Thursday, April 9, 2009

Trading Lab Recap - Money & Portfolio Management

Here are the notes from last night's trading lab:

Trading Axioms
Consistent results require a consistent approach
To succeed we must last!
We can’t last if we blow up our account

Money Management principles:

1. Risk per trade: Define what % of account you’re willing to risk in any one trade. Keep it small!
2. Time Diversification: don’t enter all your new (uni-directional) trades on the same day
For example:
Bull Put Spreads (10 contracts) Enter 5 today and remaining 5 a few days later
This helps reduce market risk
3. Price Diversification : Scale in (multiple contracts or shares)
5 contracts @ $1.00 If I can enter more later at a better price, I will. In a week I add 5 more contracts @ $2.00 Average spread is now @ $1.50
4. Strategy Diversification:
Aggressive approach: Play one side of market at all times
For example:
If market bias is Bullish: Have all bullish trades
If market bias is Bearish: Have all bearish trades

Conservative approach: Play multiple sides of market at all times
For example:
If market bias is Bullish: 3 bullish trades, 1 bearish, 1 neutral
If market bias is Bearish: 3 bearish trades, 1 bullish, 1 neutral

Portfolio Management

If in March my posture is Bullish:
My portfolio is positive delta possessing primary bullish trades:
10 bull put spreads

If in April, my outlook changes from bullish to mildly bullish-neutral, I adjust my portfolio to mildly delta positive to delta neutral. I could:
1. Close a portion of my bullish trades, tighten up stops, lock in gains, etc.
2. Enter some bearish trades (5 or 10 bear call spreads), thereby rolling my put spreads into iron condors

Remember this table:

Positive Delta (Bullish): Long Stock, Long Calls, Short Puts
Negative Delta (Bearish): Short Stock, Long Puts, Short Calls

Virtual Trades Discussed:

FCX March 26th @ $43
Bear Call Spread
Sell April 40 call $4.70
Buy April 45 call $2.11
Net Credit = $2.54
Max Reward = $2.54
Max Risk = $2.46
Breakeven = 40 + 2.46 = 42.46

Rationale for trade
Expecting a pullback on broader market (drag down FCX)
FCX was at resistance & potentially overbought
If I was expecting sideways movement (should have used OTM options)
If I was expecting downward move in price, then using an ITM call spread may have been okay

Tyler-

4 comments:

Anonymous said...

Hey Tyler,

I realize that asset allocation is probably the most important risk management technique one could learn besides hedging strategies that you discussed.

This comes in handy when you are dealt with the bipolar market that we have had in the oct.-nov. and more recently in the last 3-4 weeks where the markets just kept on dropping or advancing without much halt for breathing.

The question comes to mind, what percentage of one's portfolio should one be "investing" or speculating on? If you are again caught up in the market where it moves so fast (and remeber if it gaps up or down on daily basis, like we have been having recently) how can one manage the portfolio?

Has there been any discussions about, what percent of the portfolio one should invest (besides %in any given position) and keep the cash portion at all times?

Also what strategy one should employ if the trade goes against you....Lets say you are caught up in a month where market just turned around and it turned around furiously, in which case all your positions go against the market (unless of course you positioned your portfolio as a neutral or delta neutral)

Any comments regarding the above mentioned scenarios will be appreciated?

Also have you given a thought of getting people (and starting with you) to post the potential trades for discussions/criticism or chest thumping? I personally will like it...just a thought.

Tyler Craig said...

It’s tough to give a blanket answer on questions pertaining to how much money to invest or speculate with. What I try to do from an education standpoint is discuss the rationale or theory behind portfolio management, then allow each trader the ability to assess their personal preference, risk tolerance, trading style, etc. to make the call on what’s an appropriate amount.

To answer your question on managing trades that move against you:

Depends on the strategies in the portfolio- For example, if I had April bull put spreads on during this huge rally, all I would have been doing was closing out the put spreads when there were around $.20 or less to take profits. On the other hand if I had bear calls, once I mustered up the courage to get out from hiding under my desk, I’d probably roll them up to higher strikes to lower my delta exposure, or perhaps place bullish trades to delta hedge.

There hasn’t been any discussion on what % should be in the market & what % should be in cash. It’s a tough question to answer b/c some traders’ portfolios are all play money they can treat as risk capital or money they can afford to lose. If that’s the case then I can see scenarios where all the money is in the market at one time or another. On the other hand if your portfolio contains all of your hard earned money, then you better believe it shouldn’t be 100% invested at all times.
The other consideration is what types of strategies you’re playing. If I’m always playing one side of the market (all bullish or all bearish), then it might not be the best idea to be using 100% of my account. Because I’m either going to be very right or very wrong. On the other hand, if I play all sides of the market simultaneously, then there’s no way I’m going to lose on all my trades simultaneously. In that case, I may be comfortable with the majority of my money in the market.
Also what strategy one should employ if the trade goes against you....?

Depends on what strategy you were placing. In other words, the way I manage a bear call spread that moves against me is different than how I manage a put option. The other thing to keep in mind is sometimes just closing the position is best. So if I had on a bunch of bearish trades in March/April amidst the crazy bullish rally, the worst thing that should have happened was getting stopped out on each position. But even if that happened you still shouldn’t have lost a ton of money if you position sized correctly.

In terms of posting trade ideas or reviews – I’m not opposed to the idea. Any of the visitors to my blog are more than welcome to post trade ideas-questions, etc. in the comments section. The comments section hopefully over time will grow more into a discussion board with more participation from the followers. I have placed trade overviews (call spreads on GLD, RUT, naked puts on USO)in the past that you can take a look at if you haven’t already. I'll continue to post reviews of some of my past trades to give you a sense of my approach.

Anonymous said...

"On the other hand if I had bear calls, once I mustered up the courage to get out from hiding under my desk, I’d probably roll them up to higher strikes to lower my delta exposure, or perhaps place bullish trades to delta hedge."

Please detail your approach further..I will really appreciate it.



" In other words, the way I manage a bear call spread that moves against me is different than how I manage a put option. "


Tyler,
can you elaborate this further? Maybe with an elaborate example, if you dont mind?

As a starter, I am looking at the following trade:
I am looking at PCLN May 100-105 Bear call spread...Any comments?

Tyler Craig said...

I'll throw up a post reviewing a roll up example for bear call spreads when I get a chance. I've already discussed delta hedging a bit on my post titled "Delta" under the option terminology section on my blog. As far as the 100-105 May bull call spread on PCLN, here are a few points to consider the following.

1. Given the current trend, do you think it can reach 105 by May expiration (5 weeks). If your answer is yes, then it may be a viable strategy. If no, then you may consider a longer month (such as June), or lower strikes in May (such as 95-100)
2. Does it have earnings between now & May expiration? If so, are you willing to hold a directional trade into earnings?
3. Timing: Is today the day to enter? In other words, is PCLN at an area (such as support) that would support entering a bullish trade? If you think it may pullback b/c it's overextended then it may be wise to wait. On the other hand if you think it may not pullback, then entering right now may not be a bad idea.

Hope that helps, and keep an eye out for the rolling up example.

Tyler-