Tag Archives | philosophy of trading

My Philosophy on Options Education

Education: An activity that imparts knowledge or skill.

When I work with individual investors or write blog posts and books, my objective is for the reader to learn something he/she does not already know.  That includes providing enough details that the clouds disappear and the reader gains a better understanding of the topic under discussion.  

Careful and detailed explanations take time to explain.  If you require instant gratification and the ability to attend one webinar or lesson and then immediately begin trading, I cannot help you.

Details?  What does that mean? I stress the details that help you reach a better understanding of the lesson material.   Unless the topic is risk management (and that's a big topic) there is no reason to bother with details of events that are extremely unlikely to occur.  My job is for you to come away from a lesson with something of value for your trading career.  And that's true for the trader who devotes only two hours per month to his/her investments as well as the full time trader.

There are trading tidbits that you will accumulate and points of view that you, the trader, will develop over the years.  Rather than wait for traders to slowly gather insights on certain more advanced topics, I prefer to see that you get an inkling of the importance of certain features of options – even when it may be soon soon for some students. 

One example is the idea that two very different-looking positions can be equivalent, i.e., they produce identical profits and losses under all market scenarios. Most beginners don't get introduced to that concept until they are well into their trading.  I believe this idea is so important to an understanding of how options work that I introduce it early.  If anyone does not see the importance, or does not yet understand how equivalency works, no harm done.  The idea has been mentioned and soon enough, as specific trade ideas are introduced, the 'eureka' moment arrives and the concept becomes clear.  Accelerating the date of that moment makes better traders of those in the class.

We all wish we had understood something more clearly, or recognized the true risk of an innocent-looking position earlier in our trading careers.  For example, I believe the successful trader must concentrate on risk as his/her primary focus.  Many others prefer to concentrate on profit and loss, and do anything in an attempt to achieve that profit.  That is dangerous for reasons that may not be obvious.

When you grasp the 'little extra stuff' early in your career, it often makes a big difference in whether you succeed or ultimately give up the game.  The very first rule to understand is: Don't go broke.  It seems obvious, but it's something ignored by too many traders – until it's too late. I help traders learn how to minimize the chances of going broke.  It's not as simple as: "Don't take a lot f risk in one trade."  Some traders lose their accounts slowly and end up just as broke as the person who blew up over a single trade.

When I clarify some previous misconception held by a student, that is truly hitting the jackpot (for me).  Trading is a business that punishes mistakes.  Everyone tells us that we learn from our mistakes.  That's true ONLY when the mistake is recognized. If a trader repeatedly acts on a misconception, those mistakes are difficult to discover – and hence, are going to be repeated.

I love the breakthrough when something under discussion results in an 'aha moment' for the student.  As a writer, I never know when that happens, unless you let me know.

So what do I mean by that introductory statement – to teach something you don't already know?  Here are some examples that appear frequently in my writings:

  • Explaining something from a different perspective
  • Including extra details, just in case they can provide a better understanding
  • Including information to answer questions before they are asked
  • Explaining the rationale behind my opinions. 'Why I believe it's true'
  • Outlining a philosophy based on common sense, and not on traditional rules
  • Being willing to take a minority stance – but always telling readers when most others have a different point of view
  • Encouraging readers to think for themselves before making decisions
  • Continuously stressing the importance of risk management
  • Explaining that choosing a good trading strategy is just the beginning
  • Why trading near-term (front-month) options is more risky that it appears
  • Why it's easier to make money by selling, and not buying, option premium
  • Why selling naked short options is too risky for most traders (unless you sell puts with the intention of owning stock)
  • Sharing the opinions of other option writers and bloggers

One on one

When working with a trader one on one, my philosophy is to help with specific topics of interest to that student.

I don't have 'lessons' prepared in advance. I don't have any specific number of lessons planned.  These sessions are designed to answer your specific needs.

Risk Management

Concerned with capital preservation?  At Options for Rookies we live and breathe risk management.  I stress the importance of controlling risk from the very beginning of your trading education.  This is not a topic suitable for experienced traders only. Why?

If you trade without measuring and controlling risk, the risk of ruin is too high. Don't count on a lengthy trading career when being aware of, and respecting, risk is not at the top of your priority list.

