Option Investor
Educational Article

Is It Over Yet\?

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That's the question most investors want to know. Is the selling done or am I going to see my account balance dwindle even further? I think most of us realize that those great few months of non-stop upside movement are over and many of those internet companies that we thought would make us millionaires are all distant memories. The days of wishing the market back up, or the phrases of "it can't go any lower," or "just keep buying the dips" has caused lots of pain to many people. And this bear market has not only caused pain to the investors who got swept up in the speculative craze of dot.mania, but to those investors who are close to retiring and want to start tapping their IRA's. The blue chips that you never want to sell also have been decimated by this monster. I believe it has affected all of us in some way or another. If you trade for a living and the markets are your sole source of income, you know how bad it's been over the last year.

So what are we going to do about it? Well, let's just say that we've all been taught a good lesson. I know some option traders who have only been trading since the 90's bull run and have never experienced a downmove such as this. We learned that the markets can't go up forever and that eventually you must take some profits or hedge your gains with downside protection. Even for those people who consider themselves "buy and holders," it doesn't hurt to take a little profit. I too have my "buy and hold" accounts, and they have lost a ton of value also. Nothing has been immune. I'm just glad I still have some years left to try to recoup some lost value.

Being a commodity trader at heart, and that still being my main source of income, I've learned there's a world of difference between what influences commodity options versus equity options. In the world of physical commodities, supply and demand is the driving force behind all price movements. Not enough rain in the summer - then soybeans go up. OPEC raises production - crude prices go down, a freeze in South America - coffee prices go up. It's all supply and demand.

Equity options are a whole different ballgame. You've got so many outside influences that can affect the prices of stocks. Will the Fed raise or lower interest rates, will the company issue good or bad earnings, will the company issue a warning, what are the analysts saying, takeover rumors, day traders moving the markets, etc, etc. You've got so much to take into consideration. This isn't a recommendation to trade commodity options over stock options, it's just a fact that trading stock options isn't easy.

So getting back to the question of what we're going to do. I've decided that for me personally, when I want to trade stock options, I'm only going to trade the indices. SPX, OEX, QQQ, DJX. You can have just as many big movements as individual stocks, but you will never be exposed to the damage (or lucky gain) by those nasty gap moves that individual stocks are prone to these days. Since the indices are made up of many different stocks, they aren't affected nearly as much because an individual stock got downgraded or released bad earnings.

I know that every option position I take will be hedged in one way or another. I will only put on spreads at this point. Whether it is an outright call spread or put spread, debit or credit spread, calendar or straddle, etc. No more of these long calls that are held onto until expiration. We've seen profits built up, just to be lost within a few days time. None of that! I will be taking any profit from now on. The greed factor has caused many accounts to be wiped out. If your option position is showing a profit, how long are you planning on letting it run? Is it up 100%? Then take the gain. You don't need to wait until expiration. Are you waiting for that 1000% gain just so you can tell your friends about your amazing trading prowess? Don't get caught up in that. Taking small gains time after time will build up an account very nicely.

Of course, the hardest part is taking a loss. Nobody wants to admit that they were wrong and take a loss. The bottom line of trading is whether you made money or lost money. Unfortunately, if you lose money, then most will deem themselves a failure. I believe that is the biggest obstacle to overcome when trading the markets. It's the psychology and emotional aspect of trading that keeps us in the game too long with a loss. You just don't want to admit that your prediction of stock movement was wrong. And then there's the time when you did follow your stop-loss rules and closed out with a loss, only to see the position turn around on you. Yes, that does happen. But how many times has that happened when you decided to stay in the position until the very end? Not many I bet.

I just recently had a position on with some long puts on SUNW. I bought some to protect my long stock and some extra to try to gain a little from the downside moves. I had a gain in the puts until SUNW made a retracement back up. The puts became almost worthless and I was somewhat upset that I hadn't sold out for a profit. But I held on anyway only due to the trend of the market. Well, I got lucky this time because the market once again turned lower and my puts became profitable once again and I immediately sold out for a gain. Yes, it did happen this time for me, but this was once for about the other fifteen that I held for a complete loss.

We all think we're different and that it won't happen to me. Well, if you've been in the market over the last year, then chances are some of your portfolio has dwindled. If you've been buying puts for the last year, well congratulations then and I commend you for your fine trading abilities. I'm in it for the long haul with long stocks in my retirement accounts. This has been the way to generate wealth in this country for the last century. I'm not going to go against that trend. But I also make my living trading the markets, so I need to execute the trades that will give me the best return. Always hedge a trade and take a profit or cut a loss short. You'll see.

Next time I'll start up with a few sessions of specific trading strategies.

Until then...good luck.


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