OAP 158: What Should We Do About This Losing Option Trade? First, Trust The Process

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Somewhere, possibly from another planet, this notion of trading options with a high probability of success transformed into a subconscious greed for 100% probability of success trades. And if you think that this mentality doesn't exist in the modern market we are in, you should see the emails we get at Option Alpha on a weekly basis. The truth is that you are going to have losing trades, a lot of them over the course of your career. Sometimes they'll come in groups and bunches that make you question everything you are doing or the strategy/system you are choosing to use. But, the first step on your road to elevating yourself is to ask yourself, "Can I trust the process?".

Key Points from Today's Show:

  • A lot of traders interfere with the natural progression of trades because they are simply going through the motions. 
  • If you are worried about a single losing trade, then you have the wrong mindset in place.
  • Instead, practice great habits to move towards trusting the process.
  • There is no reason to expect to have a 100% probability of success in trading.
  • As long as you are able to stick with the process through the ups and downs, you should be able to find success in the end.

Three Steps for Investing:

This three-step process comes from Jack Vogel here: https://alphaarchitect.com/2018/06/21/trust-the-process/

1. Set an outline or goal.

2. Implement a process backed by logic. 

3. Continuously ask the hard question, "Can I stick with the process?"

Sequencing Risk:

  • The risk of getting a random string of similar events — a string of losses, or a string of wins.

Trust the Process:

  • You have got to be willing to continue to trust the process even when it feels like you're not making any headway.
  • As long as you're basing what you're doing on a mathematical positive expected outcome, you just need enough occurrences to get there.
  • You have to believe in yourself and believe that you can handle the new requirements and habits of being a trader. 
  • Don't let your mind trick you into old biases; work hard to move and shift into a new paradigm.
  • Be aware of the conversations you have with yourself that make you doubt the process.
  • It's easier to fault the system for being broken rather than doing the hard work to stay consistent in your trading process.
  • So don't fall into the trap; instead, do your research and reach out to ask for help.

Do Not Quit:

  • You shouldn't interfere with your trading, so much so that it becomes a detriment to its future outcome.
  • Once you commit to options trading, you need to stay the course and let the numbers work. 
  • The reason most traders fail is that they quit before they get to a point at which they start to see success. 

Understand the Proven Strategy:

  • Options trading is a proven strategy that works. 
  • Options selling is a proven, definable strategy that works and draws an edge from the market.
  • You have to be in the market and committed to it long enough to see that edge play out.

Buffet Case Study:

  • Warren Buffet has reigned supreme as the investing guru for many years.
  • He is also one of the best-performing investors of all time. 
  • Many people look at Buffet in totality, which is fine if you understand the context of what you're doing. 
  • Instead of just looking at his success, look at the big picture, which includes all his drawdowns and losses as well. 
  • Even the greatest investor in the world has an unavoidable by-product of earning risk, which is volatility.
  • Not even Buffet can avoid the by-product of earning money — which is the volatility in his account.

Warren Buffett's Berkshire rolling 5-year returns:

2003: 84,250 = 4%
2004: 87,900 = 9%
2005: 88,620 = 5%
2006: 1,09,900 = 8%

then...

2008 1,19,800 = 7%
2009 99,200 = 2%
2010 1,20,450 = 6%
2011 1,14,755 = 1%
2012 1,34,060 = -1%

Rolling 10-year returns:

2007: 1,41,600 = 12%
2008: 1,19,800 = 6%
2009: 99,200 = 6%
2010: 1,20,450 = 5%
2011: 1,14,755 = 4%
2012: 1,34,060 = 6%

Then when you look at the max drawdowns the stock has had you'll find the following:

1981-1982 = -19%
1987 = -37%
1989-1990 = -37%
1998-2000 = -49%
2007-2009 = -51%
2015-2016 = -18%
Just 2 months during 2018 = -16%

Conclusion: 

  • If even the best investor in the world faces loss/risk, then we as options traders are no different.
  • Are you willing to trust and stick with the process, even when you feel like you are up against a wall?
  • When you know that your process is sound and backed by logic, then you should have no fear in continuing to trade.
  • Performance chasing runs rampant in this industry, and it is well-documented as a losing strategy.
  • So trust the process, be accepting of positions that go against you and be willing to manage those positions and move on.

Option Trader Q&A

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 a listener.

Have you done any back-testing studies that validate the probability of profit calculation for options trading?

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.

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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.