OAP 157: The Untold Story Of The 3 Little Pigs That Traded Options

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A couple of weeks ago I was reading the story of the three little pigs to my daughters. And for some reason, I couldn't help but think about the untold story of the three little pigs who traded options? Yes, it's true, many people don't know this but the three little pigs were actually given a large chunk of money from their mother and each decided to trade wildly different options portfolios when they set out on their own. In today's podcast, I'll walk through each of the different portfolios they used and how volatility and variance can impact long-term performance and why it's important that we know the story of the three little pigs that traded options.

Key Points from Today's Show:

  • We look at three different portfolios to understand what volatility, portfolio performance and stability really mean.
  • Here, the Three Little Pigs story is an analogy for these three factors.
  • Each of three pigs starts out with the capital of $100,000: let’s see what happens to them.

Volatility: The Little Pig Who Built His House with Straw

  • The little pig wanted to win big and be an aggressive trader.
  • He had successful performance in some years and poor performance in others.
  • He loses 19% in his first year, 15% the next year, 12% the next year.
  • Why did he have this wide disparity in performance? Why does this often happen to option buyers in this strategy?
  • Answer: his portfolio was based on a lot of volatility.

Option Spread Type Strategy: The Little Pig Who Built His House with Sticks

  • In this scenario, this little pig doesn’t have the time to invest in building a house made of bricks but doesn’t want to risk as much as the house made of straw.
  • This little pig wants to make his returns 5% more narrow than the first little pig.
  • This little pig’s strategy is to compress the volatility of the first portfolio.
  • He moves down with a 5% compression on either end of the first little piggy’s gains and losses.

Similarities and Differences Between the First Two Little Piggies’ Strategies

  • Both pigs went through a loss streak, but the second little pig lost 5% less because of his less volatile risk strategy.
  • However, this little pig lost potential increased earnings when things went in the right direction.
  • This is a common classic complaint of losing potential.
  • The surprise: the little pig who built his house of sticks still earned more than the little pig who built his house of straw.
  • The first pig (house of straw) earned: $138,097.
  • The second pig (house of sticks) earned $154,055.
  • The interesting thing is that the average return for both of these portfolios was the same at 6.5%. So how did this happen?
  • The difference between these portfolios is the volatility or the standard deviation.
  • The first little piggy (house of straw) had a standard deviation of 27%.
  • The second little piggy (house of sticks) had a standard deviation of 22%.

The Moral of The Story: Less Volatility = More Money Long Term

  • The second portfolio (house of sticks) did not participate in all the upside potential nor did he participate in all the downside draws.
  • Still, this little pig had the exact same average return.
  • This portfolio ended up making more money in the long run.
  • How did this happen? Because less volatility = more money long term.

Narrow Range: The Third Little Pig Who Built His House with Bricks

  • The third little pig comes in with the same starting capital of $100,000.
  • This little piggy is more cautious and does things on a far smaller scale.
  • He takes just 10% off the model portfolio on either end.
  • He is preserving capital first and foremost.
  • His average return is the same as the other two pigs at 6.5%
  • But because his volatility was lower he ends up with a standard deviation of 17.3%.
  • This little piggy ends up generating: $166,587 (which is more than the other two little pigs).
  • How did this happen when all three portfolios got the exact same return?
  • Answer: the variant in the third little piggy’s was at a lot more consistent pace.
  • This proves that you should be focusing on the volatility in your account, rather than your returns.


  • Was the first little pig at a big drawdown straight out the gate?
  • What if we flip all the portfolios around at a total inverse? The pigs all still end up with the same average returns because the return distribution doesn’t matter.
  • What matters is the volatility of your account. The bigger swings you go through the less you will make.
  • When you reduce the volatility of your account you create a portfolio that is more stable and able to compound smoother going further.
  • You want a smooth equity chart.

*Bonus Feature

  • What might a model portfolio look like for an options trading strategy?
  • Try it out on our website alongside the Three Little Pigs diagrams and see the fascinating thing that happens…
  • See firsthand what happens when you simply play the math and the numbers VS what happens when you can (a) stick with a trading strategy that has a high probability of success (b) are controlled enough to keep enough money in cash and (c) reduce the volatility in your account.

Free Options Trading Courses:

  • Options Basics [20 Videos]: Whether you're a completely new trader or an experienced trader, you'll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options.
  • Finding & Placing Trades [26 Videos]: Successful options trading is 100% dependent on your ability to find and enter trades that give you an "edge" in the market. This module helps teach you how to scan properly for and select the best strategies to execute smarter option trades each day.
  • Pricing & Volatility [12 Videos]: This module includes lessons on mastering implied volatility and premium pricing for specific strategies. We'll also look at IV relativeness and percentiles which help you determine the best strategy to use for each and every possible market setup.
  • Neutral Options Strategies [7 Videos]: The beauty of options is that you can trade the market within a neutral range either up or down. You'll learn to love sideways and range bound markets because of the opportunity to build non-directional strategies that profit if the stock goes up, down or nowhere at all.
  • Bullish Options Strategies [12 Videos]: Naturally everyone wants to make money when the market is heading higher. In this module, we'll show you how to create specific strategies that profit from up trending markets including low IV strategies like calendars, diagonals, covered calls and direction debit spreads.
  • Options Expiration & Assignment [11 Videos]: Our goal is to make sure you understand the logistics of how each process works and the parties involved. If you don’t feel confident in the expiration processes or have questions that you just can't seem to get answered, then this section will help you.
  • Portfolio Management [16 Videos]: When I say "portfolio management" some people automatically assume you need a Masters from MIT to understand the concept and strategies - that is NOT the case. And in this module, you'll see why managing your risk trading options is actually quite simple.
  • Trade Adjustments/Hedges [15 Videos]: In this popular module, we'll give you concrete examples of how you can hedge different options strategies to both reduce potential losses and give yourself an opportunity to profit if things turn around. Plus, we'll help you create an alert system to save time and make it more automatic.
  • Professional Trading [14 Videos]: Honestly, this module isn't just for professional traders; it's for anyone who wants to have eventually options replace some (or all) of their monthly income. Because the reality is that mindset is everything if you truly want to earn a living trading options.

