For years, I have touted the need to have a trading plan before entering an options trade. We writers on the site have also pointed to the need to keep some kind of trading journal to track your trades. Years ago, my trade journal identified a pattern in my day trades. Some days of the week those trades performed better than on others. How else would I have known that Monday's trades performed better than Friday's, if I hadn't kept that trade journal?
I no longer day trade other than the times when I'm using long puts or calls to hedge an income trade. My trading style has changed, and my record-keeping practices have changed, too. I've evolved a method of keeping track of my trades that works for me. My records are not as intricate as the detailed spreadsheets that some people set up, automatically updating current prices and profit-loss figures on the position. Neither are they as sloppy as the jotted-on-little-bits-of-folded-papers method that is my natural inclination.
If you want the complicated-spreadsheet format, you'll have to set that up for yourselves or look for one you can download online. A good primer on Excel will show you how to import data, updating figures. I know how to do it, but I prefer to watch my positions unfold on a graph, not in a spreadsheet. I like to write copious notes that just wouldn't fit into a spreadsheet format.
I thought I'd show my current method of setting up and tracking my trades to show you the informal format that works for me. Then I'll use my plan to discuss why I include what I include, offering suggestions for what you might include, too.
XEO Iron Butterfly with Extra Long Call, Entered 6/19/2009
Positions and Profit/Loss Graph(Courtesy of BrokersXpress)
XEO Value at Inception of Trade:
Option Volatilities at Inception:
XEO 480 Call: 18.61 percent
XEO 430 Call: 23.13 percent
XEO 430 Put: 24.61 percent
XEO 380 Put: 34.18 percent
An extra long call to hedge deltas, a suggestion offered by Dan Sheridan on a free CBOE webinar on butterflies:
XEO 470 Call: 18.84 percent
Iron Butterfly: Credit of $2060.16, including commissions
Extra Long: Debit of $69.96, including commissions
Total: Credit of $1,990.20
Buying Power Effect
Breakevens at Expiration:
$409.33 and 450.79
The VIX has again approached potential support, so a vega negative position such as a butterfly carries some risk. July has been a volatile month for the last several years. Those risks led me to initiate this with only one position. On any rally, consider buying some cheap puts to hedge against a slide down. Initiating this trade, however, fits my 2009 goal of varying trades and portfolio risks, learning trades and adjustments that can be accomplished without requiring moment-by-moment time in front of the computer.
Intended Profit Target: 20 percent of credit taken in, or $398.04. If a lower profit of 10-15 percent has been reached by the time any upcoming out-of-town appointments are scheduled, close the trade. Close the trade, if possible, by the Friday before option-expiration week, to avoid option-expiration-week gamma risks.
Maximum Loss: 25 percent of credit taken in, or $497.55. If no appropriate adjustment is available at time this maximum loss is reached, exit position.
Potential Adjustments: Adjust at or before expiration breakevens. Adjustment possibilities are limited since this is a one-lot of the butterfly. Try rolling the sold option on the bad side toward the long option. Or, consider adding a second butterfly just out of the money to extend the breakevens. Depending on how fast/soon the adjustment points are reached and market prediction, could try a long put or call option on the risk-analysis charts, to see how it looks.
On 6/22, OEX (XEO) had approached but not quite touched the downside breakeven at expiration. The trade was not down my maximum loss. I was watching for the possibility that it might need adjusting. On 6/23, two things, both unrelated to this trade, had happened since the inception of this trade that changed my outlook. Most importantly, a family member's health resulted in some appointments that were going to take me out of town. The second change was that I had since put on my full allotment of iron condors for August. Due to the heavy allotment of iron condors, my portfolio was heavily negative vega at a time when the VIX had dipped to support and might rise.
Therefore, due to the fact that I was going to have to be away from the market, perhaps for several days, and that I simultaneously needed to raise the portfolio vegas in my accounts, I decided that the easiest way to raise the portfolio vegas was to close the position. One goal of opening the trade had been to experiment with the adjustments, but I had duplicated the trade in the TOS Paper Money software and could follow the adjustments there. As the markets bounced pre-FOMC, I elected to close the live position at breakeven and watch the trade on Paper Money.
After closing, I had an $11.68 loss but still held the long JUL 470 call. I don't yet have the total of the loss and/or gain because that long call position is still open, but my loss includes the debit originally paid for that. My current small loss is the maximum loss I can now incur on the position, with possibility for profit still open. Before closing the XEO butterfly, the butterfly had a delta of 10.39 and a vega of -62.44. Therefore, I reduced both the delta and vega risks my portfolio would have if the markets rolled over and volatility increased sharply. While not fully meeting my goal of practicing adjustments on an iron butterfly, I did meet several others goals. I'm pleased to be working toward a two-year goal of watching portfolio Greeks and adjusting accordingly. I'm also pleased that I attempted the trade at all, being willing to vary my trades in an uncertain market condition.
The comments under the "Results" section were the notes I had originally written to myself, not notations for subscribers here. Incorporated in my trading plan, I want notes about all the information that went into the decision to close a trade.
