Trading Mistakes: Did You Make One? How can You Tell?


Sorry to be off topic a bit. But the only way I learn is by putting
money on the line, making mistakes and not doing THAT mistake again. Got
caught in a squeeze, extricated myself with considerable difficulty.
Licking my wounds right now.

A few days ago when you or somebody else said
"Waiting for expiration is so retail" is absolutely right. What
shenanigans they play, I gotta hand it to them. Had a sleepless night 2
days running yesterday & day before wondering if I would be
assigned. I should have taken the 70% of premium.

Chalking this to

Is this why you dabble in RUT only? I was thinking of dabbling in




Hey Amit,

You are never off topic.

I trade a single underlying for only one reason – a reason that may not be applicable for others.  If I get into trouble, if the market is going nuts, I want to have as few decisions to make as possible.

Even if planned advance, three underlying assets may be responding to the market situation differently.  I don't want to take too much time to put out fires.  I want to be efficient and quick.  Thus, one underlying asset.

Yes, it's a bonus that RUT is a European style option that settles in cash. SPY options are American style and settle in shares.

Per your opening paragraph: I want to play Devil's Advocate: 

Your plan is not efficient because:

a) How do you determine when a mistake was made?  Because you lost money or could have made more money with a different decision?  This is a terrible method for deciding if the action taken (or not taken) was a mistake.

Just because exiting at 70% of the maximum profit would have been a good idea this time does not make it a reasonable strategy.  I surely hope you agree with that statement.  The only thing you learned is this:  This time, this one time, exiting at 70% would have worked best.  

Now examine 99 similar occurrences, and when you have 100 examples, then you can decide on an exit strategy.  That means you must keep a trade journal and record each trade.  Keep tabs on what action would have achieved the maximum profit.  Keep track of your actual decisions.  Eventually you will have a clue about what to do.  Act accordingly when trading.  Just remember that no valid conclusions can be drawn until there are a significant number of data points. Be ready to modify your methods as you gain experience and have many more trades under your belt.

b) You can draw no valid conclusions from a single data point.  Doing so is dangerous.  In fact, it's a mistake.  If you want to avoid a mistake, here is an opportunity to avoid one.

Suppose riding the position to expiration would have worked this time.  Does that mean you would feel differently about waiting for expiration to be 'so retail' (nice phrase; not mine)?

c) It takes repetition and statistical evidence before you can draw valid conclusions.  This is even more true for inexperienced traders who don't have a background of many trades to use as a filter for the decisions being made.  Do not decide that something that resulted in a loss is a mistake.

d) You should recognize a mistake when you make one: You took too much risk.  You traded too much size.  You traded too little size because this situation was special and 10 to 20% more contracts would have been justified.  You got too greedy. You were far too cautious for no good reason. You ignored your trade plan for no valid reason.  You felt uncomfortable with position risk (more sleepless nights?) and did nothing to alleviate the risk.  Those are mistakes.  Even if the result is a huge profit, these are mistakes.

e) If you sell premium, you will get caught in squeezes.  Your job, as a risk manager, is to anticipate the squeeze and alleviate some of that pain in advance.  You may decide to reduce the effects of a squeeze by reducing position size.  You may exit the trade and eliminate the risk of a squeeze.  It locks in a loss?  Who cares?  You know some trades will lose money.  Minimizing those losses is NOT a mistake.

Your job is not to hold on to a bad trade stubbornly, hoping for the best.  Your job is manage risk well.  Succeed at that, and most of your 'mistakes' will disappear.

You will take losses.  The market will move in a manner that does not suit your hopes or expectations.  These are not mistakes unless you missed the obvious and refused to take appropriate action.

Sometimes, the market will behave in a manner that suits your positions.  That makes you neither a good trader nor a genius.

Recognize the facts:  You will win some and lose some. If you manage risk well, you are doing your job.  If you lose money despite taking good, appropriate action, you did the right thing and it is not a mistake.

One more point: Unless you are short OEX options, why are you afraid of being assigned an exercise notice?  Early assignment reduces risk and is often a gift.  If that assignment would result in a margin call that you cannot meet, then your positions are far too large. Assignment is nothing to fear.



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15 Responses to Trading Mistakes: Did You Make One? How can You Tell?