Option Trader Q&A w/ Patrick

Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. Today's question comes from Patrick.

Let’s say I have a call spread and the stock prices are moving up and now my short call and my long call are in the money. Let’s say my short call has been assigned and my maximum risk on this call spread – let’s say it’s about $1000. My question is what kind of action will I have to take now since my short call has been assigned? Or is this something that my broker is doing automatically? Or do I need to go into my platform and what kind of action will I have to take with my long call to have this $1000 maximum risk on my call spread?

Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.

PDF Guides & Checklists:

  • The Ultimate Options Strategy Guide [90 Pages]: Our most popular PDF workbook with detailed options strategy pages categorized by market direction. Read the whole guide in less than 15 mins and have it forever to reference.
  • Earnings Trading Guide [33 Pages]: The ultimate guide to earnings trades including the top things to look for when playing these one-day volatility events, expected move calculations, best strategies to use, adjustments, etc.
  • Implied Volatility (IV) Percentile Rank [3 Pages]: A cool, simple visual tool to help you understand how we should be trading based on the current IV rank of any particular stock and the best strategies for each blocked section of IV.
  • Guide to Trade Size & Allocation [8 Pages]: Helping you figure out exactly how to calculate new position size as well as how much you should be allocating to your each position based on your overall portfolio balance.
  • When to Exit/Manage Trades [7 Pages]: Broken down by option strategy we'll give you concrete guidelines on the best exit points and prices for each trade type to maximize your win rate and profits long-term.
  • 7-Step Trade Entry Checklist [10 Pages]: Our top 7 things you should be double-checking before you enter your next trading. This quick checklist will help keep you out of harms way by making sure you make smarter entries.

Real-Money, LIVE Trading:

  • EWZ Iron Butterfly (Closing Trade): After nearly pinning the stock at our short strikes, and thanks to the volatility drop, we netted a $600 profit on this iron butterfly trade.
  • VXX Short Call (Closing Trade): One of the most consistent and profitable options trades we can make is shorting pure volatility with VXX and today we closed this naked short call in VXX after a couple days for a $420 profit.
  • DIA Iron Condor (Adjusting Trade): This neutral iron condor in DIA is need of a quick adjustment early this week as the market continues to rally. In this video, we'll discuss why I'm adding an additional put credit spread while also choosing NOT to close out of our current put credit spread due to pricing reasons.
  • COP Short Put (Closing Trade): These single short puts in COP acted as a great hedge for our other bearish bets in oil this month and helped smooth out our returns after we closed them for a nice big profit.
  • TSLA Put Debit Spread (Closing Trade): Although many people thought we were crazy for getting bearish in TSLA this pre-earnings put debit spread trade made us $200 today. After the huge run up from $140 to $260 and getting some technical sell signals, we were pretty sure this stock would pull back.
  • MON Iron Condor (Closing Trade): Following a huge drop in implied volatility we worked hard to close this MON iron condor trade adjusting the order multiple times to fill before the end of the day.
  • IBB Call Debit Spread (Opening Trade): We'll show you how I started searching for a new bullish trade and eventually found a low volatility trade in IBB looking for a move higher to hedge our portfolio.
  • TLT Iron Butterfly (Closing Trade): Following the Brexit vote TLT and bonds traded in a nearly $8 range really quickly - even still the drop in implied volatility helped generate a $330 profit for us.
  • XBI Call Debit Spread (Closing Trade): Got lucky picking the exact bottom for our entry in this call debit spread for the XBI biotech ETF which ultimately was closed for a profit of $165 today on the rally higher.
  • COH Iron Butterfly (Earnings Trade): Shortly after the market open we close out of our COH earnings trade for about a $160 profit, leaving just 1 leg on to expire worthless.
  • EWW Debit Spread (Closing Trade): Using some of the technical analysis signals we discovered in our backtesting research, we were able to make a quick $130 profit on this bearish EWW debit spread trade.
  • IBM Iron Condor (Earnings Trade): Shortly after the market opened you'll follow along with me as we watch volatility drop and liquidity come into the market before closing out the position for $250 profit.
  • SLV Short Straddle (Opening Trade): Using our watch list software we decided to continue to add to our existing SLV short straddle position with a new set of strike prices reflective of the move lower in the ETF recently.

Thank You for Listening!

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About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.