You'll also notice that, in these notes written to myself, I've praised myself for some steps I've taken, even in a breakeven trade. Am I egotistical? No. Believe me, no. I tend to castigate myself over each trading decision I make. What I'm doing is what's suggested by many trading coaches: trying to refocus my attention away from my failures as a trader, if closing a trade for near breakeven is a failure, and toward some of my strengths or steps toward meeting trading goals, giving them equal attention. Sinking into the I-couldn't-even-last-out-the-trade castigations does me no good and perhaps deters my ability to focus on my overall goal of varying and managing portfolio risks so that I make my living on something other than iron condors, as I've been doing for the last several years. Reaffirming that I'm able to cut risk when necessary helps me handle my bigger lots of iron condors with continued confidence.
Every once in a while, include some positives in your trading plans or rephrase the negatives in your results. If you took a loss just before the markets changed course and no loss would have been necessary, don't castigate yourself for doing something dumb. Instead, rephrase what happened and compliment yourself in adhering to your plan. You know you can trust yourself to do that. Maybe the next time, taking the planned loss will keep you from an even bigger loss, when a trade doesn't turn around.
Most of the other notes on my written plan for this trade proves self-explanatory, but I did want to add a few comments. They'll be in somewhat random order.
First, I use SmartCapture to snap my charts both for these records and for the charts I typically use in my articles. It's quick, user friendly, and not expensive. This isn't a plug for this product, available through desksoft.com. I have no connection to that company, but Jim Brown suggested it years ago and I've used it ever since.
As the "Special Considerations" section noted, some conditions weren't prime for initiating a butterfly. However, although it's important to begin a trade with some idea of the special risks that trade might encounter, we can't always be sure that our worries will come to fruition. If I were entirely sure that markets were going to roll over and volatilities were going to rise, then my best bet would have been to buy speculative long put positions and forget anything like a butterfly, condor, calendar or double diagonal. But we can't be sure of those things.
I wouldn't suggest that those unfamiliar with the XEO or trading with smaller account sizes attempt butterflies in the XEO. Other vehicles exist with tighter bid/ask spreads and with less margin or buying-power effect. I would suggest that these be attempted with those vehicles. When I was still day trading years ago, I mostly traded the OEX, so OEX or XEO options are familiar vehicles for me. I'm used to watching their underlying. Whatever vehicle you consider, try it on paper first if you haven't traded butterflies previously.
You might notice that my written plan included the XEO's value when the trade was initiated and the implied volatilities of each of the options employed in the strategy. The XEO's value at inception appears different than displayed on the chart, but that's because the XEO was jumping around a bit when the trade was opened and had changed from the XEO value BrokersXpress listed on my trade confirmations and that showing up when I snapped the profit/loss and positions charts.
Because a butterfly will be impacted by both price movement and a change in volatilities, I want a record of both at the inception of the trade. In my January 16 Options 101 article, "Missing the Point," I counseled that those who are thinking only about price movement are missing the point. Changes in volatility of options while a trade is in play may make as much or more difference in the profitability of the trade. So, I want to make a notation about volatilities at the beginning of the trade so I can later determine why my trade is or isn't performing as I expected.
There you have it, the current plan I use for my trades in progress. I add notes when something changes in the market, and also note why I'm exiting a position, including comments about the market conditions, upcoming economic events that might impact it and lead me to exit early, something going on in my life that might prompt me to close a trade that I can't monitor, and, obviously, my profit or loss.
When trades are completed, I want some kind of spreadsheet record that totals up gains and losses in each category of trade I'm trading this year as part of my overall plan: my typical iron condors, along with butterflies, calendars and double diagonals. I do keep such a record although it may be more minimalistic than some keep for their own records.
Whether my current evolution of my written plan for my trades proves helpful or not may depend on what you're trading and how frequently you're trading. Maybe you think you don't have time for such a plan.
On Friday, June 19, when this trade was initiated, I also put on a 25-contract RUT credit spread, closed another 22-contract RUT credit spread for a profit, closed a 1-contract XEO debit spread for a (very small) profit, and closed a paper trade, too. Oh, and I editing and sent off two articles for publication in this newsletter. I still had time to jot notes and snap charts on each trade and then type the written plan after the markets had closed. However, in my day-trading days, when a moment's hesitation could mean a trade lost or a profit lost, I perhaps wouldn't have been able to snap those potential profit/loss charts. Nor would I have needed to do so, as those trades were structured differently. What I did need then was some estimate of where my underlying was going to go and where I would take profits and what my acceptable losses would be. In the last part of my day trading days, when online platforms grew more sophisticated, my total plan for each trade might have been encapsulated in a one-triggers-two trade order, with my limit order to buy an option triggering OCO orders for a stop order and a profit-limit sell order where I thought the market might head. However, in those days, I tended to start the day with a written plan that noted a possible market scenario for the day and then a conclusion about the types of trades that would most benefit if that scenario played out. If I thought the day would be choppy and range-bound, I knew I'd likely be doing more research than trading. If I thought there might be an early move but then a reversal that held for the rest of the day, I'd make my entry plans to fade an early bounce, but I'd make that plan before the market opened.
As a day trader, I didn't have the luxury of snapping profit/loss charts and jotting down long notes just before a trade entry, but I did put together a plan, in the morning, while my thoughts were calm. I wasn't wrapped up in the frantic feelings that market actions sometimes engender.
Maybe you'll look at my current plan for trades with skepticism and think that you could construct something far snazzier and better for your needs. Probably, you'd be right. So, do it.