If "Unpredictable" were the name of a movie made in the 1940s, the film would probably be an Alfred Hitchcock movie, thrilling and smart. When "Unpredictable" is the name of a men's cologne, that cologne is described as fresh and subdued.

For traders in neutral options trades when Tuesday, March 4 dawned, very little about the RUT's unpredictable movements that day could be described as thrilling, fresh or, certainly, subdued. The RUT was to jump more points that day than it had any trading day since October, 2011. It was to jump more than 3.20 standard deviations at the high of the day and to close the day about 2.87 standard deviations higher.

That kind of movement ravaged many neutral trades. Worse, the RUT gapped higher and ran up more about 1.7 standard deviations within the first five minutes of trading, before traders had any realistic opportunity to adjust. Let's look at an example from my own live trading.

When I'm performing my end-of-day evaluation of my RUT options trades, I typically test where the profit-and-loss will be the next morning if the RUT moves about a standard deviation higher at the open the next morning, with implied volatilities left the same, or a standard deviation lower, with the implied volatilities run up higher. I then make my final adjustments so that the trade will not be outside the planned max loss if that one-standard-deviation move occurs in either direction. As Monday, March 3--the day before the outsized move--closed, I performed my usual EOD tests. At that time, a standard deviation for the RUT was about 11.85 points.

My profit-and-loss line wasn't in great shape as Monday's close had approached. The RUT had been on a relentless climb off February's low, forcing me to roll my butterflies higher several times. When the RUT is climbing and you must roll butterflies higher, you have to sell the lower butterfly at a loss and then buy the higher butterfly for more money. You're locking in realized losses each time. Butterflies are flexible, but the weight of all those realized losses will eventually sink it. Plus, I was finding that with all the uncertainty in the markets--the Ukraine situation, the upcoming non-farm payrolls due later that week--decay wasn't happening normally. That was sinking the PnL line below breakeven, too. Still, the trade itself looked viable, price under the tent, still plenty of profit potential left in that expiration tent, further adjustments possible if needed.

My Trade Monday Evening, as If I Had Not Made Any Adjustments that Day:

The loss shown here is seven percent. I try to keep the deltas at +/- 5 deltas per butterfly contract, and I started this trade with 15 contracts, so the delta was within the correct range. (By early March, I had reduced the number of butterfly contracts when I moved flies as I was controlling delta and vega risk, but I still base my delta risk, profit target and max loss on the original number of contracts.) I want my max loss in a losing month at $300-350 per contract, and since I'm conservative, I really like to keep it at $300 per contract. That means my planned max loss was $4,500-$5,250, but with my preferred loss to be closer to $4,500. Sometimes, though, there are gaps and unpredictable moves in volatility, and slippage on exits that bring the loss up a little above the preferred $300 by the time I can close the trade, so $5,250 was still within the plan parameters.

During that EOD check on Monday afternoon, I rolled the date up a day. On the ONE charting platform, the dark blue column showed me where a standard deviation move would be to either side.

Chart on the EOD Check, Monday, March 3, with Date Rolled Forward a Day, Showing a One-Standard Deviation Move:

When I'm utilizing this charting program, I'm able to position the cursor at the outer edge of that dark blue column and it provides figures for all the Greeks as well as for PnL. I can't snap the picture and show the second pull-down tab to you, however, because the second pull-down tab disappears. Although implied volatilities often decrease when prices amble higher, they don't typically do so when there's a strong gap in the morning. You can see from the "0.0" value for the "Volatility Adjust" tab above the graph that I didn't roll down the implied volatilities to determine what would happen at a one-standard deviation move to the upside.

The chart tells me that theoretically, a one-standard deviation move to the upside would lessen my loss, bringing it to 6 percent rather than then-current 7 percent, with one day's decay at least partially responsible for that improvement. Theoretically, even a one-and-a-half standard deviation move (to the outside of the lighter blue column and outside my expiration breakeven) would result in a slightly smaller loss of $3,421. Theoretically, I was good with any likely upside move at the open.

