Vi OAP 140: Why Some Option Trades “Explode” In Your Face & What To Do About It

Have you ever gotten the feeling that some of your trades just end up exploding in your face and turn into "massive" losing positions? They just never seem to go the way you thought it would and always demand or steal your attention right? Well, there's likely a couple reasons why this happens and it gets back down to some of the most basic principles of options trading. In today's podcast, I'll walk through the psychology behind many of these "bad trades" and help offer a strategy to help manage them.

Key Points from Today's Show:

Often traders get so wrapped up in these trades that are big losers or that are completely going against them.

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Their perspective is skewed, focusing on any trades that are moving into losing positions.

Example:

When a young child is learning to use a regular cup, and they spill their cup of milk and it goes everywhere; all over themselves and all over the table. But in perspective, spilling the small cup of milk is not nearly as bad as spilling the entire gallon of milk! That would be a major catastrophe. However, for a young child, spilling a cup of milk is a big deal because they were in charge of this small cup of milk which is now spilled all over. What your child will see as a massive failure may not actually be that big of an issue to you as the adult.

In many cases, people behave very much like children when it comes to investing and trading.
The psychology of many traders has not yet developed to the point of being a mature investor and trader in this market.
People get stuck in the same childish psychological ways of focusing more of our attention on things that are losing.

The Middle Child Syndrome

Often times the middle child feels left out, and sometimes get unnecessary extra attention to compensate for their feeling "left out".
In trading, people often get middle child syndrome with a trade that goes bad.
When a trade starts to go bad, it's like none of the other trades exist; it's like they're in a vacuum, 100% focused on the thing that's going wrong.

Markets are truly the ebb and flow of greed and fear.
When you have a position that goes against you, immediately your human instinct for fear kicks in.
You start focusing just on that trade and it's like nobody else exists.

1. Position Size

Position size becomes the number one issue
Position sizing is the number one thing you can do to be successful.
Try to his single, after single, after single; stop swinging for home runs.
If the trade is a big loser, it means your position size is too big.

2. High Number of Trades

Often times, people are not trading enough.
When you don't have the confidence to continuously enter trades, you might run into a series of trades that are just bad trades; a sequence of returns that just don't work out that well.
When you increase the number of trades over time, you find that those bad trades start to average out.
Having a lot of trades helps break the sequence of return risk

3. Don't change the Swing of your $300 hitter.

Don't change the core fundamentals of what you know to be successful.
Just because you had a losing trade, that shouldn't change anything for you.
Recognize and anticipate that at some point you will have losing trades.
Don't adjust everything that you've done just because one or two trades "blew up in your face"

4. Adjust, Roll, or Close the Position.

You can do a lot with a trade that is going against you.
Granted, you should be more patient rather than more anxious to adjust.
When you make adjustments later in the expiration cycle, that is generally better than making adjustments too early.
If the trade is 30-60 days out, your default answer should be to simply do nothing.
It is way too early in the expiration cycle to try to anticipate what's going to happen.
This takes a lot of patience and understanding that the markets are so dynamic and fluid, anything can happen in a 30-day time period.
When you get 1-2 weeks from expiration, then you want to start making adjustments, start rolling positions, or just simply close the position and take the loss.

Conclusion:

When it comes down to this whole conversation around focusing too much on these losing positions, it's really simple things that we can correct: Entry, frequency, the mechanics of trading, and not taking full losses whenever possible.
Control what you can control, and forget the rest!
If you take all these precautions, there is no trade that can ever "explode in your face" to the point at which you have a mental breakdown about trades.
You are going to have positions that go against you, you will have trades that end up being losers, that's just part of the business.
Understand how to move away and remove your emotions from that environment and management the whole portfolio.
At the end of the day, if everything else is profitable, one losing trade really does not matter.
Often times that losing trade adds balance to your portfolio to allow it to be profitable.

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Free Options Trading Courses:

