The past 2 years of my active options writing have been very interesting and reasonably profitable. In many monthly posts, I have asked myself the question how long it would last and what would happen when there is a correction. This is no longer a hypothetical question…
With the events of the last week, the markets in general are down and individual stocks can be down even more. What does that do to an option portfolio and how does that impact the feelings of an option trader?
The past 2 years
Results have always been good. Agreed, there was some learning money to be paid by going in big time on a market drop and using an instrument I do not understand well.
I also had to introduce the concept of elephants. These are positions are deep in the money and that I need to roll far out. That means that for months – sometime 12 months and more – there will be no profit possible. The reason that I do this is to avoid assignment. Remember, I do not want to own stock.
My portfolio should be able to make money no matter what the market does: going up, down or staying flat. Off course, there are limitations: an always win does not exists. This was my plan
Have uncorrelated underlying stock: This way, not the whole portfolio should be in problem in the case of a market event
Limit myself to stock I do not mind to won
The portfolio before the events
Early January, I started to trade some positions that combine short puts and short calls: Iron condors and strangles. These positions will be profitable when the underlying stock does not move to much in either direction. And the fact that the option position can only be hit on one side (a stock can not be up and down at the same time) and has 2 written premiums, means that you have extra protection. These positions were very small in my overall portfolio. I tell myself each month that I need to do more of these trades, somehow, I fail at this.
Uncorrelated stock: I always carry positions in regular stock, ETFs, gold and oil. In theory, there is some “uncorrelation”
Worst case, When assigned, I end up with stock that I do not mind to own. That is the theory. I work with sector trackers and dividend paying stock or some serious growth stock
My portfolio is leveraged. That means that I have more total value at risk than that I have cash in my account. It is great for the returns, it is killing when things go bad.
Observations after drop
Almost all of my puts are ITM. 3 are not. Every other position is ITM. Some deep ITM. That hurts… It creates a risk of assignment. And due to the leverage, I can not pay for all these positions.
It seems that I have far to few positions that benefit from stable or declining markets. I knew this, never acted on it. DO SOMETHING ABOUT IT. Till now, I have tried it a few times and got scared when the stock went beyond my call strike. I now need to decide if I can deal with that or not.
Correlation is a fairy tail. My gold and oil positions went equally south. Part of that is the fact that I use goldmines. Gold itself was down less. Maybe a thing to consider… There is less premium gold, it held up better in the drop.
What is next?
For each position, I will need to decide on a management strategy. In most cases, I will do what you do with elephants: roll them and try to get out of the position, sooner or later.
Some positions are less than 5 pct ITM. That gives hope to manage myself out of the position in a reasonable time frame.
Others are 15 pct ITM. That will ask a lot of time and comes with an increased risk of assignment. Sadly, these are also the biggest positions that I have and they are way to big for my portfolio.
Correlation does not help in a fire sales.
Diversification needs to come mainly from having short puts and calls. Learn to deal with it…
Keep powder dry and be patient to wait for the good times, like now. Sadly, I have no money available to write options now. And now, the premiums are really juicy…
No single position should exceed 20 pct of your portfolio
What have you learned?