Trading plan. Concrete example

Hi Mark (and Dimitris),

This discussion is something I find interesting in that I'm curious
to see concrete examples of trading plans at various account sizes,
risk/reward targets, amount of experience, etc.

I find lots of people
write about an option strategy as if it could fit in for anyone at
anytime, yet clearly someone with a small net worth will have a smaller
account size paired with (likely) lower risk tolerance. Whereas someone
with a larger net worth may want to "risk" still a small size but has a
huge risk tolerance. Etc.

What might concrete trades for these
people look like? Especially if they were looking for a way to
implement plans with ICs?




I don't believe I can supply the details that you want to see.

My belief is that the vast majority of traders have no concrete trade plan, and may not even have a vague plan in mind.  These traders do whatever they deem necessary at what they consider to be the appropriate time.  This can work for very experienced traders, and it certainly saves a lot of work.  However, unless a trader makes a serious attempt at writing and using detailed plans, he/she cannot know whether it's worth the effort.

One other 'truth' that is not so obvious:  Many traders just don't make it.  They are so confident of success that they are untrained and unprepared to enter the trading arena.  For some reason, it is commonly believed that little or no training is required and that 'anyone' can make money.  There is certainly plenty of hype that suggests that riches are just around the corner.

Thus, it's difficult to reach the 'very experienced trader' stage mentioned above if you don't develop good habits early in the game.  And writing a solid trading plan is one of those habits.  Anyone can ignore the idea of using trade plans and take the easy path – but it is not the most likely path to success.  This game is difficult enough that there is no reason to take this specific shortcut.

Specific plans

To answer your question: My best guess that the plan 'looks like' the individual trader's comfort zone.  Iron condors, butterflies, diagonals, etc. can be played in many ways.  Choosing strikes, expiration dates, probability of expiring worthless, premium collected etc. allows so many variants, that the original trade is very different from one trader to another.

Then risk management – including original trade size, depends on more than account size.  The big risk management decision of when to adjust is not a constant either.  Some adjust very early, others wait until the strike is breached.  Some roll positions, others don't. Some own insurance, most are not willing to pay for insurance.  I don't see how I can provide examples of a plan, unless readers care to share their plans.

The point is I don't know how to define a 'trade plan' that could be considered either 'typical' or a 'place to start.'  The only suggestion I have is to trade the condor that feels comfortable and then keep notes in your trade journal.  Don't make these comments based on what really works this month – instead, base them on your original trade.  Did you choose strikes that are easy to manage?  Is your exposure to negative gamma and vega really comfortable?  The more you understand if the trade is manageable and comfortable to work with, then the easier it becomes to plan future trades.  As you collect data from the comments over time, you can use that information to refine your plan.

Then 'guess' where you would make an adjustment for an iron condor that moves against you and when the time comes – decide at that time how reasonable your 'guess' was.  Again, use the journal to evaluate the quality of that guess. 

At first, the plan must be flexible as you judge how well the plan is written.  As you gain confidence in plan writing, it becomes less flexible.  But it is never written in stone.  When you have a good reason (reason goes into trade journal for later evaluation), change the plan.  But, please – make a new plan and record it.  As someone new to plan writing, consider it a guideline only.  Do what you feel is the correct decision at the time.

Just remember that one purpose of the plan is to make decisions in advance and reduce the difficulty of making trade decisions under duress.  As soon as you see that the plans are fairly good at telling you what to do, then follow them.

As you gain experience writing plans, they will become closer and closer to your real world/real time decisions and you will have the confidence to rely on them.

The two major advantages for the trader who is new to writing plans are:

a) I good, upfront idea is more valuable than a panic decision – or any decision made in the heat of battle.  When markets are calmly going against you, there is time to find a good trade.  But when markets are moving quickly, that plan becomes valuable.

b) If you are a trader who has not yet (I say 'yet' because this is mandatory for long term success) learned to control emotions, then the plan solves that specific problem – if you follow it.