Options Basics [20 Videos]: Whether you're a completely new trader or an experienced trader, you'll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options.
Finding & Placing Trades [26 Videos]: Successful options trading is 100% dependent on your ability to find and enter trades that give you an "edge" in the market. This module helps teach you how to scan properly for and select the best strategies to execute smarter option trades each day.
Pricing & Volatility [12 Videos]: This module includes lessons on mastering implied volatility and premium pricing for specific strategies. We'll also look at IV relativeness and percentiles which help you determine the best strategy to use for each and every possible market setup.
Neutral Options Strategies [7 Videos]: The beauty of options is that you can trade the market within a neutral range either up or down. You'll learn to love sideways and range bound markets because of the opportunity to build non-directional strategies that profit if the stock goes up, down or nowhere at all.
Bullish Options Strategies [12 Videos]: Naturally everyone wants to make money when the market is heading higher. In this module, we'll show you how to create specific strategies that profit from up trending markets including low IV strategies like calendars, diagonals, covered calls and direction debit spreads.
Options Expiration & Assignment [11 Videos]: Our goal is to make sure you understand the logistics of how each process works and the parties involved. If you don’t feel confident in the expiration processes or have questions that you just can't seem to get answered, then this section will help you.
Portfolio Management [16 Videos]: When I say "portfolio management" some people automatically assume you need a Masters from MIT to understand the concept and strategies - that is NOT the case. And in this module, you'll see why managing your risk trading options is actually quite simple.
Trade Adjustments/Hedges [15 Videos]: In this popular module, we'll give you concrete examples of how you can hedge different options strategies to both reduce potential losses and give yourself an opportunity to profit if things turn around. Plus, we'll help you create an alert system to save time and make it more automatic.
Professional Trading [14 Videos]: Honestly, this module isn't just for professional traders; it's for anyone who wants to have eventually options replace some (or all) of their monthly income. Because the reality is that mindset is everything if you truly want to earn a living trading options.

Option Trader Q&A w/ M

Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. Today's question comes from M, who asks:

In regards to adjusting pricing, how much credit should I look for when rolling the untested short leg?

Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.

PDF Guides & Checklists:

The Ultimate Options Strategy Guide [90 Pages]: Our most popular PDF workbook with detailed options strategy pages categorized by market direction. Read the whole guide in less than 15 mins and have it forever to reference.
Earnings Trading Guide [33 Pages]: The ultimate guide to earnings trades including the top things to look for when playing these one-day volatility events, expected move calculations, best strategies to use, adjustments, etc.
Implied Volatility (IV) Percentile Rank [3 Pages]: A cool, simple visual tool to help you understand how we should be trading based on the current IV rank of any particular stock and the best strategies for each blocked section of IV.
Guide to Trade Size & Allocation [8 Pages]: Helping you figure out exactly how to calculate new position size as well as how much you should be allocating to your each position based on your overall portfolio balance.
When to Exit/Manage Trades [7 Pages]: Broken down by option strategy we'll give you concrete guidelines on the best exit points and prices for each trade type to maximize your win rate and profits long-term.
7-Step Trade Entry Checklist [10 Pages]: Our top 7 things you should be double-checking before you enter your next trading. This quick checklist will help keep you out of harms way by making sure you make smarter entries.

Real-Money, LIVE Trading:

EWZ Iron Butterfly (Closing Trade): After nearly pinning the stock at our short strikes, and thanks to the volatility drop, we netted a $600 profit on this iron butterfly trade.
VXX Short Call (Closing Trade): One of the most consistent and profitable options trades we can make is shorting pure volatility with VXX and today we closed this naked short call in VXX after a couple days for a $420 profit.
DIA Iron Condor (Adjusting Trade): This neutral iron condor in DIA is need of a quick adjustment early this week as the market continues to rally. In this video, we'll discuss why I'm adding an additional put credit spread while also choosing NOT to close out of our current put credit spread due to pricing reasons.
COP Short Put (Closing Trade): These single short puts in COP acted as a great hedge for our other bearish bets in oil this month and helped smooth out our returns after we closed them for a nice big profit.
TSLA Put Debit Spread (Closing Trade): Although many people thought we were crazy for getting bearish in TSLA this pre-earnings put debit spread trade made us $200 today. After the huge run up from $140 to $260 and getting some technical sell signals, we were pretty sure this stock would pull back.
MON Iron Condor (Closing Trade): Following a huge drop in implied volatility we worked hard to close this MON iron condor trade adjusting the order multiple times to fill before the end of the day.
IBB Call Debit Spread (Opening Trade): We'll show you how I started searching for a new bullish trade and eventually found a low volatility trade in IBB looking for a move higher to hedge our portfolio.
TLT Iron Butterfly (Closing Trade): Following the Brexit vote TLT and bonds traded in a nearly $8 range really quickly - even still the drop in implied volatility helped generate a $330 profit for us.
XBI Call Debit Spread (Closing Trade): Got lucky picking the exact bottom for our entry in this call debit spread for the XBI biotech ETF which ultimately was closed for a profit of $165 today on the rally higher.
COH Iron Butterfly (Earnings Trade): Shortly after the market open we close out of our COH earnings trade for about a $160 profit, leaving just 1 leg on to expire worthless.
EWW Debit Spread (Closing Trade): Using some of the technical analysis signals we discovered in our backtesting research, we were able to make a quick $130 profit on this bearish EWW debit spread trade.
IBM Iron Condor (Earnings Trade): Shortly after the market opened you'll follow along with me as we watch volatility drop and liquidity come into the market before closing out the position for $250 profit.
SLV Short Straddle (Opening Trade): Using our watch list software we decided to continue to add to our existing SLV short straddle position with a new set of strike prices reflective of the move lower in the ETF recently.

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