In today's video tutorial, I want to talk about this concept of just having a little bit more patience with some of the trades that you’re making.
I think it’s best defined by what most people have generally said, but I know that Buffet’s one that has said, “Don’t just do something, sit there.” His whole idea and his mantra about investing is that you have to be patient with your investments.
You’ve got to not be active in messing with them too much, but making the right decisions early and then having patience to see them out over the course of many months and years. I think this can be really applied well when it comes to options trading.
Specifically when we’re trading risk defined strategies, and these would be things like credit spreads, butterflies, iron condors, debit spreads, anything where you have defined risk, there is rarely a time when you need to act quickly to make adjustments if (the key here) you are placing the trades correctly to begin with.
If you’re placing trades bad to begin with and they have no liquidity and you don’t have a high probability of success, then you might need to do some work, so that they end up becoming winners.
But if you’re placing trades the way that we coach and teach people how to do them here at Option Alpha where you have high probability of success, really liquid underlying’s, you're on the right side of implied volatility, then you really don't need to do much, there’s no requirement to make adjustments.
You’ve got to be diligent enough to let the positions go all the way through expiration, so that the probabilities have enough time to work themselves out.
Here’s the thing. We know we will be challenged on positions and the math suggest that up to 50% of the time, we’ll have a losing trade even if we place 80% probability of success trades. Let me say this in another way.
If you place a trade that has an 80% chance of success long-term, up to half of the time that you make that trade, you’re going to see a loser in your account. It doesn’t mean it’s going to materialize into a losing trade, but you’re going to have some sort of paper loss up to half of the time.
What most people think is that when you get into this business and you start placing high probability trades that immediately you go from place a trade to have a profit and 80% of the time that’s exactly how you think it goes, but it’s not the case.
Sometimes trades go bad during the beginning of the expiration cycle and then they turn around and the math suggests and the probability suggests that up to 50% of the time, this can happen.
I wanted to look at just one example of probably many, many, many more we could use from my own trading account just recently. And actually, as of the time of this video that I’m recording, January 14th, this is exactly how it is setting up in my account.
We had traded an XLE call credit spread above the market where we sold an option spread above the market anticipating that oil might continue to slide just a little bit lower which it did as it headed into January.
Now, you can see here on the screen, this is just the live screenshot of my trading account right now this afternoon, and we had entered this trade at about 10:45 in the morning on December 10th, 2014 and we had sold four of the credit call spreads and we traded each of them for $62 in premium.
So we took in $62 on each of those trades and currently with about two days to go in expiration, until expiration, you can back-test this and look back, it’s January 14th right now at the time of this recording and there’s two days to go in expiration, these are trading at $.2 apiece.
The market is at $.2 apiece, meaning that the profit that we have right now before expiration is about $240 on each of these. But here’s the thing. It wasn't always a profitable trade. In fact, for about two and a half weeks, this trade was a big fat loser that we were holding in our account.
Here's a stock chart of how XLE traded relative to the position that we made. You can see the red circle here, this is the day that we actually entered the trade back on December 10th.
This is exactly December 10th that we entered the trade and XLE was trading about 75 and you can see this blue dotted line is where our short strike is at about 78.
We did not want XLE to move above that price point. In fact, we wanted XLE to continue to move lower than that. But right after we entered the trade, just four days after we entered the trade, XLE started to move aggressively towards 80 and then basically sat at 80 for about a week and a half.
This basically let our position materialize into a full loser. Had we actually closed out the position early when it was a loser and cut our losses, kind of manage the risk and exit the trade because it was a loser, we would've ended up assuring ourselves of banking a losing trade.
As you can see, as we headed towards expiration, we just had to be a little bit patient, had to sit there and not do anything, we actually ended up seeing XLE reverse back and it ended up being a very high probability trade that turned into a winner.
Again, had we used the stop loss or tried to adjust, we might have ended up losing money on this position versus just waiting for the numbers to work out in our favor.
That's the key here, is that sometimes with these risk defined trades, we’ve got just to let them work all the way through expiration till you start to see profits and that's exactly how we coach it inside of our membership area.
I’m not suggesting that you be completely passive in your trading. You still need to be active, but there should be some assurance in knowing that adjusting and hedging are not a requirement to be successful. And I often say it this way.
If you’re targeting a 10% return per year, you can place high probability trades and hit that 10% return per year by placing trades and just not doing anything with them after they get placed, letting them go all the way to expiration, win, lose or draw, you just place trades and let them go.
But if you want to add some adjusting or hedging mechanics to your trading plan, then you’ll only increase your potential return, so where if you’re making 10% just placing trades and letting them go all the way to expiration, maybe you make 15% or 20% because you are doing smart adjustments and hedges for your positions.
But the key here is that you don't have to do that, and I think this should add some level of reassurance to people who are new in this business or people who have even been in this business a long time and just aren’t finding success that you just have to let the probabilities work themselves out over time.
As Buffett says, "Don’t do something, just sit there."