  1. amit 07/15/2010 at 10:27 AM #

    Please let me think and post after awhile. Your writing output is enormous!
    Thanks for your thoughts

  2. amit 07/15/2010 at 5:40 PM #

    I understand why you deal with RUT.
    Responding to your points
    a) This time and every time, it was terrible of me to keep on hoping for more money while ignoring that there is strong possibility of strike gyrations in last 10 days of trading.
    Yup, I am keeping a journal. Doing a single contract, doing 3 contracts etc. Testing my appetite for risk.
    b & c) I couldn’t risk waiting for expiration as I don’t know how high they would milk it. I will now wait for expiry only if is more than $4-7 of bottom leg of call spread, and market is poised to go low. But I like your suggestion of closing the trade and avoid sleepless nights.
    d) Agree I did too much size. But few of my positions were underwater for long time in recent market rally of June of S&P to 1140, but they were September’s, and I could ride out the storm fairly comfortably. I closed one at break-even and one at slight profit. This was first trade in dealing with and understanding expiration dynamics. I won’t dabble in it until I get some more confidence back. I was afraid of a irrational gap up after INTC results, considering what happened with AA and CSX. This happened twice so I moved to eliminate risk and take certain loss instead of uncertain loss ahead. S&P has floated up and up and up, so it was my worst case thinking.
    e) Yup, next time I will go for more time to ride out the squeeze. Right now I am underwater in two more trades as it is trading slightly above the bottom strike prices, but they are August’s so there is still some time to recover. No earnings scheduled before August expiry for one position and a earnings in 2 weeks for the other.
    I prefer big time stocks in S&P above $100, and I can’t even short one hundred shares. (You get the size of my account right?) This removes acquisition risk and the resulting gap ups. No medical stocks ever, got burnt once in JNJ long time ago. No Financials either.

  3. amit 07/15/2010 at 5:55 PM #

    How would a trader like you decide to do early exercise? Say you bought calls when they were trading in the 1.0 -> 2.5 range, now underlying has risen so that calls trade bid-ask at 4.0 -> 4.8 and there is strong possibility of it going higher. Also assume in another case that they trade 6.0 -> 7.0 range.
    What would make you wait for early exercise till Wednesday morning, Thursday morning, Friday morning of expiry week as a trader? Assume you have cash to buy all contracts. The time value is negligible, and theta is eroding it fast. Would you change your mind if the risk-free interest rate was say 8% and not 0-1% as currently? Is that rate a huge factor for 2-4 days anyway?
    I read some books where a bunch of math says except for dividend paying underlying, American == European. Early exercise is trending to impossible.
    Personally, if I was the call buyer and I had bazillion money, I would not offset the calls as the spread widens and they play games. I would choose early exercise sometime on late Wednesday or anytime Thursday to remove option spread slippage, so I buy underlying at the strike price and immediately sell it to lock in profit, because underlying spread is narrower than the option spread.
    Very interested in your reply.

  4. Mark Wolfinger 07/15/2010 at 6:33 PM #

    There is the possibility of strong gyrations at any time. But as expiration nears, the effects of negative gamma increase. That means you make and lose money much more quickly.
    For me, that’s far too much risk. I prefer to make/lose money more slowly. I have more control and don’t have to depend on good luck.
    Holding positions in which the short options are already ITM is high risk. I am not telling you that you can not or should not do this. But it seems to me that you don’t do much in the way of risk management, and simply allow the markets to give you what it gives you. It’s your right to do this, but once again, luck will play a big role in your overall performance. Winning traders understand the necessity of taking losses to prevent large losses.
    I can see that you are trading too much size. That is often a mistake. I wish you well

  5. Mark Wolfinger 07/15/2010 at 7:06 PM #

    This is a very easy question.
    But the discussion is lengthy.
    I’ll post on this topic (yet again) soon.

  6. rluser 07/15/2010 at 9:01 PM #

    Amit writes “I moved to eliminate risk and take certain loss instead of uncertain loss ahead.”
    This to me is an important quality and one which I have recently become concerned I may lack. It is confounded by the absolute risk experienced at any moment, which I have always kept extremely small relative to portfolio size.
    That and lack of time have sadly kept me from persuing or expanding some boundaries of my comfort zone. I have had to shift strategies to cope with the lack of time. Any hints on dealing with time constraints would be appreciated.
    Amit, imo, should be commended for recognizing the known pain is better than the possible pain, particularly when it is probable.

  7. Mark Wolfinger 07/15/2010 at 9:57 PM #

    I agree, that’s a necessary quality for a trader.
    You seem to have passed over the part of Amit’s message where he states that he is holding iron condors with the short option already ITM. That is not the signature of someone who pays careful attention to risk management.
    Obviously he should adjust according his how own comfort zone.
    Lack of time makes it difficult. It certainly steers you more into the investor camp than the trader camp. Can you live with that?
    If not, can you get 15 minutes at lunchtime to look at portfolio? I advise as few positions as possible under these conditions
    Obviously this is okay if you want the risk of covered calls or naked puts. Too much risk for me.
    Iron condors do require watching. There is not much you can do about that.

