In last week's Options 101, Which Is Better?, we looked at the decision-making process someone might have undergone on Thursday, June 7. The article discussed the choices a bearish SPX trader might be considering if that trader thought the SPX was topping out.

Those decision-making inputs would have included how certain the trader was about direction and how long the trader thought the anticipated move would take to unfold. The inputs also included how much money the trader wanted to commit to the trade and whether the volatility levels suggested that a straight put was a better trade than some kind of spread trade.

The article set up several potential trades with the intention of following through with a price check about a week later. I checked the prices on each setup midmorning on Friday, June 15, 2012. That would likely have been a reevaluation day for any bearish trader.

The previous Thursday afternoon, prices had been dropping heavily into the close. The SPX threatened to break through support when suddenly prices started strange and violent gyrations. Rumors began circulating that a coordinated response was being talked about if the Egyptian, Greek and French elections unsettled the markets over that upcoming weekend. Shorts started covering, an event probably worsened by the fact that Friday morning, settlement value would be established for SPX traders. By the time that Friday morning came around, traders were reassessing weekend risk.

They also knew that by the next week, the JUL options would become the front-month options. That would impact pricing and the way value held or didn't hold. Traders had no way to anticipate exactly what would happen over the weekend with those elections and exactly how central banks would respond and exactly how markets would respond to their response.

Some bearish traders might have elected to close their trades, even though all the choices outlined on June 7 were then losing money. Let's look at those trades and see how much the trader would have lost since the June 7 entry. Remember that I'm doing this in live market conditions, when the SPX is moving, so the SPX's pricing and implied volatilities will be changing as I'm uploading charts. Some will show one value and some, another.

First, let's look at a chart comparing the prices of the trades on June 7 and 15. The chart includes the theoretical losses that would have been incurred for each strategy, with these prices collected midmorning June 15. These are of course theoretical prices. I did not attempt to execute any of these trades, so I can't guarantee that these exact prices were available. Since we're not backtesting a specific strategy to determine our profits and losses over a period of time, I have used mid-prices and have not included commissions. This is not, however, the way you would want to backtest a strategy you were considering employing, as I mentioned last week. Also, please forgive my lack of chart-making skills in advance.

Table Comparing Strategies:

For newbies, ITM means "in the money," and ATM means "at the money," etc. I have calculated the percentage based on the margin or buying-power effect. That's easy enough for the straight put purchases. For the call credit spread, however, the margin or buying-power effect would be the distance between the strikes x $100 multiplier - credit taken in: 10 x $100 - $586 = $414. The percentage loss as I've calculated it would be $89/$414 x 100 = 21.49 percent. Similar calculations were made for the iron butterfly, a strategy in which the trader receives a credit. It is obvious that none of those bets would have paid off from June 7 to June 15. That includes the non-directional iron butterfly trade I threw in last week, as an example of the case in which the trader thought markets might turn lower (but not tank, since that wouldn't be good for a butterfly trade) but wasn't confident in that outlook.

The ITM put fared the worst as far as dollars lost, but not in percentage of buying-power tied up in the trade. Does that loss mean that a trader should never buy an ITM option to make a directional bet? Not at all. Day traders, for example, might want an option that's going to trade in lockstep with the underlying. McMillan in Options as a Strategic Investment recommended that day traders trade with deltas as high as they can afford.

I chose the JUL 1360 put for our ITM example because it was the first put with a delta below -70 (absolute value above 70) in the JUL chain. When I day traded, I liked to have options with absolute values of their deltas being at least 70.

If this trade had gone the right direction from June 7-June 15, that ITM put's price would have moved more in concert with the SPX's move, and the dollars gained would have been greatest with this strategy in this time period. Over a longer time period, the butterfly might have made more if the price change had been small.

As it was, the direction wasn't the right one during that time period from June 7-June 15, but the ITM's percentage loss is not much more than the ATM's option. The person trading these options would have needed to have set a maximum allowable loss when entering the trade and, barring a gap that surged past that level, stuck to that maximum loss plan.

