How the Options Business is Supposed to Work (For Premium Sellers)

TK All-Star posted on 10/30/12 at 09:58 AM



I always tell readers that my suggestions are based on my experience. I want to share the lessons that I’ve learned, hoping to spare each reader from some of the heartache that I had to endure. I also mention that my comments are suggestions and not demands. I believe the lesson content represents a good solution for the problem being discussed, but I also allow for a difference of opinion. Each trader comes to the table with an individuality that has a large influence on how decisions are made.

Still, there are some issues that I take personally. It’s not that I believe I am infallible. Far from it. I go out of my way to mention big mistakes in my trading history. It’s not that I believe the student is out to get me by going against the suggestion. However, in a small number of specific situations, I believe that my mindset represents THE TRUTH. I am hurt when someone goes the other way, even though I want every reader to make up his/her own mind, and my real job as an educator is only to guide your decision-making process. I want to influence how you trade and manage risk; I do no want to tell you what must be done.

One example comes to mind, because I see it far too often. I confess: I have this trait somewhat myself and strive to overcome it. Perhaps that’s why I am so unhappy to see it in others.

We trade to make money. I consider trading to be a business and encourage others to believe the same. That’s true for the part-time trader and the full-time trader. The two top priorities/objectives of this business to make money are to always take on only an acceptable level of risk, and to be certain that we never go out of business with some large, unexpected loss.

If we get these right (and the business plan is viable), the business should flourish. For this discussion, we’ll assume our business plan is viable.

This business can be summarized succinctly: Make a trade that provides a reward sufficient to merit the risk being taken. Then, manage the trade as needed:

1. Cut risk when necessary. When a trade is in trouble and loss of money has already occurred or is imminent, the only priority is to get risk down to an acceptable level. It is not to find some way to stay in the trade. It is not to worry about making enough money tomorrow to overcome losses to date. It is to get out of trouble. It is to stop the losses. It is not to salvage the profitability of this trade. It is not to prevent a loss. It is not to keep your ego satisfied. It is to get out of a high-risk trade. You do that by cutting risk or exiting the trade. That is the only priority.

2. When you have done the job well and once again own a position that is worth owning, manage that trade from today into the future. Ignore any break-even point. Ignore what has to happen for the whole trade (initial trade plus adjustment plus exit) to show a profit. Your goal is to earn money from the point of adjustment into the future.

3. Making and owning viable positions is how we win. Holding positions that are underwater or which have earned too little money to satisfy our needs and risk requirements is not viable. You are not married to a trade. You are married to the business.

4. If it can’t be managed, get out. If a trade is not working, if it becomes too risky to hold, if your opinion changes, if the trade becomes no longer suitable-- Get out. Unload the inventory.

5. Finally, begin anew with another trade when conditions are appropriate.

That’s it. That’s the business plan. We own and manage attractive inventory. We dump unattractive inventory.

So why is it that (judging from messages and questions) we still refuse to adopt that philosophy 100% of the time? The goal is to make money. And not to make a killing from one trade, but to prevent being killed by one trade. Our goal is to earn more money from winning trades than we lose from losing trades. It is not to have as many winning trades as possible. It is to make money, commensurate with acceptable risk. This means giving up on a trade when we have a better trade to own in its place. This means not seeking the last possible penny from every trade. It means trading with humility and the understanding that we are not invincible. Why is that so difficult? And why does it upset me when I am asked a question that shows that a reader is not obeying these rules/suggestions? I know why. It is because I, like many of you, have so much difficulty following them myself.

Mark D Wolfinger
Options for Rookies

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Posted by TK All-Star on 10/30/12 at 09:58 AM

Comments

Buster01 posted October 30, 2012 (11:22AM)

Very, very well written article.  I have printed a copy for myself and plan on reading several times a week to keep the "business" mentality in the forefront of my mind while I trade.

I have noticed several things which line up exactly to what you are mentioned and are actively warning against.  I can make 10 great trades and easily take gains when they exceed 10% but then, on several occasions, I have essentially lost all the profit from the prior ten trades on one massive poorly managed trade.  While I knew the trade was bad (sometimes within the first day) I kept the position in hopes of "breaking even".  If I could have just cut my 4-5 massive trades losses when I first noticed they were bad and my conscious told me to sell, then my account would be close to double where it is now.

spshapiro posted October 30, 2012 (10:56PM)

It is a normal part of the human experience to begin thinking that the world revolves around you.  Most of us begin to realize that that is not quite so sometime begin the years 2 and 5. However, this is not a delusion that is dispelled all at once, and many of us carry a residual for the rest of our lives. Unfortunately, for some it surfaces in the world of investing but the thought “If only I could get back to even, I would get out.”

In the world of investing, there is no personalization.  It really doesn’t matter who the counter party is, and the counterparty doesn’t give a damn want price you bought in at.  Thinking about getting even is like driving the highway ONLY looking in the rear view mirror. It is where you are going that chiefly matters, not where you have come from. Decisions about what you should do about a position today, likewise should only be based on what your opinion is of where it may likely be tomorrow, not where you wish you bought it yesterday.

repfarm posted November 29, 2012 (05:21PM)


Thanks for your article. I read it at the right time. I have been wrestling over closing out some winning trades that can't make me much more in order to enter another trade that is more profitable and matches my risk comfort level.as well as the first trade.  I had to laugh when you reminded us that we are not married to the trade. How quickly we fall back into our own quirks. I am prone to focus on the pennies left to be picked up off the ground and miss the low hanging fruit that is still on the tree right at eye level.

I have only been trading options for a couple years now. I have found it to be a light into my soul that is both brutally honest and a great gift at the same time. It pays me when I learn and grow. It costs me so severly when I refuse to listen; that, I always want to be honest with myself and not play the denial game. Your point number 1 is most excellent.

Again, thank you for sharing your article and thanks to the others who commmented.

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