  8. amit 07/15/2010 at 10:03 PM #

    Its a bear market! My timing was horrible, but previously when I was on the pure buy side, the waiting game was eroding value. Here I am just waiting for it to fall by $1 from today’s price in 35 odd days, then I will use your principle and get out. Even if the stock gaps up, it doesn’t go beyond the range that it won’t pull back. The bear market dictates that. They are busting the shorts that way. I don’t average up or down nor do I adjust. I just wait for the theta decay, and will close out at slight profit or slight loss. I admit I might be doing things foolishly in doing more size.

  9. amit 07/15/2010 at 10:09 PM #

    I don’t do ICs, I just do bear call spreads. They have enormous staying power if you have time left and the short call is decaying faster than the long call. I don’t want to do ICs because of the commissions and because I deal in stocks, so the fills will be horrible for a IC. IMHO, IC is probably best for the indexes, am I right?

  10. Mark Wolfinger 07/15/2010 at 10:18 PM #

    You may certainly trade short – as if it were a bear market. I don’t want to wager on that right now.
    It’s not my principle. It is not anything I ever recommended.
    Amit, I’m not sure if you are understanding my points.
    I make suggestions based o my experience. Suggestions that fiy my comfort zone. You should trade with a plan that suits yours.
    This trade for example. I would never suggest that if stock falls by $1 you should ‘get out.’ I don’t even like that idea.
    What I would have suggested is to be out before allowing the position reach one point ITM. There’s a huge difference in those ideas.
    What do you do, if while waiting for the stock to fall $1, it rises by $3 instead? It’s just a question. I am not seeking anything but a reply.
    There are always stocks that move higher in a bear market.
    Not adjusting and collecting theta is one way to play. In my honest opinion, it is a very poor choice, but that is an opinion based on many ears in the market. I played that game at one time. Thought I was a hot-shot, It is also the opinion of the vast majority of professional traders – with no risk management plan, you cannot expect to survive very long.
    The problem with size is that one trade can destroy your whole account. Are you willing to take that risk? If yes, then so be it. I merely ask
    Question: How long have you been trading options, if you don’t mind my asking.

  11. Mark Wolfinger 07/15/2010 at 10:53 PM #

    OK bear call spreads.
    The short call ALWAYS decays faster than the long call. That’s why the spread works. The only time the long call decays faster occurs when it is closer to being ATM, and that means that the short is already ITM.
    If that is why you believe this spread has ‘enormous staying power’ it’s not a valid reason. That’s equivalent to saying a bear call spread can be held a long time because theta is on your side.
    I suspect you are very new to trading. You love theta – as do we all – but you have not learned to respect gamma. Gamma is a much bigger enemy than theta is a friend.
    If commissions are a factor in your trade decisions, you are using the wrong broker.
    I have no statistical evidence, but I believe an IC is easier to trade in an index. There is a large selection of strikes, and that’s a good thing.

  12. amit 07/16/2010 at 8:47 AM #

    You are right, I am a newbie. Honestly I never did anything but buy options before I was wiped out in bull market of 2003.
    Your reply is pushing me to be thinking very much over my current strategy. Thanks for the friendly warning. I will think over the weekend.

  13. Mark Wolfinger 07/16/2010 at 9:26 AM #

    You are asking good questions.
    You are trying to make reasonable decisions.
    BUT – you have no experience. Thus, all that you are doing wrong is forming conclusions based on too few trades.
    Learn as you go. Keep good notes of your thoughts. But don’t draw ‘valid’ conclusions so quickly.
    Experiment, consider using a paper trading account in addition to a real money account, to try out new ideas.
    Keep asking questions, but don’t jump to conclusions. I can offer guidance, but please: My ideas are not gospel. They are opinions based on a lot of experience.

  14. amit 07/16/2010 at 9:35 AM #

    How much does TK charge for 1,2,3,4,5 contract credit spreads?
    Is it
    $5 + (0.65 x 2 x 1) for 1 contract
    $5 + (0.65 x 2 x 2) for 2 contracts
    $5 + (0.65 x 2 x 3) for 3 contracts
    $5 + (0.65 x 2 x 4) for 4 contracts
    $5 + (0.65 x 2 x 5) for 5 contracts

  15. Mark Wolfinger 07/16/2010 at 10:16 AM #

    It is $5 per series. Plus $0.65 per contract
    Thus, a credit spread is
    ($4.95 + .065 X # of contracts) X 2
    An IC is (4.95 + .065 x # of contracts) x 4