3:05 p.m. New York time
I placed no trades today.
11:45 a.m. New York time
No change in the chart.No immediate trades in sight.
SPY has dropped off a little from yesterday’s peak. Elliott wave analysis shows that peak might have been the end of the 3rd wave of the Submicro degree, but not necessarily. It could have further to go.
The daily and monthly Fisher Transform signals on SPY remain at odds, uptrending for the daily and downtrending for the monthly. The 20-minute chart and 3-hour chart have both moved to downtrending, although I don’t use those in my decision-making
In other words, boring. So in the absence of anything interesting, let’s talk trading.
One thing I always remember about options is that they are a proxy for the underlying stock or ETF shares. They’re a leveraged trade, each contract allowing me to control a 100 shares of stock for a fraction of cost.
That’s important when it comes to assessing a position. If I were trading the shares themselves, I would have far more money at risk. By trading options, I am able to take most of that money, put it safely in Treasury notes and only put a portion at risk. By that way of thinking, though, the true profit and loss are the options result as a percentage of the share price at the time of entry. I call it it “share-equivalent result”.
Some traders have set exit points that limit their losses to a certain percent, 3% being a commonly used one. Losses in an options positions, compared to the options entry, very quickly exceed that. I would argue, however, that my share-equivalent position is the proper basis to use, by taking the dollar profit or loss on the options and calculating their percentage of the stock buy-price at the time I entered or exited the options position (entry or exit depending upon whether the position is long or short).
I have two options positions, both on SPY ((here and here). Both positions are in abysmal shape. Take the first one, a bear call spread short the June $264 strike and long the $271 strike.
It’s a short position, so the options premium when I opened it is my sales price and what I get for it when I exit is my purchase price; at present that would be bought for $659 per 100-share contract and sold for $292 per contract, a loss of 126%. The share price itself is $274.57 at the time of this calculation and at entry it was $262.50.
The shares themselves have gained 4.4% since I entered the position, the equivalent in a short sale of a 4.4% loss.
Had I sold short 100 shares of SPY, I would have bought at $27,457. My present options dollar loss on the position is $366. And the bottom line, my share-equivalent loss is $366 / $27,457 = 1.3%.
That’s what leverage gives us. And a thing of beauty it is.
Of course, when I trade options its always as a short/long pair, the long option putting a floor on my maximum loss. In the case of the trade under discussion, the maximum loss is $408, or a share-equivalent loss of 1.5%.
My goal in trading is to limit my maximum loss to $500 per position. In this case, a $500 loss would be a share-equivalent loss of 1.8%.
By trading options positions the way I do, my maximum loss is far more conservative than it is with share traders who set a 3% stop/loss. And note that while the share controlled by the positionI had a $27.457 value, only $408 would be at risk. The remaining $27,049 would be safely parked in other, less risky assets.
Options, if properly hedged, are among the most conservative trading vehicles in existence.
Nassim Nicholas Taleb, in my view the most useful thinker of our age on the subject of risk, in his book Fooled by Randomness: The Hidden Role of Chance in Life and the Markets quotes his avatar Nero Tulip: “I love taking small losses. I just need my winners to be large.”
In practical terms, the low share-equivalent losses on my positions mean that the pressure to exit is really quite low. I can afford to wait, and shall.
By Tim Bovee, Portland, Oregon, June 5, 2018
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