Thursday, February 4, I received an email from the OIC, the Options Industry Council. This educational site sponsored by the major exchanges was advertising its latest online course, "Options Strategies in a Bullish Market." What terrible timing, I thought.
What terrible timing for many of us who recently put on options trades, too, unless those were bearish directional trades. Those of us who trade income-type trades that depend on prices staying in a range, even a rather wide range, suffered, as did anyone in bullish trades, of course.
I spent part of Thursday, February 4, unwinding a much-adjusted XEO FEB iron butterfly I'd entered on January 19, when the OEX was at 525. Since the trade had been entered, I'd made appropriate adjustments to keep that trade within the range of frequently adjusted upside and downside expiration breakevens. The trade had been cooking along fairly well, given what was happening. Most of the time, I was able to make adjustments that put the price squarely back in the middle of the range of potentially profitable levels. Finally, however, the toll that the commissions and fees took and the cost of the adjustments themselves resulted in the maximum loss being approached as the expiration breakeven was also approached on February 4. Further adjustments were possible, but none avoided the maximum loss that I was willing to incur. They did present the possibility of earning back some of that loss, at least breaking even if not making a small gain, but I was nevertheless going to still be at maximum loss when the adjustments were made.
That maximum loss was typed exactly as follows, in the trade's written plan in my trade book: "Buying-power effect is now $13,855.24, including commissions. 15 percent profit would be $2078.29, and 20 percent max loss would be $2771.05." As I was unwinding that trade, I thought that several of yesterday's events might provide fodder for a Trader's Corner article. I thought some lessons from the trenches might be appropriate, and I wanted to send the article out early, in case some were struggling with trades gone wrong.
Have a plan. I've talked about overall trading plans and plans specific to a certain trade many times in prior articles. I won't repeat myself here, except to say that the written-down plan saved me from the should-I-shouldn't-I kind of hesitation that might have actually resulted in a bigger loss than I took. I didn't have to scramble to know when I should get out of the trade. I had the potential profit-loss chart (perhaps through your broker or another service) up at all times, but I also had that written plan with the maximum loss that I would accept written, in red font in my actual trade book, no less! All I had to do was glance at the page in my trading book. If you don't yet have a plan for your trade, spend some times this afternoon making logical decisions about what you'll do if prices are at X or Y point into the close.
Adhere to the plan. Several times Thursday, charts set up for a potential bounce, and a bounce would have taken prices back up into the potentially profitable zone. One of my charts had shown likely strong support on daily closings at the OEX 494.70-497.00 range. The downdraft indeed slowed at least momentarily in that range that day. I could have easily convinced myself that I didn't have to follow my plan because the downdraft was already overdone to the downside and a bounce would likely occur at any time, if not Thursday, then surely Friday. I did believe that the downdraft was short-term overdone and that markets were due for a relief bounce. However, anyone who lived and traded through 2000 and 2007-2009 should well know that we can't let what we believe will happen or should happen guide our trading behavior. We trade based on what is happening, what we see in front of us. As these words are typed on February 5, the OEX remains below the expiration breakeven, but only slightly below it, and the OEX again shows signs of trying to stabilize. Will it bounce? Would that trade have been okay? Who knows. I no longer care. I'm out of it and will soon be moving on to other trades.
Occasionally not following the plan will benefit the trade. Sometimes our beliefs about what will happen do turn out to be correct. However, over the long run, learning bad habits such as ignoring a trading plan will hurt the trader's account. Nothing hurts worse than a maximum allowable loss except an even bigger loss.
Get rid of guilt when a trade goes wrong. This has been a difficult emotional hurdle for me personally, and I'm certain it must be for some of you. I'm finally at the point that I don't feel ashamed if a trade goes wrong. Market conditions swamped the trade, not my skill as a trader. I'm still the same trader who trades many trades well, still the one who collected profits of $5,564 in February's iron condors. In fact, I'm proud that I kept that butterfly trade alive so long, learning much along the way as I adjusted. Right up until about midday on Thursday, it still had a strong possibility of achieving profit at expiration. I'm also happy that I can trust myself to get out when it's time to get out. If I feel shame these days, it's during times when I feel that I didn't adhere carefully enough to my trading plan.
I didn't always deal this way with losses. While I accepted the fact that losses were going to occur, I harbored the feeling that I was somehow a bad trader when they did occur. That's damaging to more than one's confidence. It may damage the account. Someone who is ashamed to take a loss may be tempted to stay in that trade just a little longer, to hope it works out. One bad trade can grow so large that it overwhelms all those gains you so nicely accrued. Get over yourself. Everyone has losing trades. Get out of that bad trade and free your mind and your funds for a better one.
Some market realities, some of the nitty-gritty of trading, must be addressed from the trenches. Exiting a position in a fast-moving market, especially a down draft in which volatilities are expanding, requires different tactics than exiting in calm market conditions. There's stronger correlation between the various markets in strong down drafts than there is in other market conditions, so you may have multiple trades getting hit at once. Always set alerts for your trades as soon as you've received confirmation that your trades are filled. If one position after another is being hit, you'll need those alerts as your attention may be scattered. As I was typing this article, two alerts sounded, so that I had to make slight alterations to open March trades.