Not so with a one-standard deviation move to the downside. I used the "Volatility Adjust" button to roll implied volatilities higher by 3 percentage points, a modest amount, I thought. Theoretically, a one-standard deviation gap lower would have brought my loss to $6,855 or 13 percent, well outside my planned max loss. My question then, that Monday afternoon, was whether I should abandon the trade, closing it for a loss, or adjust to control for a sharp downside move.

Since the price was well inside the tent and would remain so for both a one-standard deviation and a one-and-a-half-standard deviation move to the downside and more than a one-standard deviation move to the upside, I elected to adjust. I sold some of my call debit spreads and lowered the delta. It wasn't as positive. Of course, I had to retest for a one-standard deviation move to the upside. My test showed that the trade would still be okay in the case of an upside move.

Theoretically. It didn't happen that way, of course. Within the first moments of trading the next morning, Tuesday, March 4, the RUT had gapped up and run well past 1.5 standard deviations. Together with the changes in implied volatility in the individual options and the lack of any decay that early in the morning, my loss was well beyond the max planned loss. Seasoned traders know that it's often best to wait out the initial volatility during amateur hour and let pricing regulate. In addition, it's also hard to fire off the many needed orders to close a complex trade in volatile trading, especially when the RUT was quickly approaching 1,200 and might get knocked back, at least momentarily. The RUT didn't get knocked back, and the loss quickly grew another $1,000 as 1,200 was breached.

When you're caught in the headlights, what do you do? You don't act like a deer. I did that for an extra day once in 2010, and I feel it's incumbent on me to talk often about what happens when we face losses, using my own experiences. Therefore, as I felt was appropriate on March 4, I did wait out the initial volatility, especially since I wouldn't have been able to easily exit the trade without incurring huge slippage risks during that time. I wanted to be sure a clear market direction had been decided, and that there wasn't going to be a pop-and-drop reversal. I knew I would then be making an exit decision if the RUT hadn't turned back or losses hadn't begun regulating closer to what they theoretically should have been. Experience had taught me that when shorts were caught by surprise like that, that unless there was a reversal fairly soon after amateur hour, they were going to buy-to-cover on any small downturn to lessen their pain. Their buys-to-cover would keep support under prices. There wasn't likely to be a big retreat. I had waited to see if decay would kick in and start helping my position, although I doubted that would happen with the kind of move we were having. My decision at that point was whether to move flies again, so that the price was again under the profit tent at expiration or to take my loss, and when to take my losses if I decided to take them.

Different traders will decide differently, but if I'm at my planned max loss or if the market action takes the trade beyond that planned max loss, there is no decision about whether to adjust again. I must get out of the trade, even if an adjustment will again park the tent above the current price.

My account statement showed that my first exiting trade filled at 10:26:47, and my last one, at 11:35:08.

Exiting Trades:

I had waited until the initial push had ended and I thought it possible to exit without wide price swings. However, I had to take care in how I exited this complex trade. I didn't want to sell all my call spreads at once, for example, and then have price take off the upside again as I was chasing fills on the negative-delta butterflies. I didn't want to sell all my butterflies at once, and be stuck with positive-delta call debit spreads as the RUT turned sharply lower. Either possibility would have greatly increased my loss. As you can see, I exited in bits and pieces, closing first some of the delta-negative butterflies and then some of the delta-positive bits. My goal was to keep delta as neutral as possible while this occurred. Because the price action had been so volatile all day, I couldn't be sure that fills would be quick, so I couldn't risk selling all my butterflies and then selling all the debit spreads in a timely manner, or vice versa.

It turned out to be true that fills weren't always easy. At one point, I had to break up some of the call spreads to close them: I couldn't get fills on the orders otherwise. I had to first buy in the sold call and then sell the long call.

