This Options Trading Hedge Strategy Cut Our Loss By 56%

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Hedge strategy: In tonight's video update, we're going to be going over all the trades that we made for Wednesday July 8th. It was a pretty active day. We had a couple hedge or adjusting trades and then an opening and closing order so definitely one of our more active days. Yesterday we didn't do anything. Yesterday was kind of, for me a sit back and wait and see what happens.

There was a lot going on with FXI and the Chinese markets and then we had a lot of stuff with Greece and everything but it was more of a sit back and watch things unfold, see what's really going to happen before we start adjusting. For me it's really just because everything we have right now is risk defined.

We don't have any necessarily undefined risk trades that we're holding as far as major positions that we need to be frantically adjusting. Everything that we have is risk defined. We know our position size heading into it. There's no need to be rushing into making adjustments.

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The first thing I want to talk about tonight is FXI. Here's the deal, I know it can probably get a little bit confusing with all the trades and adjustments so I want to recap where we are here with FXI start to finish with real trades, real examples so you guys can see exactly why we are doing what we're doing here by continuing to roll down our call side and take in a credit, take in a credit, take in a credit.

The result here, just as a quick side not before we get into it and I'll show you, is that we've taken our max risk on this trade and dropped it from $450 down to just $198. We've cut our max risk in this trade almost by 55% or so, almost 60% that we've cut our max risk by making systematic and smart adjustments.

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I don't say that to boast or anything because it might still be a losing trade but, to me, this is the difference between guys who make it in this business and guys who don't. Believe me; I've been in this business for eight years now. I know what it takes to make money in this business, and it also means that you have to cut your losers when they go against you.

I want to show you how I did that tonight. Again, a trade that we made today on FXI was we rolled down for the second time our call side from 45 to 41. As FXI moved lower, we closed out of our 45 calls that were short, we bought those back, and we resold the 41 calls, took in an overall credit of 74 cents for each of those that we rolled down, so there was two of them that we rolled down.

Here's the chart of FXI, you can see, it's gone crazy which is great for implied volatility hence why we made another trade in FXI already. We've closed out a profitable trade in FXI already this month, and so we're starting to salvage a little bit of what's left in the portfolio for the rest of July.

Now we're building out August as well and continuing to do that in an aggressive way. Again, implied volatility's high, we'd done this before back in March and April, it paid out well for us this year already, so we're going to continue to go back to that same well.

Now that the market's moved lower, again, what we're doing here systematically is taking our 45 strike calls which are up here, and we are rolling them closer to where the stock is trading currently. We rolled them down; we did not touch the put side, we have not touched the put side, we still have our deep in the money puts.

We're not messing with that side; we're just continuing to follow the market all the way down rolling and rolling and rolling the whole way that we go here. We went from 48 to 45 to 41. Here is a look at my account the last 45 days just in FXI, just so you guys can see exactly what's happening here.

Again, these are all real live trades. I'm not making any of this stuff up; it's all real money lost or gained or whatever the case is. This first position here in FXI, these were our three contracts that we closed out of and made a profitable trade, so I'm not going to cover these because we entered an FXI trade for 322 credit, we bought it back for 240, made a nice profitable trade there.

Those two lines here we're not going to talk about. The next one here, this is our first original opening trade. This is the beginning trade here for FXI. We sold two iron butterflies here for $275 credit overall. Again because of the width of the strikes in these trades is $5, the original trade that we took in, that means that our max risk when we entered this trade originally was $450.

We knew from the beginning that we entered this trade, this was the most amount of money that we would be willing to accept as a complete loss if it went against us. Fast forward a little bit, and you can see that these are all August positions, so we're not going to cover the August, we're just talking about July right now.

Still, have August open. Now you can fast forward a little bit, and you can see these are the July adjustments that we made, these verticals over the last couple days, so earlier this week and then again today. The first thing that we did has we had an opening and closing; we rolled down our 48's that were down here, these were our 48 calls.

We bought those back and sold the 45's. The difference between doing that was a 52 cent credit. Again, we did those on each of those, so now we're starting to add that 52 cent credit to our original credit of 275. Then we did it again today where we rolled down our call side from 45 to 41.

So we had an opening and a closing order as part of that vertical, and we had the 45's that we now moved to the 41's and again we took in another credit of 74 cents. We add all of these totals up, we've now got an overall credit in everything of about $802 on this new FXI trade that we've had since July.

Now we still have the same amount of strike width and everything like that that we can keep here with the entire trade, so now if FXI just keeps going lower from here. We didn't adjust our put side; we didn't roll down the put side, we're just moving the call side down. If FXI stays here or lower or crashes we stand to lose $198 overall.

Now our trade risk has gone from 450 down to $198 because we just kept taking in a credit the entire time and rolling down that call side. Hopefully, this is a clear, very easy to use an example for tonight. Here's what our FXI position looks like right now. We've tapped everything off, at least for July, this is just looking at July.

You can see that the risk right now, it shows that there's about $500 of risk, but again, that's just positions that are remaining, so that's why I wanted to recap all of the positions because we have closed some out and rolled some down. The ones that we closed out were all profitable mini trades, but the overall position should lose, at this point, unless we do anything else, about $198 versus 450.

