Tuesday, March 1, 2011

I'm probably guilty of over trading this position (MO)

Last Friday 2/25 I put on a designed low risk income trade and didn't bother to post about it. But now I want to share my experience since then and how I'm probably guilty of over-trading this position. So for the sake of context, I'll explain the original trade idea first and then show you what's happened since then. The idea was to take advantage of a relative high IV in (MO) combined with a bullish chart to sell some OTM puts for a March expiration income play. So here is what I was seeing:

  • Bullish trending channel
  • Past support at $24
  • High IV (high for MO, not high in general)

So I sold (30) MAR 24 puts for .17 on 2/25, intending to hold until expiration and pick up $487 after commissions. But at the end of trading on Monday 2/28 I could buy those puts back for .08. Normally I would strongly consider taking this play off simply based on the percentages. Any time you can lock in 50% of the maximum possible gain in one trading day, I do it. Why take another three weeks of risk to possibly pick up another 50%. Very simply, the risk/reward for me favored exiting the trade. And my real thought process was to not only lock in those gains, but I have three weeks left for another entry point on the same trade if we do get a pull back. Now let me show you what I was seeing on the chart that led me to exit the trade:

  • Closing at possible resistance
  • RSI of 85, probably overbought on the short-term (last time we hit that level MO sold off pretty good)
  • Broke out of its bullish channel, probably confirming overbought short-term.
  • And here is a non-quantitative measure for you. This is one of those days where if I was long, I would love to unload here because my gut just tells me there will be a better entry, maybe even tomorrow.

So when I'm seeing the above indicators and I'm already inclined to take the 50% in one trading day, I just did it and didn't think any further. Now here is where I get in to trouble. First of all I was more than willing to own at $24. This wasn't a gamble on my part hoping that I don't have to take possession. It was meant to be an income trade and if I got in at that price I'm happy to own and write covered calls on it. So I've already taken down a trade for one reason that really isn't correlated to the initial trade idea. Here is my second offense, I didn't even model out the trade and estimate what price I needed (MO) to pull back to in order to find that next entry point were selling puts would be attractive to me. Case in point, see the screen shot below. The stock does pull back today by 1%, even closes on the lows, and the bid/ask is .11 by .13. Even if I successfully split the middle and get .12, big deal. I pay .75 cent per contract so I need .015 cents net just to break even. Does selling in to this pullback and getting .12 when I got out at .08 make it worth while? hardly. Wow, strong move, you just netted $25 genius. It's wasn't worth the time, effort, or commissions. Now while I may get a chance to sell these again this week at a more attractive price that does justify the trade, or use this capital for another trade, the point is I was reacting without thinking all the way through and that's just bad trade management in my opinion. I feel a little silly and calling myself out on it publicly will hopefully be a reminder to me next time I face a similar situation.

The Bloggers of In The Money Trades always welcome and encourage blog participation, suggestions, or constructive criticism. Please feel free to comment on this post below or contact me privately. Let's all help each other keep our trades "In The Money"

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  1. Jason, I see some problems with your trading. First of all its great that you are sharing your experience and looking to receive input. I am a proprietary options trader and I want to offer some criticism.

    You said that risk to reward favored you exiting the trade. However you didn't mention what risk you were willing to take on this position. Since this is a naked put position your full risk is the entire amount of the stock minus the credit. And your reward is limited to .17. I understand that many traders would buy back a naked put if the market went against them...
    However you stated that you were willing to take delivery and continue to write calls against it. I'm assuming you know that a naked put is equivalent to a covered call.
    To sum it up it seems you are willing to expose yourself to unlimited risk and are merely settling for a 9 cent profit. This method of trading gives short term emotional satisfaction but inevitably leads to sizable losses. I've seen it happen in my experience.

    One question: What software are you using to chart IV and HV? I ask because you must be sure what the graph is telling you. Is it an average of all front month IV's in an option chain or is it for ATM options? IV should be compared to itself and not HV. I warn you because I noticed you have them in the same graph.

    I wish you success

  2. Hi Steven, thank you for your participation on the blog. Maybe I just assumed that readers understand some of the basics as you’re trying to point out. I am very much aware that the risk/reward characteristics of a naked put is synthetically equivalent to a covered call. That is exactly why I chose to sell puts instead as it saves me transaction costs on the stock. Why pay more to accomplish the same thing right? Also when state I was willing to take possession of the stock, this implies that I do indeed have $72,000 to buy the 3000 shares at $24. This was a cash secured put and not a speculation trade where I would panic if the stock dropped drastically and scurry to offset the trade.

    This is the crux of the post I wanted to draw attention to as I felt I over traded this position. The original intent of the trade was to either receive income from the expired puts, or if the stock got put to me at a cost average just under $24, that is an attractive enough entry price to me to get long so I wouldn't be upset with it. Therefore, there shouldn’t have been a desire to exit the trade early. As I mentioned, my error was in assuming I could get back in to the same short put position but at a higher price, but yet I didn’t model the trade out before exiting to find what price I would need the stock to pull back to in order to reenter at a higher price. Example, let’s say I thought that getting out at .08 but getting back in at .14 was my goal, well I didn’t use the modeling tool to attempt to find out what price I would need the stock to pull back to in order for the bid on puts to be .14. I hope this is a clearer explanation of my initial post. Thank you again for your input.

  3. I just realized I forgot to answer your question about software. I use LiveVol charts for volatility and purposes of putting screen shots on the blog. I am aware of what the charts are telling me, thank you. The purpose of showing both IV/HV was to show that historically, actual movement in the stock is less than the market is predicting for the front month contracts. That's why I thought it was attractive to sell the relatively high IV for a name that does not historically move that much.