Creating My Own Luck

Sean McLaughlin
November 10, 2022

There’s a profound mental shift that happens when you flip from being in positions where bad luck could damage or ruin your trading account, to being in a position where the unexpected might actually make you a ton of money!

For options traders, an excellent example of these two positions is a short straddle vs. a long straddle.

In a short straddle, a trader is naked short an equal amount of calls and puts at the same strike and expiration. The PnL graph of a hypothetical 100-strike short straddle looks like this:

You’ll notice that as long as the underlying price (as displayed along the x-axis) stays +/- $20 from today’s price of $100, the trader will likely earn a profit as options expiration approaches.

Traders like these trades because they are high-probability bets, meaning that one has a better-than-average likelihood of earning a profit. Of course, when winning odds are favorable, the payoff usually isn’t all that high. And even worse, if the unexpected happens and a large directional move materializes, not only can you lose a lot of money, but your losses are theoretically unlimited. These losses also get increasingly worse (thanks to negative gamma) the further the market moves away from your short strikes.

I’ve been on the ass-end of moves like this before – and it’s never any fun. Ever.

The mirror image of the above situation is a long straddle. In this case, we’re long equal amounts of both the 100-strike calls and puts and a hypothetical PnL graph looks like this:

The challenge in a trade like this is that if the market sits still and does nothing, then each day will feel like a death by a thousand cuts as your position slowly bleeds value all the way to expiration day. It might feel like every day you wake up and lose money. It makes you not want to get out of bed in the morning!

But the plus side is that you’re very unlikely to suddenly find yourself in a badly losing position that is getting rapidly worse and/or spinning out of control.

Likelier, every once in a while, there will be a surprise move that catches traders off guard (this morning’s move off the CPI number being a perfect example), and everyone else’s misfortune will be your tremendous gain! This position can earn theoretically unlimited gains – and it only takes a few of those to make your year or even your career (just ask Nassim Taleb, author of “The Black Swan” and other important reads). It just isn't all that frequent, and therefore it makes it “hard.”

Hard because patience is hard. And patience is required in a trade like this. Patience to wait for the opportunity to present itself, patience for the move to develop, patience to sit on your hands and wait to take profits. You don’t want to be too quick to take your profit on a runaway move!

Anyway, I’ve recently shifted to a long options straddle-like strategy with my personal S&P index options trading that I talked a little bit about on Tuesday. And I’m not going to say that every day is profitable, nor do I think that I’ve discovered a golden goose. But it's a refreshing mental headspace to be in when I’m no longer losing sleep worrying about the potential of being caught on the wrong side of a tremendous move.

A day like today where the S&P 500 was up over 5% might have been a deadly blow to my trading and mental capital in weeks/years past. Instead, today was a good day.

But more to the point, I’m winning for not losing. And sometimes that makes all the difference in the world.

I’m going to continue to adapt and learn from my experience and mistakes. It’s the only way I know how.

Trade 'em well,

~ @chicagosean

Filed Under: