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Q & A. Timing the Market



Updated two hours later

Mark,


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.

Dave

***

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.

"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 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 ๐Ÿ™‚

Sorry for the diatribe… I love your blog.


***

Dave,

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.

405



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