This is a dangerous tactic for the inexperienced options trader, but I show this list from my brokerage page and mention this for a reason. It's not to suggest that you follow my footsteps. This was a dangerous tactic, and it could have greatly increased my loss if the RUT had suddenly dropped immediately after I bought-to-close the sold call and before I could sell the long call. This is mentioned only to alert subscribers that the trader entering a complex trade composed of many parts must be aware that it's not always easy to close those positions in one fell swoop. If the only components of your trade are those making up the butterfly, it's easier to exit. If the only components of your trade are those of an iron condor, you may occasionally need to break up the call credit spreads and put credit spreads, but that's not unmanageable.

Consider this worst-case scenario of having to exit under adverse conditions before you elect to open a trade. Despite the evidence of this way outsized move (as measured by standard deviations) on March 4, always plan what your maximum allowable loss will be. Test the trade at the end of each day to determine what will happen if the underlying's price moves to next upside or downside targets, however you like to determine those targets.

And then realize that sometimes markets are unpredictable. In rare but not impossible events, your planned maximum loss might be exceeded at the open by a combination of a gap followed by moves not seen in several years. When you're planning your trade, look at what you "could" lose, not just what you plan to lose before exiting. For example, my expiration chart showed that the maximum I could lose at expiration if the RUT were outside the expiration tent to the upside was a little over $10,000.

Plan what you'll do to avoid acting like the proverbial deer in the headlight if that headlight shines right in your eyes one morning, shocking you with the danger you're facing. I could have decided the RUT was due for a pullback since it was jammed under what I had previously identified as likely resistance on daily closes. I could have decided that all that decay was likely to flow out after Friday's non-farm payrolls unless those were so shocking they sent the RUT into freefall, and even that would bring the RUT back under the tent. I could have, and some of that might have happened and did indeed happen. I'm editing this article midmorning on Friday, March 14, 2014, and I followed my trade through as if I hadn't closed it, simulating the adjustments I might have made. I did this for learning purposes and so I could report the results in this article. The theoretical loss is currently $2,061.47, or 3.24 percent of the max margin in the trade, although I of course do not know if I could have gotten timely filled on any of those simulated adjustments since I closed the trade.

What does that prove? Not a lot. That lower loss depended on the RUT moving lower after Tuesday, March 4. If the RUT had continued to move higher, I would again have had to move flies since it was getting harder and harder to extend that upside breakeven, and I would have built in a bigger unrealized loss for the trade. Perhaps I could have seen a loss closer to that $10,000 level. The markets didn't deliver a case like that for me to study this time, but it certainly did in the spring of 2010.

Something even worse could have happened. If I traded like that, one day I would lose a whole lot more money than I lost on March 4. I don't want to do that, and I don't want subscribers to do it, either.

If you got caught in the headlights and acted like a deer or even if you acted decisively but still experienced a big loss, wallow in the woulda-coulda-shoulda's for as long as you need to do so, then go back to planning. Think about what went wrong and how you might have better protected your trade and your trading account. Some of you will likely decide, as I did, that it's impractical to think you can protect your trade against all variations of outsized moves such as these, and that every few years, you're going to experience something like this. I decided that in the spring of 2010. The loss I experienced this month stung and was larger than I anticipated taking, but a $6,201.47 loss instead of an absolute maximum planned loss $5,250 or even the preferred max loss of $4,500 wasn't enough larger that it decimated either my account or my confidence in myself. If I had held onto a trade that I shouldn't have kept open, I would have damaged that confidence in myself, even if the loss was lessened, and that might have led to panicked decisions in the future or fear of entering new trades.

The knowledge that every few years we're going to be hit by some it-can't-happen-that-way event caused me to change the way I traded a few years ago. That's why I have an Armageddon put underneath my butterflies, always, and I hedge to the upside with my DITM calls and/or call debit spreads. My loss would have been huge without those upside hedges that day. Most importantly, they help me sleep at night. What options tactics could help you sleep at night? Perhaps for you, it's trading debit or credit spreads in which the risk/reward parameters are about the same, so they're set-and-go trades for you. Perhaps it's trading weeklies in smaller size so that you never have too much at risk at one time but have the opportunity to make decent money in a month's time. Perhaps it's day trading.

Linda Piazza