Many had a rough trading day on Friday. Let's talk about another rough period not so long ago. Monday, January 13 exploded with big intraday moves on the RUT and many other indices.
Intraday Chart of the Russell 2000:
The RUT broke down out of that tight channel. At its low of the day on 1/13, the RUT was down almost 2.4 standard deviations or about 1.9 percent off the close on Friday, January 10.
My Live Trade near the Close on Friday, January 10, after Adjustments:
This is a February bearish butterfly trade (15 contracts), a butterfly placed with its central strikes below the money when the trade was first entered. It was hedged with various call debit spreads to manage risk to the upside. That day's adjustments had been to add the 2 FEB 1150/1170 call debit spreads. That adjustment was made in accordance with my adjust-by-the-Greeks approach. On the Monday that followed, of course, I wished I hadn't added those extra debit spreads and had in fact taken off some of the ones already in place, but I of course had no crystal ball.
For those not accustomed to reviewing these types of charts, an explanation can be found in last week's archived Options 101 article. What we can tell from the shape of the curvy line that shows "today's" profit-and-loss is that the risk was fairly well hedged, however. The RUT could theoretically travel a number of points without too much damage to the position or the Greeks. Let's see what happened that following Monday.
My Live Trade near the Close on Monday, January 14:
For some reason, the reddish whoosh along the today's PnL line does not accurately portray the RUT's path that Monday. It certainly didn't drop from above 1300.
Ignoring that whoosh, the trade shows that the unrealized profit has decreased from Friday's level. After adjustments, the day ended with the delta somewhat positive, as you can see from the pulldown below the graph, but it's positive by an amount that's okay by the guidance of the trading plan I employ. Because I know that the deltas are actually more negative than TOS shows them to be, and this graphing program is currently drawing its feed from TOS, I know that the delta is likely somewhat negative rather than somewhat positive.
I was comfortable with the way the trade was positioned at the end of the day after the adjustments. That big drop had required me to drop some of my call debit spreads since the delta had grown way too positive without that action. If the RUT had continued dropping the next day, the trade would have suffered a big and growing loss. The sidebar on the left side of the graph shows that I paid a price for selling those debit spreads that day: together with the two-way commissions, the trade now shows a realized loss of $1,611.91. That's from selling the call debit spreads for less than I paid for them.
We know what happened Tuesday. The RUT gapped higher and kept on running, right back to where it had been Friday afternoon. You know what I had to do, don't you? Yep. I had to buy more call debit spreads after I'd dumped some the previous day. And, of course, they cost more than they had when I sold them because the RUT was running higher.
My Live Trade near the Close on Tuesday, January 14:
And there it went, my accumulated unrealized profit. The realized loss went up because I paid commissions to buy more call debit spreads. I didn't like this action at all, as you can imagine. Since the RUT had stayed within the expiration breakevens of this butterfly the entire time, I had a moment of wishing I'd just ignored the trade guidelines I follow.
But only for a moment. I've backtested this trade and I know it works for me. I know that during my backtests, there were many instances such as these when I'd be buying and selling the same debit spreads when the RUT experienced volatility, and the trade had survived the experience. What is important to me is that I can position the trade so that I don't stay awake at night worrying about what might happen at the open the next day.
I'm going to pay a price because I want to keep that profit-and-loss line flat enough that I can sleep easily at night. That price is an actual cash price in realized losses. That price is also more time to let the trade again accumulate profits. This trade is slower to unfold than many. So, although I had my moment bemoaning the adjustments I'd made that didn't turn out to be necessary after all, it really was just a moment.
This article is not meant to promote a specific way of trading. In fact, since I want to keep my PnL line so flat, I also pay a price in lower returns on my investment than most active traders would like to receive. The point is that, whatever a trader's plan is, that trader must have confidence enough to put it into effect when needed, to stay in the trade long enough to let profit accumulate, or, alternately, to close down the trade when the planned maximum loss is reached.
For example, Dot Hazlin, writer and developer of the current Couch Potato trades, sent out an email on that Monday noting that the open SPX Weekly Credit Spread position had been stopped out. When Dot sends out a suggested trade, her guidelines include setting a OCO (One Cancels Other) order to close the trade either when the profit limit is reached or when the max loss triggers the stop. That trade had been for a put credit spread, and I think we can all imagine that Tuesday's reversal would have rendered the trade okay or perhaps even profitable.
That's not the point. The trader who relies on the belief that prices will or "have to" reverse will be the trader who eventually loses a big chunk of money. Because there's less time to recover from an adverse move in a weekly trade, Dot encourages subscribers to be vigilant about exiting trades that aren't working. She counsels, as do I, that losses are never fun but are part of trading.
Action such as that seen on Monday, January 13 and Tuesday, January 14 are part of market behavior. They can require adjustments that cost money and then turn out not to have been needed. They can even cause us to exit a trade that would turn out to be okay the next day. Instead of lamenting the action you took, pat yourself on the back when you adhere to a trading plan. You gave yourself a better chance of keeping your trading capital in the future.