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8 Responses to Trading plan. Concrete example

  1. Joe 08/01/2010 at 6:38 PM #

    I heard about a saying in the options world ‘sell the meat, buy the wings’, which I believe to be short CTM options and 1 and half as many long very OTM options many strikes further away but in same expiration month. I ran different positions on the risk graph to reflect what it might look like and found the greeks to be simmilar to that of an IC but with a better pay off and possiblity of performing well in a big move event.
    Would you be so kind as to respond in a blog post or a reply as to the pit falls of this positions and how best to manage?

  2. Mark Wolfinger 08/01/2010 at 7:17 PM #

    Your interpretation of that phrase is not the usual one. It’s a very flexible term and can be used to describe any butterfly or condor trade. It also describes trading credit spreads.
    It means: sell options and buy options that are farther OTM than the options sold. It does not mandate buying extra options, nor does it suggest that the options bought have to be ‘several strikes’ removed.
    A single farther OTM strike is sufficient. However, much farther OTM is also within the definition of ‘sell the meat; buy the wings.’
    Will discuss in a post this week

  3. davmp 08/02/2010 at 2:32 AM #

    Hi Mark,
    Thanks for the response! I do appreciate the answer (as I do create plans) but I believe I may not have worded my question as accurately as I had thought. The discussion I was referring to was more along the lines of what indexes, ETFs, or other underlying, to use if wanting to trade ICs efficiently at various account sizes?
    For example, for a rookie perhaps its best to start with real money trading using IWM because of it (a) being an index ETF, but (b) being capable of doing $1 spreads instead of $10, $25, or more, thus requiring less margin. However, seems to me that you’d want to avoid using this for trading anything but real small account sizes as the commission cost gets pretty unwieldly pretty quickly, right? But I know there are other factors that go into picking an underlying, such as volume, and thus I’m wondering if (1) there are aspects that haven’t occurred to me that I should be taking into account, if (2) you had recommendations for what to trade at various account sizes, or (3) whether readers cared to share what they’ve found to work well.
    As another example, prior to your posts on using wider spreads, it hadn’t really occurred to me that you could reduce lot sizes (by half), and thus commissions, by trading wider spreads while keeping risk the same. Is this just a more efficient way to trade larger account, or am I missing something?
    Would it make sense to combine the wider spread idea with trading IWM to scale up your ICs as you build up your account size? Or maybe there are simply characteristics of using 10 point spreads on IWM that make it attractive in some situations over a 10-point spread on RUT?
    BTW, it is ‘davmp’ rather than ‘dvamp’ 🙂

  4. Mark Wolfinger 08/02/2010 at 10:46 AM #

    Apologize for incorrect name
    1) The negatives to using IWM are: increased commissions and American style exercise. The latter is not a problem for many traders, but I prefer the ease of cash-settled options.
    However, the positives easily outweigh the negatives for the small trader. The primary advantage occurs when making adjustments. When trading one- or two-lots of RUT, it’s essentially impossible to adjust (unless you adjust with IWM options).
    But there is no good reason to trade 50 or 100-lots of IWM when 5 of 10 RUT options save commission dollars.
    This holds true for SPX/SPY and NDX/QQQQ trading.
    2) Ten one-point spreads is the same as one 10-point spread. Margin is the same.
    3) Volume is not of any concern when picking the options mentioned. All of the indexes and ETFs have enough volume to allow easy trading. If you move to obscure ETFs, then that no longer holds true.
    4) If you are comfortable trading the specific underlying, that’s the main deciding point. For example, if you believe large cap stocks are more representative of the positions you want to trade, then avoid IWM/RUT and choose SPY/SPX.
    Same for specific stocks. There is risk involved when trading a stock, rather than an index, and ‘news pending’ is always a more risky time. Be aware.
    Other than those items – if the volume in the option meets your needs; if the bid/ask spreads are acceptable (i,e., the spreads are tight or you can easily trade between the bid and ask prices), then you should be okay with whatever you choose to trade. No special secrets or hints here.
    5) Yes, you can halve commissions etc, but a 20-point spread is not exactly the same as two 10-point spreads. It’s similar – but one of the spreads has different strikes.
    If you prefer to trade the 900/910C spread, then trading the 900/920 is fairly similar, but it’s not the same. It’s one of your preferred spreads, but it’s also a 910/920 spread.
    This is a way to cut trade expenses, but the positions are not identical.
    6) A 10-point spread in IWM is not even remotely similar to a 10-point spread in RUT. It would be similar to a 100-point spread in RUT.
    Look at it this way: The wider spread is composed of two or more narrower spreads. If EACH of those narrower spreads is something you want to own and trade, then go ahead and use the wider spread. But DO NOT use this idea as a cost reducing process. You would be trading different spreads. And that’s a big decision. It’s not a bad idea – but neither is it something wonderful. Don’t trade something you don’t want to own just to reduce commissions.

