Archive for April, 2009

Are you trading or gambling ? 2

I did not make the General Motors trade. The main reason is that time was not a strong enough weapon. Time decay, also called theta, is a powerful edge especially in the last month of the life of an option. Had the trade lasted 30 days instead of 53 days, I would have done it.

Most pro traders already know that they are going to have losing trades. By investing part of their money, they use speculative strategies in a conservative way. In order to take advantage of this strategy, you need to open up your mind to the fact that you are not going to try to predict where the market will go to in the alloted time frame,( expiration month ), but where the market likely won’t go to. There is a huge difference in those two approaches.

You can and should find other strategies  along with a trading style that best fits you, but don’t do what most new traders do. That is having no edge and putting at risk all or most of your money with the hope to double it right away. It might work sometimes, but in the long run it is emotionally and financially draining and the market will burn you.

I’ll make worse trades than the trade I didn’t make, I am still learning. Today my performance is down, but as long as I don’t destroy my account, I am confident. It will get better.

Are you trading or gambling ?

Trading stocks options and commodities makes you feel like you are doing something more respectable than betting on the ponies, but if you trade you want to have a more than 50% chance to make money. If not just go have fun in Vegas because you are gambling and will eventually lose.

By selling an option, ( What is an Option ? ) you gain an edge because in 3 of 4 cases you get to make a small amount of money.

When you sell one put option, you have an obligation to buy a stock at a strike price within a certain time period. You also get to control 100 shares for each contract sold. 

On March 3 2009 General Motors was trading at $ 2.7  

You could have made this trade: Strike price $1.0

Time period: May [meaning 3rd Friday of May by market close]

Market determined sell price per contract $0.30 [times 100 shares per contract = $ 30 per contract] To summarize it in trader terms: sell GM May $ 1 Puts @ $ 0.30

If the price of the stock stays above $ 1, You get to keep the premium money. Who would let you buy the stock at $ 1 when the stock is worth more? No one.

gm7 

If by May 15 the blue line does not go under the red line ( GM does not go under $ 1 ) You keep the $30 for each contract sold. Return on investment: 30% on each $ 100 risked.  [$1.0 x 100 shares per contract], with the capital at risk for 53 days. Not bad.

We don’t know what will happen to General Motors, but the trade works if price will not go below the red line. In other words you make money if the stock:

1 goes down a bit

2 goes up

3 stays the same

You lose if:

4 stock falls below $1.0  =  now you have an obligation to buy 100 shares at $1.0 even though the shares are worth less. If GM went belly up and was worth $0.0 then you will lose $70 per contract sold [-$1 x 100 shares per contract + $0.30 x 100 shares per contract; and yes this means you keep the premium even when you have to buy the stock at a loss.] 

No one can predict the future, but your edge is that 3 out of 4 cases this trade wins.

It is imperative that you apply money management because you can get wiped out.
Whatever you do remember:

If you don’t have an edge you are gambling.

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