The iron butterfly was down only a little over 11 percent. Some butterfly traders plan to collect 15-20 percent on their trades, so would feel that an 11 percent loss was an acceptable loss during the trade, not requiring the trade to be exited. Was that a wise decision on Friday, June 15, 2012?

Of course, now in hindsight, we know what happened and can answer that question. On June 15, however, no one could tell what was going to happen after the elections in Greece, Egypt and France the upcoming weekend. What the trader could do was use all possible analysis tools to try to make a decision. Because this article was roughed out that Friday, June 15, we're able to see what the trader would have seen that Friday.

For example, let's take a look at the T+0 chart for the iron butterfly. For newbies, this is a chart showing how a trade will perform a certain time period away from the current day since the "T" stands for "today." A trader examining risk June 15 could have--and should have--rolled the date forward to the following Monday, trying to determine what might happen if the SPX were to gap higher when trading opened that next Monday, which would have been June 18. The upside move was causing the loss from June 7 to June 15, so it was a gap higher that would be problematic.

Iron Butterfly T+0 with Date Rolled Forward to 6/18:

The red dot is positioned at the SPX's price midmorning on Friday, June 15, and the date is rolled forward to June 18. When this chart was snapped Friday morning, the price had already begun rolling down the right side of that hill, a hill with a fairly sharp slope. Losses were going to accumulate fairly quickly if prices moved higher.

This isn't a chart I would want to see if there were danger of prices gapping higher the next trading day. As of June 15, unrealized losses have been small. The bearish trader has a new decision to make. What is that trader's outlook now? Is it worth it to adjust the trade and commit more money to it? Possible adjustments might include rolling up some of the strikes on the call side of the butterfly, rolling up the entire call side, adding another iron butterfly ATM or selling the current butterfly and repositioning a new one ATM. That decision of whether to adjust and what adjustment to make will result in different conclusions for each trader, depending on the funds left to commit to a trade, the trader's risk tolerance and the trader's overall outlook.

Normally when I look forward to determine what might happen if markets climb, I roll implied volatilities down. I didn't do so in this case. Especially when markets gap due to market news, implied volatilities might not drop immediately.

What about the spreads? They've each lost a considerable percentage of the margin or buying-power effect, but the actual dollar amounts have been small. The put debit spread, for example, had a cost of $400 but a profit potential of $600. With defined risk and reward, is it worth it for the trader to keep that trade open? What if the trader had a stop-loss planned at 30 percent of the original investment, so at about $133? Could that trader endure a gap higher on Monday, June 18, while waiting to see if the markets would instead drop and the trade work?

Point Where Put Debit Spread Theoretically Incurs $133 loss on June 18:

Sizing requirements cut off some of the legend below the chart. The red dot is positioned at about 1349.87. That's the point at which the trade would theoretically incur a $133 loss, with the SPX at 1335.50 and up 6.40 at the time the chart was snapped on Friday, June 15. Of course, with the benefit of hindsight, we know now that the SPX closely approached that level on Monday, June 18, but didn't quite hit it. On Friday, June 15, our theoretical trader did not know what might happen and had to make a judgment call.

The decision about closing a straight long put trade is easy, made when the trade is initiated. A profit target and stop loss can be set and should be acted upon which reached. More complex positions that allow for adjustments or have limited risk and profits might call for different decision-making processes along the way.

So, which is the trade the trader should have chosen June 7 if that trader expected to be in the trade only about a week? It's obvious, isn't it?

A call! In all seriousness, these comparisons of a trade gone wrong over a short time frame allow us to think about what would have been the right trade for us, what our preferred time frames and investments would be, and how well our accounts or emotions would tolerate certain risks over others. I did not know when the two articles were first conceived on June 7 how the trade would evolve, but accepting the possibility of loss is a reality of trading.

What if the trader's time frame was different? The strikes that compose the trade and the debit or credit at entry are listed in the table. You can test for yourself as time unfolds and see how each trade fared.