Try, if at all possible, to get to the computer to exit or adjust those trades rather than use conditional or market orders. However, some trading coaches advise that you have just-in-case orders set at catastrophe levels. These catastrophe orders should be set, they advise, just in case you're not able to get to the computer, your platform goes down or you're physically not able to type and/or click and send in all the orders you need to have filled. These catastrophe orders are not ones that you want to let get filled. They exist only in case of emergency. The idea is that you sit down at the computer and pull those orders and put in more advantageous ones before those catastrophe orders get hit. I watch my trades at all times, so I don't put on these catastrophe orders, but if a huge market crash were to happen at a time when I had six or seven different trades on in three different accounts, I'd probably wish I'd done so.
Realize that in fast-market conditions, your platform may not be keeping up with correct quotes. I use two different brokerages. Before I elected to unwind my unprofitable trade when maximum loss and expiration breakeven were hit on Thursday, I had tried a last adjustment earlier in the day. The brokerage in which the trade was held provides bid and ask for the spreads, but not midpoint quotes, so I sometimes simulate the trade on the other platform, too, to watch the midpoint. That way, I don't have to manually calculate that midpoint between bid and ask when it's time to put the order in.
The mid for the spread I wanted was quoted at 8.35 on that platform, but the other provided a bid of 8.35 and an ask somewhere just north of 10.00. (I don't remember the exact number.) I looked at market depth on the platform giving me a mid of 8.35, and that platforms market depth figures showed me a bid of 7.4 and an ask of 9.3 for the spread.
Which platform was right? I started with the mid the second platform provided, in case it was right, and kept stepping up increments until I was well into the range that the first brokerage had provided for its bid and ask. The brokerage quoting the higher figures was the correct one, it turned out. This was a big discrepancy. I've seen it happen with all brokerages, from way back in 2000, so I'm not picking on a specific platform here. That's why the platform with the quotes that were too low for a fill is unnamed. Just be aware that this can happen.
You may have to change the way you exit trades in fast-moving markets. When it was time to unwind the trade that was going bad, I unwound some individual options rather than unwinding separate whole butterflies at once or all the individual credit spreads that made up the butterflies. Earlier in the day, I had time to wait for a fill. When I needed out, I didn't have that time. In fast-moving markets, especially to the downside, it may be difficult to get a fill on a spread.
There are pros and cons to spread orders. The pro is that you don't have movement risk. If you separately buy-to-close the option you sold and only then sell-to-close the option you bought, the market could move away before the trade is confirmed and the second order placed to sell the long option. In other words, when I was buying back the sold puts, I could have bought them and, while waiting those few seconds for confirmation before sending in the order to sell-to-close the long puts that had been part of the spread, prices could have bounced. I would have received less for my long puts than I might have a few moments earlier. The result was that I would have ended up paying a bigger debit for the whole spread than I might have paid if it had gone in as a spread order. The con is that, in fast-moving markets, you risk not getting a fill on a spread or not getting an advantageous one. If I'd tried to exit the spread and no one wanted to take the order, I would have been chasing it and gotten a worse price. As is true of most aspects of trading, there's no right or wrong way that works each time, but be aware that you might need to change the way you exit a trade in fast-moving markets.
As I started unwinding the trade, I started first with the options that were hurting me the worst, to get them out of the way. Those were the sold puts that were part of the position. Unless you have a huge account and portfolio margining, always buy back that sold option before you sell the long one or you might have margin problems. In any case, it's a good idea to first get rid of the options that are hurting the position the most. After I had unwound all the put positions, I did put in and had filled some orders for the call spreads that were part of the butterfly position, but those were getting more profitable by the moment, so I could wait for fills, which happened relatively quickly anyway on the call side.
If you're accustomed to getting fills at the mid price between the bid and the ask, as often occurs in fills for the SPX, OEX, and RUT in calmer markets, realize that you're not likely to get those mid-price fills in fast-moving markets. If you're not desperate, of course try for the mid-price fills, but if the trades aren't filling, start moving your limit in closer to the ask if you're buying an option and closer to the bid if you're selling one than you're accustomed to doing for your particular underlying. The thinner the market or the faster-moving the market, the closer to the bid or the ask you may have to move your limit order.
In fact, although my listed and planned for maximum loss was $2,771.05, by the time the entire position was unwound, my loss was $2,879.68. That was mostly due to prices moving away from the mid and closer to the bid for options I was selling and the ask for those I was buying.
Once you're out of a trade, there's a temptation to show the markets up, to make back all that money you just lost. Don't succumb to that temptation.
Once again, having an overall trading plan will help avoid this temptation. If your plan says that you have x number of trades in y number of strategies in z number of underlyings, entered r number of days before expiration, then you know what your next step will be. That next step likely won't be showing the markets anything, but will instead be showing yourself that you can trade your plan. Allot a little lottery money for showing up the markets in times such as these, if you must. However, when your primary impetus is to prove something to the markets, you're operating from a different part of your brain than you are when you're making calm and deliberate decisions. You may literally not see warnings as the logic centers in your brain are not primary at that time.
There's nothing new or profound in this article, but it does include some lessons we have to learn over and over again. It was a tough week for many traders and certainly for many investors. As I often say after a week such as this one, get away from the computer most of the weekend. Spend the weekend reminding yourself what's important to you. Allot a specific amount of time for planning your next steps or obsessing over the losses you took this week, and spend only that amount of pre-allotted time doing so. Write down your plan. Queue up or save any trades that you think might need to be executed if the downdraft continues. Then spend the rest of the time refreshing your brain. Disconnect the part that wants to show up the markets. Happy trading next week!