Teaching is an educational experience for everyone involved. There was a time when I believed that when the instructor explained something in simple language and the students did not display looks on their faces that suggested they were completely lost, that all was well. That was a mistake on my part. Many times people are embarrassed to ask questions. And today, with so much education available over the Internet, the classroom can be impersonal.
One never knows what beginners are thinking. I hope my friend, SD is not offended by any of today's post. This is a classic example in which he took only the parts of our discussion that he liked (make the trade) and ignored anything about the trade that he didn't like (risk management), or possibly didn't understand. He's here seeking helpful ideas for uncomfortable situations.
My comments are in bold.
I had an iron condor position on AAPL with a January 2011 expiration: 290/300P; 350/360C. It was very scary.
Very scary! That is all you need to know. You do not want to own such positions. Why would you continue to own a position that frightens you? They are frightening for a reason – and that reason is the possibility of losing far more than you can afford on this trade.
I felt like I jumped from the air plane and the parachute opened just before hitting ground!
In the real world, that would be too late. The chute must open much earlier than that. The time to seek an exit is early enough for the chute to open, or before the trade has taken too much of your money. Again I ask: why would you subject yourself to such feelings? It's obvious that you do not pay any attention to risk. You must ask yourself why this is true. It cannot continue.
I thought my positions would gradually diminish in value like it did last two months.
Explanation: He is trading an iron condor, and for the past two months all went smoothly. Time passed, the options lost value, and he made money. This trader apparently drew the conclusion that if it worked for two months, it would always work, and that he had found a method for printing money.
This is one of those things that I cannot understand. Surely 'everyone' knows that if something occurs once or twice that it is not guaranteed to happen again. If a fair coin lands on heads twice in a row, is there any reason to believe it will be heads next time? Of course not. We know better.
So why should a trade be different? Why should a trade be profitable 100% of the time? My correspondent recognized that AAPL had moved too far. He was scared and felt as if he were going to crash. However, there was no effort to escape. He did not attempt to use the parachute – he only mentioned how it would have felt. He was a deer caught in the headlights unable to move and unable to make a rational decision.
Here is a trader who is willing to sit tight with a position, hoping it works because it worked on two previous occasions. I get the 'hoping' part. Undisciplined traders spend a great deal of time hoping. The part I don't get is the correspondence with me. I cannot help. I'm the person who told him repeatedly that holding positions when they become uncomfortable is not viable. 'Scared'? That's way beyond uncomfortable.
The point is that he never learned the lessons. He never understood that danger is real and that it doesn't always disappear to provide a happy ending.
Here's the message I sent to him in response to his line that he thought the value of the iron condor would diminish: It only diminishes when the stock does not make a major move. the iron condor does not always work as you hope. Remember there are traders who hold the opposite position – and they are happy when the stock makes a big move. The stock market is not designed to make you happy.
But this month was different. Steve Job's sick leave announcement on Sunday really helped. I felt like Rodeo riding on a wild bull, I had hard time holding the bull.
A recognition that things were different this time, but no recognition that he should have behaved differently. Bad news for AAPL saved him one day, but the next day, good earnings pushed the stock higher. Did he exit when he had the chance? I don't know.
A 'hard time' riding on the back of a bull. The metaphors are good, but the lack of discipline and the lack of attempting any risk management are traits that no trader can have. It is far too easy to blow up a trading account, and depending on good luck is one of the quickest ways to accomplish that.
I don't want to pick on someone who is learning to work with options and to trade some of the strategies. But the bottom line remains the same: Traders who ignore risk are not going to survive. This is a business of probability, and unless someone earns a quick, lucky fortune and then retires, that trader is going to have a very difficult time.
Please show me something more steady.
That's easy. Take less risk. Trade smaller size. Evaluate other strategies. But to insure steadiness, you cannnot ignore risk. There is nothing I can do to help, if you do not manage risk with skill.
I had smooth ride during previous two months owning AAPL spreads, so I thought same will happen in January. Anyway lesson learned: Indexes only from now on.
Now we come to the advice part. He traded iron condors without understanding how they work. He did not understand risk, apparently believing that options always lose value over time, and that selling them is almost guaranteed to work. In other words, the market never allows option buyers to make any money. It makes me want to cry in anguish.
And the lesson learned? That's more of the same bad thinking. He lost one month, so he will never do this again. He will change to indexes. That may produce less volatility in the portfolio, but it's hardly the cure. One winning or losing trade is not the basis for deciding what works and what doesn't.
I am upset at a basic level. I did not believe it possible that someone would take a small portion of a learning opportunity (an iron condor strategy may be profitable) and ignore the rest (it's not always profitable and risk management is the key ingredient to any success). Sure I often write about iron condors. But I always write about risk management, adjustments, and avoiding ruin. Why did all those portions of the lessons go unheeded? This is a prime example of why paper trading and months of practice is an excellent way to get started with an option education.
I learned something important from my friend: Don't take things for granted. Be certain someone understands the lessons. Ask questions, and hold the conversations. Don't wait for the rookie traders to do all of the asking. Anticipate problems.
Sampler version of The Rookie's Guide to Options
The Basics, a short introduction to options for the novice