The only one to blame for the loss is Amber Tree Leaves. Not trading options, not the market. Me… I do consider this a valuable lesson. Let me tell you why.
I am active in option trading. Volatility is one of the key drivers behind my trading income. It is that intangible, difficult to understand concept that is at the basis of the price of options. Well, volatility can be traded as well. Not directly, but there are ways. And I wanted to do this.
Among all the instruments to trade, I picked VXX. This is an ETF that tracks the volatility in the US market by owning a combination of futures on the VXX. As often the case with an ETF, you can either trade the ETF or an option. I took the option.
I wrote a put on the VXX and was able to buy-to-close the trade for a profit. So far, so good. I now also master this mythical beast (or so I thought).
The start of the end
At the start of the summer, I
felt was super 100 pct convinced the markets were due for a correction any day. I am sure you thought that as well! Hence, I looked for a trade that would allow me to make money when the market corrects.
I choose the VXX, via options. Why? When the markets go down, the volatility goes up. (In a certain way, volatility express how much fear people have. When the markets drop, they start to fear) And when volatility goes up, VXX goes up.
As a correction was a given, a 100pct sure thing to happen, I sold a put on the VXX once again. When the market corrects, the VXX goes up and I can make money. How? The put will be cheaper to buy back. E.G. I sell it for 0,50 when the VXX trades at 14, the VXX goes up to 17 and the put is now worth 0,25. I thus sell for 0,50 and buy back for 0,25. That is 50pct profit.
And then, nothing happened. The markets did not move. Or, not a lot.
When this would happen with a put that I wrote on my regular ETFs, this would be great. The option would loose slowly value (the famous time decay) I would be able to close for a profit. That is how I made money in the past, why not now?
Well, it turns out that the VXX, by design, loses value each day when the markets are flat or go up! Can you imagine? I did not know then. I do know now! Here is why! ( Velociraptor explains it for a similar product).
So, while for my regular options, this is a good thing, it is a disaster for the VXX. It did not take a lot of time for the put to be in the money. I did what I always do: roll the postion. This has worked well in the past, especially when you understand the underlying business and I am willing to own it (for dividend reasons or long term growth reasons).
Remember, I was sure the market would crash! so, I was willing to own the VXX. I did the following: write more puts and buy the VXX outright!
And then, I started to learn how the VXX reacts to stable markets: I goes down.I also stared to realise that the correction might still be months away. As a result, my puts were deep in the money, eating up a lot of my available cash and the VXX ETF I owned was lossing money faster than I could update my spreadsheet! I was shocked… I had set myself up for a DISASTER!
I acted quick and I completely got out of all the trades and licked my wounds. Ouch….!
To make a long story short:
- I wanted to time the market crash
- with an instrument that I did not study before
- and I took a bigger position than reasonable
Never, never, never, never, ever do this! Study what you trade, keep your postion small!
Do I blame the option trading? No. I was greedy, stubborn, trying hard to time the market… I should have known better….
Slowly, I go back to the basic option writing, sticking to my rules. It feels better, results are better.