  5. davmp 08/04/2010 at 7:44 AM #

    Re (5) What is different between a single-lot, 20-point spread vs. a two-lot, 10-point spread? The things I’ve thought of so far are:
    (5a) You only need a 10 point move to lose it all for the 2-lot, whereas it takes a 20-point move to lose it all on the single-lot.
    (5b) It seems to me that the risk amount in dollars is the same.
    (5c) The inflection point between losing vs. gaining is the same (certainly at expiration this is true, though perhaps not prior to then.)
    (5d) I believe option prices won’t be the same and thus max profit, or any profit actually, won’t be the same if you had made the exact same decisions in each instance.
    (5e) It also occurs to me that method of adjustment won’t be quite the same either.
    But all of those should be pretty close, right? Or am I missing something obvious?
    Re (6) – apparently I had a typo as I only meant margin-wise, 10 points on IWM should be equivalent to 10-points on RUT. I understand that RUT would need to move 100 points to move through that 10 point spread on IWM, whereas it only needs to move through 10 points for the trade directly against RUT.
    Thanks for your continued discussion!

  6. Mark Wolfinger 08/04/2010 at 8:30 AM #

    I don’t see the point you are making.
    Equivalent positions are equivalent. Sure, trade execution is better when trading just one spread, rather than two, but that’s not the point.
    If your 20-point spread is the 560/580 and if your two 10-point spreads are 560570 plus 570/580 – then the positions are equivalent with same risk, reward , inflection point etc.
    If your two 10-point spreads are any other combination, or even when they are two of either of those spreads, then the positions are not equivalent and cannot be compared as you are comparing them.
    10 RUT points is almost equivalent to 1 IWM point [Likewise, 100 is equivalent to 10].
    [Almost because IWM is supposed to track RUT, but misses by a small amount].

  7. davmp 08/05/2010 at 6:42 AM #

    Hi Mark,
    Ah, I now see the point you were trying to make earlier – I had ASSUMED that in comparing a 20-point RUT spread to a 2-lot 10-point RUT spread, that we were already comparing 560/580 to 560/570,570/580. I see now that in your earlier point you weren’t assuming that, thus why you said things were not equivalent.
    I’m not following why you can’t compare a 2-lot 570/580 vs a single lot 560/580. They aren’t equivalent, but certainly you can compare them and figure out in what ways they will differ. I’m guessing that your use of “compare” was thus a typo. Anyway, it is this difference I’m trying to make sure I understand.

  8. Mark Wolfinger 08/05/2010 at 7:56 AM #

    I was referring to the same thing you were. However, without specifically stating what you meant by ‘two 10-point spreads’ I did not want to make any assumptions.
    Yes, you can compare two different plays. The 2-lot of 570/580 has a higher probability of earning a profit, and that profit is smaller. There’s not that much else to compare.