In this article, we are going to discuss how to deal with, and fix losing trades.
Around three times a year, we end up having a position that becomes deep in the money.
While you can win up to 98% of your trades you’ll still have an occasional trade that you’ll need to manage and fix in order to reduce trading risk.
The problem with selling options is that you have to make sure that during periods when the actual volatility is more than the expected volatility, you must be able to minimize your losses, not incur significant anxiety/stress, and make sure that you don't run out of buying power.
If you’re unable to deal with the occasional trade that becomes “in the money”, then it's highly likely that you should not trade at all.
Trading During a Bear Market or Recession
When the market pulls back, there's usually a large volatility expansion. As a result, your existing options will likely end up showing a loss.
For example, if you sold a position last week, when the VIX was trading at 15, and then the VIX increases to 30, then your position that you sold previously will show a large loss even if the current market price of the stock is far away from the strike price of the option...
The volatility component during a large downtrend is likely going to be one of your biggest enemies.
It’s not necessarily the “in the money” positions that cause option sellers to lose money, but more so the volatility expansion that causes an increase in option prices which will reduce your buying power and may force you to close existing positions.
This is why you must ensure that you always have excess buying power, so that you do not have to close out positions at the most inopportune time.
One way that you can protect yourself is to always trade small.
Additionally, by trading small, you’ll have much more flexibility to manage and roll your positions.
When I have an “in the money position”, I do not stress out or get anxious. I've had numerous “in the money” positions previously and I’ve gotten better at handling them as I’ve gained more experience.
I would also recommend trading strikes that are further out of the money while also trading underlyings that have strong brands like Amazon or Apple (or even stocks that are resistant to a recession like Dollar General).
Trade options on indices or futures, like SPY, SPX or /ES, is also a good choice since there tends to be less volatility in indices.
How to Manage and Trade around a Challenged Position:
Sell Call Options
If you have a challenged put position, you can sell calls to collect more premium.
You can then allocate this premium to roll down your short put strikes.
Be Patient & Trade Later in the Day
Wait until the last 10 or 15 minutes of the trading day so that the day’s trading action has revealed itself.
During recessions, the market tends to sell-off during the last two hours of the trading day.
Additionally, if you have an expiring option that is trading close to the money, you can wait until expiration day to manage the position because there will be almost no extrinsic premium left on that option. As a result, you can roll that position to a more advantageous strike price.
When volatility is high it's relatively easy to roll positions because there's so much extrinsic premium baked into future option prices.
As an example, I had a $185 strike on PayPal that was set to expire on December 3rd, 2021. On December 3rd at around 3:50 PM Eastern, or ten minutes prior to the market closing, I rolled the December 3rd $185 strike to $165, with an expiration date of December 10th.
I also sold a call option with a strike of $230.
I was able to roll down the strike by $20 simply by extending the duration by one week and by selling a far OTM call option (while also collecting a small credit)...
The following Monday, I closed out the $165 strike put option for about $0.30.
Trading during a recession requires discipline, especially because many of your positions will get challenged.
It’s important to be less aggressive with your strike selection, and trade later in the day.
Another good strategy is to sell call options on stocks that you perceive to be overbought.
You can also sell calls on your existing positions and use that money to roll down your put options.
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