Taking Losses. Why is it so difficult?

Mark:

I write covered calls on SPY.  When the ETF drops in price, I would never
write a covered call at strike price and expiration date, where if
assigned, I
would lose money.

Recently I woke up in the middle of the night
(that was a
mistake) and thought what would happen if I did.  What
would happen if I accepted the
unrealized loss and just wrote at the new price like it was the first,
which
would give me the best premium.  What if
I thought of the ETF holding as shares that generate premium, rather
than dollars?

Ultimately the ETF goes back up or I die, and then my
estate
has the unrealized loss, but at that point I’m not worrying about it.

I must be wrong some where here, what
am I missing?

Thanks,


Martin

***

Good question.  This is a common situation that must be faced by writers of covered calls.  But, it's similar to investors who buy something and watch it decline in price.

For many, taking a loss is just impossible.  Over the years, they wind up with a portfolio of garbage – all those losers they are still holding.

'Traders' as opposed to investors are less likely to be in that situation because they understand that when the investment doesn't move as anticipated, the investment decision was wrong and it's time to exit and move on.

471

ADDENDUM:  The difficult for most to recognize is that you have already lost the money.  Refusing to write covered calls until you can sell calls at the original strike price is a strategy based on hope.  To me you must decide:

Do I write calls now – and generate premium as income – or do I become a investor and hold the stock, doing nothing unless it rallies?  For my comfort zone, this is an easy choice.  I write the calls, hoping to reduce my loss.  My goal is to make money from today forward – I do not worry about realizing a loss – because the money has already been lost.

6 Responses to Taking Losses. Why is it so difficult?

  1. Jeff 10/02/2009 at 12:56 PM #

    Martin,
    Hope you will find this article on “Counteracting the Disposition Effect” helpful in your thinking on this topic:
    http://tinyurl.com/o57hxe
    Jeff P.

  2. Mark Wolfinger 10/03/2009 at 1:38 PM #

    Jeff,
    Thanks for the link to your blog, Covered Calls Advisor. As you posted:
    “People want their investment positions to end as winners, not losers, and will forgo their reasoning to make that happen.”
    I’m sure most of us recognize ourselves in the above sentence, but it is an absurd way to behave.
    Your job, as risk manager and investment advisor of your individual portfolio is to make money. You choose investments with the objective of being profitable in the future. You must be aware of risk and own positions whose risk is commensurate with potential profits.
    Beyond that money is money. Let’s look at a specific $10,000 in your account. It’s worth $10,000 TODAY and you must decide how to best invest it.
    Hoe can it possible make any difference whether you have that 10k as a result of earning a 25% profit from an $8,000 investment or from losing 17% from a $12,000 investment. You have $10,000 today. It’s the same 10k, and how to invest it going forward is all that matters.
    What do you want to own? Do you want to write covered calls on that holding? Do you want to protect it with a collar? Those are the decisions to make. It does not matter whether the cash comes form a losing trade or profitable trade.
    The past is behind you. You have that 10k TODAY. Deciding how to invest it is your job. Holding losers is for losers. Hold it only if you believe that is the very best investment TODAY, at today’s prices in today’s investing environment.

  3. TR 10/04/2009 at 12:59 PM #

    Mark
    Thank you for repeatedly making this point. I will admit that while I 100% know that you are correct, I still from time to time think about “How do I save this trade?” rather than simply taking the loss and starting out fresh with something I want to own. Your constant reminders about the criticality of risk management and “own what you want to own TODAY -forgeting the past” are good reminders for me. And even for someone who has been reading your blog for a while, the same message continues to be sound advice, as I am still plagued by the disease of wanting to win on every trade.
    Rgds
    TR

  4. whitefishmont@yahoo.com 10/04/2009 at 8:56 PM #

    Martin,
    I’m sure you know this, but take a look at the CBOE’s BXM. This vehicle does exactly what you’re proposing.
    whitefish

  5. Mark Wolfinger 10/05/2009 at 9:00 AM #

    TR,
    Thanks for the comment.
    It’s ok to try to ‘save’ the trade. Sometimes that is a very realistic situation and there are sound adjustments to be made.
    But let’s face it, if you traded an iron condor and the short let is ITM and the long spread is quickly becoming ATM, there’s not a whole lot you can do.

  6. Mark Wolfinger 10/05/2009 at 9:06 AM #

    Agree. Martin: the CBOE buy-write index opens positions once per month (expiration Friday) and never makes any adjustments. The underlying asset is SPX.
    If this idea appeals to you, buy SPY shares and write calls. It’s for people who want to make specific rules and stick with them with no further thought. I don’t like that idea for every investor, but it is one way to be certain that you don’t panic.
    Thanks whitefish