are so good. You can add some positive gamma to your portfolio in an attempt to be prepared for such an event. You can anticipate certain types of risk and own some insurance against that occurrence. Or you can ignore it – which is what stock traders are FORCED to do. Option traders at least have the choice.
    I am trying to get you to understand the advantages available when trading options that are not available when trading stocks – and then to take advantage of the differences. It’s your decision, not mine. Nor is it something about which we should argue. Options allow you to do things that stocks don’t. You are not required to do those things.
    To answer your last question: Absolutely not. But my portfolio is not like yours. I don’t have positions like you do. I have many iron condors working simultaneously, all in RUT. I own a bunch of extra calls and puts (naked long) for gamma and vega protection. When an IC loses, the naked long gains. Sometimes I still lose overall, sometimes the loss is more than offset by the gains from the strangles.
    So I don’t have the possibility of cutting losses at any specific percent. I don’t even know the original entry price of each of my iron condors. What difference does it make anyway?
    I don’t care how much I have made or lost on a specific spread, nor in my opinion should you. I BELIEVE that you own a position (or portfolio) at today’s price – not the original trade price. That position has risk and it has reward potential. It has a probability of success and a probability of loss. Do you want to own this position, right now, at this price? That is all that matters. How can your entry price play any role in deciding whether you like today’s position? The entry price affects your emotions, and trading with emotions is destructive.
    It is my strong opinion that far too many traders pay attention to that one price – the entry price when they should ignore it. That price is ancient history.
    If you like the position with all of its characteristics, then hold it. If you don’t like it, then there are two choices: Adjust it so that you do want to own it, or exit. Take a profit, take a loss. It does not matter. Manage your portfolio on risk/reward, and compatibility with your comfort zone and you will succeed. That’s my philosophy. Feel free to disagree because I know what I believe is not gospel. It is however how I trade.
    You are encouraged to trade as you see fit.

  10. Dave 08/02/2009 at 2:34 AM #

    Thanks Mark, I agree with you for the most part, especially “owning” a position at today’s price not the original trade price– which means absolutely nothing. I don’t have much experience with options; so far I’ve traded only highly liquid ones which is probably why I haven’t experienced any of the spread problems you’ve refer to. But, thank you, I will certainly keep those in mind.
    I am shocked and certainly apologize that it appears I am telling you that you are wrong, which would be sooooo absurd for many reasons including #1 you ARE the expert and I AM a rookie, and #2 as we all know– there are MANY ways to play a market.
    I do think entry is absolutely critical before you pull the trigger (afterwards it’s ancient history/ meaningless) and I don’t see it as a “timing” issue as strange as that may sound– so we can agree to disagree on that lol.
    I faithfully visit this blog everyday to learn (and usually do!)
    You’ve put alot of words in my mouth and you’ve proclaimed my monetary worth to be less than a certain figure– which puts me a bit out of my “comfort zone”. I guess it’s probably time to say enough, huh?

  11. Mark Wolfinger 08/02/2009 at 8:38 AM #

    I certainly did not want to make you uncomfortable, not to ‘put words…’. I assumed I was safe claiming you weren’t a Billionaire. I do hope I was incorrect.
    Our conversation is not private, and when responding I try to make it apply to other readers as well.
    You were not telling me I was wrong. To me, there is not much that is ‘right’ or ‘best’ when using options. Some methods give the trader a better chance of success, but if it comes along with discomfort, then it’s probably not a good method for that trader. There are always going to be differences of opinion – and ‘different strokes…’ and all that stuff.
    Thanks for this discussion.