Note: I added an update at the end so make sure you read the entire post!
If you listen to most ‘experts’ they’ll tell you to spread out your risk by placing many smaller trades to reduce your exposure. I used to do that until I realized that was exactly the wrong advice for me. They’ll typically recommend if you’re putting capital to work to use 1-2% of total portfolio capital for each new trade. If you want to put 5% of capital at risk that would be around 2-5 new trades. If I’m putting 5% of my capital to work I’ll take 1 new position for the entire 5%. Sometimes I’ll put even more than 5% at risk in that 1 new position. Now, don’t stop reading here and think that the moral of this story is to be reckless with your risk capital! After you read the entire post you’ll realize that I control my risk probably better than any other trader you know or have heard about. The details of this strategy are what make the difference. And finally, everything I say in this post applies to my trading, I’m certainly not recommending it for you. The point of this post is to give you the knowledge of a different way of managing portfolio risk. The way you choose to manage your risk is your responsibility.
Before I get into a long discussion of my strategy for trading and portfolio risk management it’s best to show you my actual current portfolio risk profile so you can quickly decide whether or not it’s worth your time to continue reading this post. If I can’t pull this strategy off in my own portfolio why should you even consider it for yours? Below is my current SPX Beta weighted portfolio.
The grey background on the TOS risk profile page represents an expected 1 standard deviation price range by whatever date is selected. For this risk profile I’ve selected the January 21, 2022 expiration (today is July 10th) since many of my positions expire then. For purposes of this analysis let’s assume that I started my investing on January 1st of this year with a $100,000 in risk capital and I now intend on making no additional trades for the rest of the year. My current portfolio value would be $139,000. Assuming SPX price will be within the plus/minus 1 standard deviation move the best I could do for the year would be a $57,000 profit and the worst I could do would be a $23,000 profit. Think about that for a minute……. That’s the worst I can do. In most trading strategies and methods the worst you can do is lose it all. I told you in the first paragraph that “after you read the entire post you’ll realize that I control my risk probably better than any other trader you know or have heard about.” At that time you were no doubt thinking ‘yeah, that’s what they all say’ but you can see from my portfolio that it may actually be true.
So how did I get to a position where I can be virtually certain that I’ll do no worse than make a $23,000 profit while still having open positions and the ability to more than double that minimum profit even if I make no additional trades? By adding trades one at a time as the title of this blog states. When I add a new trade it’s based on my chart analysis which has very specific entry points and, more importantly, stop-out levels where I no longer want to be in a trade. My method of chart analysis is well documented in this blog and on the twitter feed so I won’t go very in-depth here. The trade strategy is what’s most important. If I enter a new position I can hold it and not enter any additional positions until one of two things happen. One is that I either get stopped out for a relatively small loss or price moves so slowly that I no longer think this is a good trading opportunity. If that happens, I’m out. The second way I can move on from this position and initiate a new trade is by eliminating my initial capital risk in the position. I use a method that I refer to as Delta Hedging to accomplish that. I like to get to $0 net cost or, even better, a locked-in profit before considering a position to be Delta Hedged. The best way to demonstrate that strategy is by example. Here is one of my actual Delta Hedged positions. Remember, this isn’t a theoretical example, it’s my actual trade.
60 minutes after the open on June 16th I had a bearish trade setup on the INTC chart. See chart below for a quick description of the setup.
I responded by buying the Oct15 INTC 52.5 Puts for $1.67. Because INTC did move lower I had the opportunity exactly 250 minutes later to Delta Hedge the position into a Butterfly spread with a minimum guaranteed profit of $30 and a maximum potential profit of $2,530. Why did I pick that time to Delta Hedge the position? Because I could! The spread that I used to Delta Hedge the position surpassed the cost of the Puts that I bought so I took advantage of the opportunity that the stock price was presenting to lock in a profit. Below is the trade history and below that is the risk profile.
250 minutes of initial capital at risk! Just over 4 hours and I can now add a new position to the portfolio when I get a good chart setup. I can basically ignore this INTC position for at least a month or more because not only is it not using up any of my risk capital but, more importantly, it isn’t using up any of my mental or emotional capital! I won’t even consider managing this position until mid-late September. I won’t have to because not much will be happening to it until it gets closer to expiration.
Not all trades work out this quickly and I don’t start out all trades by just buying Puts or Calls. Often I’ll start with with a Vertical Debit spread or sometimes even with a Condor. Both of those option structures take progressively less risk at trade entry and take longer to Delta Hedge the initial risk out of the position. I’d estimate that it typically takes me 4 hours to 2 days to get to $0 cost (or better) with a trade that’s initiated with just long options. If I initiate a trade with a Vertical Debit spread I’d say that I average around 2-5 days to get to $0 cost and when initiating with a Condor it’ll often take 1-3 weeks to eliminate the initial risk. If price does not move in the profitable direction and triggers a stop I exit the trade. No exceptions! If the chart pattern fails to follow thru I don’t fight it. There are too many good setups that do follow thru to hang onto one that doesn’t!
What expirations do I use when I initiate new trades? Guess what? It doesn’t matter! I can use expirations from 1 week to 1 year (or more). The INTC trade discussed earlier was an October (over 3 months from now) expiry. I could’ve used July or January or any other expiry. I like to spread out the expirations of my various positions so that I have some positions expiring in every month of the year. That diversifies my portfolio by time which is important with an option portfolio.
I want to end this post with what I think is the most important takeaway. If you’re not finding success with your options trading it’s very likely that you have too many positions on that haven’t been reduced to $0 net cost. Consider what I have discussed here. If you have 2 or 5 or 10 or however many losing positions on consider closing them all. Clear the deck! Free up your portfolio and your mind. En Vogue, the great philosophers of the 1990’s, said in their hit song “Free your mind and the rest will follow”! Who knew they were singing about trading? 😁
Once you’ve done that find one good setup and trade it. Be disciplined! If the trade performs get it to $0 cost as soon as possible. Register a win! If the chart doesn’t follow thru take the small loss and move on. Once you have 1 Delta Hedged position now you can add another. Get that new position Delta Hedged as soon as possible or, again, exit it if it fails and repeat the process. In this scenario you’ll have no more than 1 losing position in your entire portfolio at any time in the future. Below is the breakdown of my current portfolio. It’s constantly changing since, as I said earlier, I have positions coming off every month of the year. I just stated that you should never have more than 1 open losing position at any one time and you can see that I have 2 here. Oops! Actually, to be fair, as I roll positions up and receive a Credit that profit is ‘booked’ and no longer shows up in the P/L Open in the ThinkorSwim Position Statement. I truthfully have no losing open positions based on initial cost at the moment.
Please consider what I’ve posted here. I suspect that it could help most if not all of you become better, happier and less risk-taking traders. Post any questions or comments here or on the twitter feed.
July 14th Update:
Today’s RUT trade is an opportunity to highlight the content in this post. Shortly after the open I added a new bearish position. See the fill below.
After RUT moved lower I tweeted the following thread.
I hope this twitter thread helps reinforce the ‘one at a time’ concept!