Stocks and Futures traders like to talk about how they use stop-loss orders to define their risks, and that’s smart.
A lifetime ago I managed a small, independent hedge fund that traded commodities with a trend-following strategy. This strategy entered positions that I’d attempt to hold for weeks or months (if they were working).
Every position I had on had a resting stop-loss order working in the market, giving me comfort that I knew the most I could lose if I was wrong.
All that comfort I was enjoying changed one day after a trip to my clearing firm’s office in downtown Chicago.
I sat down with one of the firm’s risk managers for a simple “get-to-know-you” chat. He was curious about my trading and just wanted to get to know me a little better and see if there were any ways in which he could help me get to the next level.
We got into the weeds of my trading strategy and he was nodding along in agreement that he was in favor of what I was doing and he thought the returns I was earning were impressive and better than average for accounts of similar size with that firm.
If you would've told me a few months ago that we'd see a large crypto exchange (FTX) go bust and later a number of big banks become insolvent and collapse to zero, I would've laughed you out of the room if you followed up with: "...and bitcoin will rally."
I mean, there is no way I would've agreed with that sentiment.
Thankfully, I don't get paid for my opinions. Because the market couldn't care less about what I think.
The strength in Bitcoin (and crypto in general) has truly been a sight to behold in recent months and in particular over the last few weeks.
The poster child instrument to play bitcoin in the equities market is via Microstrategy $MSTR. For those with their head in the sand on all thing bitcoin, this software services company has transformed itself into essentially a bitcoin ETF, having invested all of its working capital into bitcoing, and taking loans to leverage into even more bitcoin.
We'll leave the discussion on whether or not this is crazy to another blog post. But for now, MSTR offers us a great way to participate in continued strength in bitcoin and we're going to do it with a defined risk options spread.
The shorter my timeframe, the shittier the market. ~ Brian Lund @bclund
That quote was uttered during a Twitter spaces I hosted yesterday in which we discussed the emergence of “0-DTE” options and the opportunities and challenges they are spawning.
As Brian brought up, the phrase “0-DTE” which stands for “zero days until expiration” is a bit of a misnomer as options that are expiring today were not necessarily first listed for trading on the same day that they expire. Regarding SPY or SPX options, some of these “daily” options are first listed for trading as far as two weeks from expiration day. So if you were to look at the options chain for SPY, you would see options expiring every day over the next two weeks.
We're still in premium-selling mode until the market calms down.
That said, we're not taking any wild risks. This time, we're targeting the relatively tame utility sector and defining our risks. April expiration will become the "front-month" next week, so this delta-neutral spread should pay relatively quickly if the trade works.
I’ve received a few emails over the past few weeks from people who had long calls trades that went their way – a good problem to have. But they had questions about how to manage them.
They hear me often talking about selling half of my calls when they’ve doubled in value, giving my original risk capital back, while also offering a risk-free ride on the remaining half position. This is a Best Practice I frequently employ.
The question is some variation of: “Ok, great advice. But how do I do that if I only purchased a one-lot?”
For the record, I trade a ton of one-lot trades, especially on higher-priced stocks. So I’m very aware of this issue.
To take profits out of a winning long calls trade while still remaining exposed for more upside, there are two options that I prefer:
All things considered, the tech sector is holding up well. This gives me some comfort that this is an area we can sell some delta-neutral options premium to ride out this market volatility.
But we're going to do so carefully, defining our risks and playing it conservatively.
Check out this chart of the Technology Sector ETF $XLK:
The horizontal lines on this chart represent areas we can sell April options premium at that feel far enough away for me to like our odds.
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.
Today's trade is going to leverage the rising volatilities introduced into the stock market this week thanks to testimony from the Federal Reserve Chairman (I've been told).
When markets get dicey and volatility rises, I like to look at my universe of Sector ETFs and choose one that is both displaying higher relative options prices than its peers and looks set up for rangebound trading action over the next 3-5 weeks.
An ETF near the top of my list is the Materials sector ETF $XLB. We're going to bet on the recent sloppy trading action to continue sideways for a bit, and we're going to sell a delta-neutral spread to collect premium and position ourselves to earn the decay.