When dealing with the stock market in any capacity, you are dealing with statistics.  You must be alert for unlikely events.  By being aware of the probabilities of winning and losing, you can trade only when the reward justifies the risk. 

You will have many winning trades by doing just that.  However, long shots have their day and black swan (unexpected) events do occur.  Your task as a trader (and mine as a teacher) is to see that you are prepared for the unlikely event. 

As a premium seller, gigantic market moves represent the enemy.  Portfolios can be protected against disaster, if you are willing to pay the price of insurance.  One alternative is to be very careful when sizing trades.  Be aware of the worst case and you can limit losses to an acceptable amount.

It's all part of risk management.



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Exercising at Expiration: A real world example

Hi Mark,

Let me first say that I have been reading your blog for a couple months and I found it very educational. I really appreciate what you are doing.

On your latest post about options expiration, you mentioned that you don't like exercising. In fact that is what I did this past Friday and I'd like your insight on that.

I bought 2 (Discover Financial Services) DFS 15/17.5 April 2010 call spreads back in December when they cost me $0.88 and DFS was around $15. DFS has since dropped below $13 but went up a lot after it bottomed. During the past two weeks I finally saw a way out with profit when DFS was getting close to $16.

On Thursday it gapped open to more than $16.50 and I thought I could close the spreads at $1.40.  I entered the order but it didn't get filled. I thought I'd wait until Friday and enter another order. Then on Friday the stock slides further and I can't even make it even.

I exercised and planned to sell ITM expiring in a couple months (Ask prices of the May and Jul $15 calls are $0.90 and $1.30) to get out with a profit. Of course I know that DFS may drop again but I am willing to hold the stock and write calls. Essentially I'm exercising so I can still hold the position when my Apr $15 calls expire.

What are your thoughts?

Thanks a lot.



Interesting scenario for you.

1) You have a plan.  Your plan is to hold the stock and write covered calls.  That's fine by itself.  The crucial part of this exercise is that you planned ahead and know what you want to do.

But I do have a question, and that comes later.

2) My problem with exercising, as a general practice, is that someone who bought an option for a specific reason forgets the original reason and suddenly owns stock.  Along with that stock comes a great deal more risk than the original trade.  That's just a bad idea, and cannot work over the long term.

When you buy an option (or spread), if your original premise doesn't become reality, accept that fact and exit the trade.

3) Here's the big question that makes me doubt that you did a smart thing.  And remember this is my opinion, it is not necessary for you to agree.

Quote 1: "Then on Friday the stock slides further
and I can't even make it even."

Quote 2: "I exercised and planned to sell ITM…to get out with a profit."

Quote 3: "During the past two weeks I finally saw a way out with profit"

My question:  Did you exercise those calls just because you refused to exit this trade with a loss?

Planning to write covered calls is a very reasonable idea.

Planning to write covered calls just because you refuse to accept that this position lost money is beyond foolish.  Because you mentioned it three times, I believe you don't really want to write covered calls.  Instead you are obsessed with getting back to even or earning a profit.

As an option trader, you must know that you will have winning trades and losing trades.  That's part of the game.  If you accept additional risk (and owning a $15 stock is substantial extra risk when compared with owning a call option), just to avoid a loss, you are going to incur some much larger than hoped for losses.  Yes, you will also turn some losses into profits.

I have my trade philosophy and you certainly should have yours.  According to mine, these are the points I believe that should matter to you:

  • Is it your thought that writing covered calls is the best play in DFS?
  • Is there no play, with less risk, that appeals to you more?
  • If you do want to write covered calls, is it a good idea to hold the stock naked long over the weekend?
  • Are you writing covered calls ONLY because you refuse to take a loss?

You had a choice.  Exit the calls and open a new position Monday (yesterday); hold via exercise; or buy the Apr 17.5 calls and sell the May or Jun call last Friday (if you had the margin available to make that trade).

My major comment is that the exercise is okay – but not if you did primarily to avoid taking a loss.


Options:  Isn't it time you learned why options volume is exploding and how individual investors use options to earn extra income and reduce risk? 

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