Again, it's still a losing trade, and I accept that, but the reality is is that we've been able to cut that by more than half and started to now put ourselves in a position where it's not killing us if this thing goes lower. That's just one way that we adjusted out of it. Hopefully, that makes sense.

As always if you have any comments or questions, throw them in the comment box on this page right below here. Try not to email me because I want to get all the comments inside the platform. We did have another adjusting trade today. We sold a vertical in FXE. This is very similar to what we did in FXI where we're just rolling down our call side from 112 to 109, so you can see we bought back the 112's, we sold the 109's, that's our new position, took in a 73 cent credit.

You can see, very systematic here, nothing changes. It's very vanilla and boring if you will. Now, this is our new resulting position for FXE. We ideally want this stock to trade anywhere between 109 and 112. The stock's just a little bit below that, but it had a nice rally today, so I'm feeling pretty good about this stock as we come into expiration week.

We just needed, again, to move up a little bit higher, about 30 cents, that would be ideal. Haven't made any other adjustments to it, that's exactly where we're going to leave it right now as we head towards next week. Closing trade wise, we had a nice closing profit in EFA.

This thing is an August position that most of the time you would expect to hold a number of months, but I believe we've only been in this trade for about a week or so and so we went ahead and bought back our spread for a 7 cent debit, much less than what we sold it for, so it banked in a nice little $90 profit.

For EFA, it was just a matter of everything else falling and the market falling, and so that gave us an opportunity to bank some money. The stock was down; I believe a little over 2% today so you can see that. Even though implied volatility has spiked in this thing, we're still going to look to get into more of these types of contracts.

We had a working order today, but it just didn't get filled, but we got the bulk of our profit on just the pure stock dropping. It went from 68 to 61 in a matter of two weeks and nothing else besides that helped out, but we'll take it. We wanted to make a bearish trade in this, and that ended up to work out really well for us.

The other trade that we got into today is surprise, surprise, FXI, so continuing to sell premium in exactly what has the best opportunity right now and I believe that that is FXI, even though it's gone crazy, most people are running from it, we need to be aggressively doing something in it. What we're doing here is we're doing a very nice wide, aggressive iron butterfly in FXI.

We did everything centered around 39, so at the time that we actually made the trade, this was a little bit lower than where the stock was, but since we have some August positions that are centered above where the stock is trading, we felt that we could actually tilt this particular trade a little bit bearish, give us a little bit more room in case the stock falls.

It did end up falling a little bit, so we're sitting right in the middle of the range right now. Again, we centered everything around the 39 strike then went out to the 48 calls on one side and down to the 30 puts on the other side and went ahead and bought those for protection. Then took in a nice big credit on each of those of $392.

Again, the goal is not to hold this thing all the way through expiration, but to buy it back early with some profit. Now, this is what our resulting August position looks like for FXE. Now we've got a pretty massive position building in FXE. Again, you can see today's aggressive selling of the 39 calls and puts everything centered right where the stock is trading right now.

If we get a bounce back, we get a bounce back, but we've got a very wide break even window here, anywhere from 37 up to about 44 is about the window of opportunity that we're looking at here with FXI. Anything can happen at that point, so if we go to the chart here, we're looking at, again, a break-even point of about 37 as it currently stands up to about 44 which is a huge window.

Allows the stock a little bit more room to fall if it does and even rebound in a big way if it does rebound in a big way, but it will be interesting. The reason that we're trying to get aggressive here is that implied volatility is very high. We were very successful doing this the last time when implied volatility jumped, and the stock had a huge run-up and then just basically traded sideways for the better part of two months.

Maybe we get that right now, maybe we don't, but we're going to continue to sell premium here and be aggressive about how we did it. When you look at the August position, so this is what's going on here, just wanted to show you guys. Most of the position that we started to build earlier in the month, you can see, is centered around 45/46, so very far from where the stock is going right now, but those were small positions.

We knew we could add to that position and so now you can see that we have added that new position here at 39. It's a much bigger position than these two small ones so now that puts our average somewhere in between. Somewhere around 40.5,, 41 or so is ideally where we'd want the stock to go.

We still make money down to 37 because we're still taking in a lot of premium that helps widen the break-even points on this trade, but you can see how we're just being very systematic about selling and being aggressive doing that and we'll continue doing it if implied volatility's really high, stays in the 100th percentile.

We will absolutely 100%, no questions about it continue to sell premium here because this is what you have to do to be successful in this business is continue to sell high implied volatility when the opportunities present themselves and they don't always present themselves all throughout the year so you've got to pick your spots here to start selling premium. Hopefully this video really helped out tonight.

I wanted to make it a little bit more detailed to help answer a lot of questions and hopefully get you guys over that hurdle if you are a little concerned or maybe even just a little less confident in your trading right now because things are going crazy.

You just have to understand that you've got to stick to our system and plan of selling premium, doing it in a very methodical and mechanical way because that's ultimately what is going to lead to the biggest success in your portfolio. Again, if you guys have any questions or comments, please add them to the video below, and happy trading.

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.