OAP 139: The 4 “Not-So-Obvious” Ways To Avoid Blowing Up Your Trading Account

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We all fear losing money, it's a natural human emotion. Myself included, I fear losing money just as much as the next person. But today I want to try to walk through a rational and logic sequence of questions that I believe, if follow the series, will help you uncover the only true risk in the market to your portfolio - and more importantly how to avoid blowing up your trading account in the process. I'd even dare to say that if you follow my 4 question logic sequence in the beginning of this show, you cannot help but come to the same conclusion about trading options including why the "staying alive" framework all but ensures you'll find success in any market.

Key Points from Today's Show:

  • Options trading gets a really bad reputation in the industry and the investing community. 
  • A lot of people look at options trading as this really evil thing - highly leveraged, rodeo cowboys throwing money back and forth.
  • However, when you use a very defined, conservative system it becomes a lot less volatile than trading stocks. 

Logical Reasoning:

Q: Do you agree that we cannot make only one trade and be successful?

If you agree, then the next logical question is: 

Q: Do you agree that making only two trades won't work either?

If you agree, the next question:

Q: Do agree that many trades work better than fewer small trades?

  • Everything can be mitigated, except for sequencing risk.
  • Sequencing risk is the risk that you run in any system.
  • It is the risk that you will run into a string of bad trades where you have no control over the outcome.

1.  Trade Size

  • If you are allocating 10% of your position to every trade, and you allocate a full portfolio 10% to every ticker, then you are effectively giving yourself an opportunity to completely blow up your account, given one bad swoop of trades. 
  • If you randomly pick 10 tickers, allocating 10% for each ticker and in a really bad sequence of returns, you could end up seeing those 10 trades completely wipe out your account. 
  • What we suggest at Option Alpha is keeping your trades size under 5%, because if you have a small account, you might have to push that 5% threshold just to get the trade on. But if you've got a large account, you should be at 1-2% for every trade or less. 
  • If you get a string of 10, 20, or 30 of them in a row then you will definitely feel it, but you will not be knocked out.

2. Balance

  • If you agree that trade size can definitely help, the next logical sequence is balance. 
  • Using options gives us the wonderful opportunity to trade both sides of the market; having bullish, bearish, and neutral positions. 
  • That way, if the market makes a wild, ridiculous move in one direction, it only affects half the portfolio.
  • Having trades on both sides allows you to potentially reduce the impact of a major sequence of trades that move your positions lower to the downside. 
  • This will not absolutely overcome the move in the market, but it will keep you alive to keep trading for another day. 

3.  Diversity of Tickers

  • The idea is that if you understand trade count and you understand that you have to be balanced, then it makes to have a diversity of tickers with uncorrelated risk.
  • This means having trades on both sides of the market in a lot of different industries and sectors. 
  • If you get around 10-15 tickers (on the high end) you'll probably get as much diversification as you need to be successful. 
  • As you really diversify the number of stocks that you are trading, you get less and less of a benefit to doing that. 
  • In options, because you can choose sectors very easily, then you can complete that diversification pretty quickly in 10-15 different tickers. 
  • There is no set rule on which tickers to choose; select the major markets ETFs, including bonds, emerging markets or currency, a metal or commodity.
  • The idea is to try and hit some of the major groups, and then fill in the gaps with tickers that are really popular at the moment with high IV. 

4. Trade Count

  • There is no magic threshold to cross when it comes to trade count. 
  • We have no way of knowing what you sequence of trades is going to be. 
  • Even at 100 trades, you still have some variance. 
  • It's not until you start getting up to 500-1,000 or even 1,000-2,000 trades that you start really solidifying your system and your probabilities and your expected outcomes. 
  • You could have a series of 20 trades that go against you, but they get averaged out through 1,000 trades. 
  • The only thing that really breaks the sequence of returns is trade count.
  • Traders who stay in the game the longest end up being the most successful.
  • Stay alive, never letting one bad movement knock you out!

Option Alpha Podcast Show Notes[FREE Download] Podcast Show Notes & Transcript PDF: No time to read the show notes right now? We've made it incredibly easy for you to save time by giving you instant access to the complete digital version of today's show. Click Here to Download Your FREE Copy

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/ Kevin

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 Kevin, who asks:

I was studying options last year, then strayed away from it and got involved in stocks. I have lost a couple thousand dollars since then. I currently have $25,000 in an IRA brokerage account that I transferred over, so I am looking to get up to speed and take my time to learn all the fundamentals before I jump back into options trading. I do currently have two stocks — I know you mentioned that it is probably a better idea to just have your whole portfolio either in cash or at the 5% stock level, but I'm pretty bullish on Microsoft and Rite Aid. I think Rite Aid could see a 50-75% return in 2018. I appreciate your time and consideration. I'm not going to skip any steps and I will do exactly what you say, because that's going to be the formula for success.

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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