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July 21, 2012 / redman59

A Note on Risk and Following Some Simple Advice to Save Some Money

This is a post of some trading pain that I endured recently. Some takeaways from this are risk management and cutting your losses when others suggest so. In a prior post, An Addiction I Am Trying To Control, I stated on hoe uneasy I was about some recent positions I took on in the $SPX and $ZB_F (SPX Index options and Thirty Yr Bond Options). I received some good and short replies as noted:

Basically they said that I should exit/unwind the position. While I felt that was the right idea I also thought since the max loss in position was a small percentage of my portfolio, I wasn’t too worried about it. I even replied to @The_Real_Fly that my plan was to exit this position. The position that I took on is noted below. This has been a consistent winner for me and part of my portfolio is allocated to this strategy, which consists of selling weekly credit spreads int he $SPX options. So below you can see the risk graph of when I took on the trade and my max gain was $35/contract and my max loss was $565/contract on a close below 1310, with the $SPX trading 1340 at the time. Also I thought I got a great fill as I was profitable immediately.


As you can see any close Friday morning (when SPX options settle) above 1310 would bring me a profit of $35/per contract. This strategy has been a weekly strategy that seldom consisted of adjustments and the odds of probability have been great. Seeing the action this day as a nice bounce point I decided to enter a long bias into this strategy. The problem was towards the end of day the market characteristics changed and I was doubting this entry. But thinking this was an extreme I decided to hold the position and exit on the next morning knowing this trade went against me. So on the next morning I could have exited for about -$70.00/contract which was definitely reasonable given the month of gains had with this strategy. But my thought was that this action with the nice hammer on the 15min and green bar follow, that we would see some more upside or chop around but still I was a little uneasy with the price action and looked at the profit and not the loss.

So what happened? As you can see after 1:00 EST the selling undercut the days lows and the selling continued. But me “hoping” for a bounce did not want to sell. Unfortunately the selling continued into the close and looking at the risk graph I did not want to risk the downside and decided to sell. As seen below at the time I closed my trade my loss was -$225/contract.

This was closed near the end of day and given the sentiment I thought I gap down would kill me as the SPX options are settled on a Friday morning basis after all SPX stocks have traded. So if we settled Friday morning below 1305, which was only -5pts from Thursday close, I would see -$465/contract near double my loss. But if we settled above 1310.35 I would see max gain. So what is one to do? I accepted my loss and did not want to risk double my loss and hope for an up day settlement for max gain. So what happened at settlement the next day? Yes the SPX settled at 1310.33 which would have resulted in a max gain of +$35/contract or a difference of $265 difference from my close.

Does this hurt the psychology of trading? Yes it does as now I question myself going forward and have not put on the trade since. But in fairness I am still profitable on the strategy but just need to get that confidence back. One thing I do know is that the market action has changed and while trading on a close to close is fine the whippy action affects my thoughts with this strategy so I may continue to sit out while the volatility comes down a bit and the market is not so news driven. Either way I still have faith in the system and losses are expected. But this is where the trader and risk management comes into play as I was uncomfortable from the beginning and comments solidified my action for the next day but I still refused them on that next day “hoping” for the best…a disaster on most occasions and proven. I will say this compromises a small portion of my portfolio and maybe why I put the suggestions to the side, but none the less, they should have been executed and the psychological damage is still a factor.

The chart below is the price action of the SPX and where and when I exited and when I could have exited.

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