People love the idea of entering options trades with a high probability of success. It’s easy to be seduced by the prospect of winning on 60, 70, or even 80 percent of our trades.
It doesn’t take much imagination to enjoy visions of swimming in all the cash we’d surely be earning with such a strategy. And why not? With that kind of win rate, we’ll often go on runs where we win on multiple trades in a row.
Talk about a confidence builder!
Of course, there is no free lunch on Wall Street. And in strategies with a high probability of success, there is a dark underside that people conveniently like to ignore.
This type of discussion quickly makes us unpopular at cocktail parties. So we avoid it. Many know, but most are unwilling to talk about it.
The trading action in the regional banking sector, and to a lesser extent bond ETFs, drove home a stark reminder to anyone involved in naked options (like me) — that there will be times when we will suffer large losses.
This is unavoidable.
If we do enough short strangles or naked puts or naked calls, we’ll eventually get torched on a position. It’s a mathematical certainty. It’s only a matter of when.
Therefore, when we execute these strategies, we have to be careful about position sizing. I always try to err on the side of trading them too small. This is the number one thing that keeps me in the game when the shit hits the fan.
Like this week…
I’ve had a short strangle position on $KRE options in an account I manage for JC. At one point this week, the $KRE ETF was down as much as 27% in just 3 trading days! That is a historic drop. And it’s causing us to suffer large losses in this position.
That’s the bad news. The good news is, our portfolio was only down about 6% off our highs at KRE’s nadir. That sucks. But it’s totally recoverable. In fact, we’ve had several such drawdowns in our account over the past 10 months, only to eventually reclaim new equity highs shortly after by sticking to the process.
We don’t recover by revenge trading or taking any unusually aggressive bets that we wouldn’t normally take. Nope. Just sticking to the process. The process wins over time. We have to learn to take the PnL volatility when it comes.
We can’t have our returns without it.
Trade ’em Well,
Chief Options Strategist
All Star Charts, Technical Analysis Research