Analyzing New Trading Strategies – An Example Of One That Didn’t Go So Well

I’m always testing and analyzing new trading strategies. Well, maybe not new strategies per say but at least new techniques, entry points, risk management, etc. For the past 2 months I’ve been testing a new strategy with a small trade that hasn’t gone as well as I’d like and I wanted to share it with you…

I’m a fan of learning by doing! You can read all the books you want but nothing compares in the stock market to actually putting money at risk and seeing how your strategy or trading system works. Like when we were kids, you just have to play around until you find out what works.

You know by now that I’m always 100% open with my trading. I’ll show you our monthly performance and also the really bad trades I’ve had as well. Frankly it makes me a better trader knowing that I have to be accountable to you. And hopefully you can learn from me as well – or at least learn to avoid some of these pitfalls.

ENTRY: Short 3 SLV October 19 Puts for $35

When I entered this trade SLV was still in the process of falling hard from it’s highs. It had moved from near $50 to $35 in just 4 short days. As such the implied volatility was still high though not as high as it had been at the top.

The 3 contracts had a total premium of $105 and required an initial margin of approx. $950. The return on this was 11.6%. Not bad right? Well, this was for the entire 169 days, some on a monthly basis it was more like 2.06%.

My Strategy Going Into The Trade

My strategy was to sell the naked options far OTM and deep in contract expiration. At the time (May 5th) the October contracts were more than 169 days away – usually not what I do with my trading strategy but again I was testing something new here…

Although it had no time decay of Theta, the volatility premium was fairly high and I expected a short term bounce in SLV in the coming weeks. The overall strategy was to enter the trade with enough room so that if SLV kept falling I would be okay, but to try and quickly take advantage of the volatility.

Honestly I hadn’t planned on being in the trade longer than 2-3 weeks at most. The return I was shooting for was the 2.06% on a monthly basis (or a little higher) by quickly entering and exiting the trade.

Current SLV Position…

As it stands right now I’m still short the 3 SLV October 19 Puts. They have come down in premium to $21 per contract and are only taking up $634 in margin. This is a 40% decrease in the premium over the last 40 days – not bad but also not what I was expecting.

Per the chart, the main problem I had with the trade is that I didn’t get out when I had mapped out the trading plan. The first move higher as expected in late May would have been the ideal exit and the premium at that time was down to $12 per contract.

This would have been both the 1 month timeline I was planning for and also a great return – $24 in premium capture with $950 in margin = 2.42%.

Since SLV has basically moved sideways which I account for the premium decay I got thus far. Virtually no Delta move helped me at least at this point; it was mainly volatility.

I Should Have Recycled My Money

I’m still making money on this trade but I went wrong by not correctly exiting. I still have the position open right now. The Theta is still worthless at this point since we are still 129 days out from expiration but there is good Vega premium left on the table.

In my opinion the best investors are the ones who can quickly and efficiently recycle their money. It’s not about day trading to recycle money, it’s about using margin and premium in the best possible way whether that means trading for 4 days or 4 months. The question for me is always, “What is the best possible use of my money right now?”

Looking back it was a good strategy to test out and I have learned from it. Now I’ll take this nugget of knowledge and apply it to the next strategy and so on. As always, I’ll be here sharing these experiences and lessons with you in the coming weeks and months!