Friday, August 24, 2012

Lessons Learned When Selling Spreads

If you sell spreads like I do then you might be reminded of a few good habits here. For the purpose of this post, assume that my trades are all selling spreads. These can be Credit Put Spreads, Credit Call Spreads or Iron Condors. These are not recommendations; these are my thoughts and/or rules to MY OWN trading. Trading options is dangerous and could lose you a lot of money. I only trade with money I can afford to lose.

I have a set of rules (I listed few below) and I NEVER break them for WHATEVER reason (believe me it only takes one negative situation to make you rue all your successful rule bending attempts).

* I Don't trade willy-nilly. I have a daily target. I Don't try to push the target for I will probably find myself bending other rules which will eventually cost me money. Occasionally it is ok to fall short of the target.

* I have a budget and stick to it. By that I mean that I established a fund for options trading and I don't add to it to fix potential problems.

* TAKE THE LOSSES: sometime I can't ROLL out of trouble. I just take the loss and live to trade another day. Don't develop a gambler attitude like "I can make this loss up by..." Just take the loss and consider it tuition for lessons learned (I have had many). The money will be wasted IF you don't actually learn the lesson and APPLY it 100% of the time going forward!

* I use multiple resources. All resources are fallible! dates, quotes, spreads, news can be wrong so I check multiple places before placing a trade. perfect example is the trademonster earnings date feed. I also use automated calendars via Google and yahoo who send me reminders of dates on watchlist of stocks. These keep good track of company presentations announcements etc.

* I check into competitors of what I am looking to trade. They may have catalysts that will indirectly affect my decisions and/or positions. Perfect example is FFIV and CRM. I wanted to open a new position in FFIV yesterday but held back because CRM was reporting after hours.

* A few of my rules

- The most important rule of all: I call it my BAAD rule (long story for another day) = staying away from trouble wins over all other factors. example: if I had a position with short time to go till expiration. And this position is in danger of getting breached by price, YET it still has a chance of expiring worthless for maximum profit I close it for partial profit or roll it to give it more time to become a winner! in other words, I resist the urge to keep it on for the off chance I get lucky. This risk on hopium that things will turn out ok will get me in trouble more often than not.

- NEVER LEAVE THE CHEAP UPPER OR LOWER LEG OPEN!!!!!! I had a situation where .05 cost to close ended up costing me $4.5 with hours to go till expiration. So I close all positions that cost pennies to close for almost maximum profit. .05 is as good a level as any. If a position is sizable I may close it at .1 or maybe close half if you don't feel like you want to contribute to your broker's bottom line. The cost of 1 major mishap here would offset all the .05 closes that this rule will cost you.

- THERE ARE NO SURE THINGS: I never assume that a spread that I sell-to-open is a sure thing (like I sometimes read on the twitter stream; you know who you are ;-)

- If I am not so sure of my trade yet I feel compelled to still put it on, then why not open half of a position?

- I try to keep all my trades to be 1wide. I find it much harder to adjust wider spreads. especially closer to expiration as the protection leg ends up losing premium much faster than the short leg (especially if the spread is under pressure).

- I have woken up on days to a $150,000 maintenance call due to getting exercised. You can read about it in a previous post:
"$QLD Lesson in "exercism" #2 $NDX"
It's worth a read.