Just a quick word on managing positions.? As a short premium trader, I expect that when the market heads south quickly, I will need to manage my positions aggressively.?
I often do this in various ways; long premium trades, short VIX futures calendars, long VIX calls, and short delta trades like short naked calls.? After my Sept 26th blog, which was spot on (as I always say, ?even a blind squirrel finds a nut now and then!?), I protected myself using all of the above strategies.?
This past down draft was significant enough that several trades hit my losing exit prices.? Thus, I mechanically exited those trades at a loss per my Kelly Criterion (see Nov. 1, 2013 blog post.)? The point of this post is what must happen next.? Since I had purchased insurance against this type of move, as I take losses, I need to take profits on my insurance trades at the same time and in a similar proportion.? For example, if I take losses on 5% of my portfolio, I should take profits on 5% of my insurance trades.? Why?? Using the current market as an example, I would now be taking losses on my insurance trades to add to the losses I took on the original trades, as the market as rallied back fiercely.? Instead of protecting me, the insurance trades would be adding to my losses and my frustrations.?
Even after 27 years of trading, I will occasionally let one of these trades linger in hopes of getting more out of it.? In this move, that trade was some short HD Nov. 95 calls.? Home Depot, which is near its 52 week high, was one of the last stocks to capitulate in the market selloff.? As such, it was one of the last protective trades I made as it was still ?ripe for the picking? as traders began to throw out the baby with the bath water.? But, when the market turned back up, it also led to the up side.? I was not quick enough in taking those profits and it quickly turned to a small loser.? Not the end of the world as it was a small trade and I took plenty of profits along with my losers.? But, it was a chink in the armor of a mechanical approach.
I have talked to some traders who took their losses and held ALL of their insurance trades in hopes of turning their losses into wins.? They are now faced with losses on both sides of the move.? When the market craps out, short premium traders should expect a loss of a reasonable proportion to their winning months.? These months only happen once or twice per year and should be expected.? Do not get caught up in the crowing of people who are ?raking it in? on the way down.? In most instances, they are merely recouping part of the losses they incurred on the way up.? If you are quick enough to ?turn the cards over?, and profit from the down draft, all the better.? But, as a mechanical, short premium trader, you should be content with having losses (constrained by the Kelly Criterion) in these difficult times.? Just my opinion, of course!