Even though K.I.S.S. stands for Keep It Simple Stupid it’s not my intention to refer to anyone reading this post as stupid! It’s a reminder to all, myself included, that we can often make things more complex than they really have to be. In this post I’m going to present a potential trade that was available as of yesterday’s close and I’m going to show you how it could be managed based on 3 potential outcomes that could occur.
Below is the risk profile of a SPX Put RS+. If you’re not familiar with the strategy you can find several posts in the blog covering the topic. It’s basically a Vertical spread combined with a Horizontal (Time) spread. This is the current risk profile as of Friday’s close. This trade would’ve been placed if I expected SPX to move lower.
The next 3 risk profiles are estimations based on the price of SPX moving up 2%, remaining unchanged, and moving down 2% within the next 2 trading days.
Potential outcome #1. SPX remains basically unchanged. This risk profile shows that the position is marginally profitable. It could just as easily show a marginal loss since, again, this is just an estimation. The bottom line is, if SPX is relatively unchanged over the next 2 trading days this position would likely also be relatively unchanged.
Potential outcome #2. SPX moves higher by 2% within the next 2 trading days. Clearly my chart reading skills have let me down again and price is not doing what I expected. I don’t hang onto the position hoping that it’ll turn around and accommodate me! I take the $1,600 loss and move on to the next setup.
Potential outcome #3. SPX moves lower by 2% within the next 2 trading days. This is where the real trade management happens! Most traders would hang onto their position and not reduce risk. If they’re lucky price continues lower and they make a nice profit. If they’re not lucky, price moves higher and they end up with another loss! Sound familiar? It’s imperative to reduce risk when you have the opportunity to do so. Don’t rely on luck! I would Delta Hedge (DH) this position using either one or both of these adjustments. That would reduce the maximum possible loss to $550 while retaining the potential of a $10,000 profit. And by the way, the probability of the $10,000 profit is much greater than the probability of having a loss once these adjustments are made!
So there you have it. The K.I.S.S. method of trading! Now, just so you don’t think this is just a theoretical simulation post and the DH strategy doesn’t work in actual trading, I can assure you that it does. The majority of posts on this blog are my actual trades, not simulations so I’ll end this post with an example of some trades that I made this past week. I initiated a new position on Monday and I cost averaged UP over the next 4 days before DH’ing the position on Friday. Below are my trade fills starting from the bottom of the list.
I’ve added those trade fills to the risk profile below so that you can see the net effect of the trades. I’ve bought 110 contracts at an average cost of $12.03 and sold 110 contracts at an average cost of $13.00 which means I’ve locked-in a $.97 minimum profit and I still own a position that has a very large additional potential profit if SPX moves lower over the next 2 weeks.
You can add your questions or comments down below.