It is Dec 19 2015 and a whole year is almost behind me. It has been a momentous 12 months for me and I have a learning experience to share. My trading account had gone on a nosedive and gave back my year to date gains and then some. How did that happen? I was over confident and sold more puts and were holding a few stocks at the top of the market when I should have been sitting on 50% cash knowing how frothy the market had become (hindsight is 20/20 but there was no excuse as I had gone through 2008). Considering the fact that I had close to 40K+ of realised gains (100+% ytd returns), the one thing I should be doing is scale back risks and not business as usual. I am no Niederhoffer, but what my portfolio went through the last 3-4 months albeit tiny compared to his billion dollar portfolio reminded me of Niederhoffer's trades before and after Sept 11 2009. This was told in the April 22 2002 New Yorker article titled "Blowing Up" by Malcolm Gladwell. Victor Niederhoffer was collecting juicy premium selling LEAP puts on S&P and when market crushed big and he was sitting on those upside down put options and his account holding decimated as a result. Niederhoffer would spend the next many years trying to rebuild his trading capital. Here is the
article on Gladwell.com a very entertaining read.
August was THE month that undo all the good deeds. I remember how in July I had noticed volatility was starting to pick up. Daily market range had gotten bigger à la summer 2008. As Aug 1 kicked in and summer boredom took hold and the angst was palpable. The market was not bored by any stretch of imagination on the contrary one could tell from the daily point swings that the amplitude was about to get bigger. Day traders, machines, algos, just about everyone were antsy (the smart ones had gone to the beach in the Bahamas). A lot of chatters, twitter rumors, anything to get the market to move bigger. Everyone was talking about a market top but no one wanted to be the first to get out of the door. In the mean time scalpers and day traders were still trying to trade and fade and trying to irk out a living every day.
My trading strategy over the last 2-3 years have not changed much. I would pick a stock I don't mind holding if it gets put to me and sell cash covered puts on. If it ends up getting put to me, I would turn around and sell calls, thereby generating my own dividend income so to speak. My criteria for stock selection is one that has a good beta, and higher beta stocks are usually associated with high risk stocks. High beta can also come about if there is upcoming earnings or anticipated news. My rule of thumb is one where the option premium will pay me at least 5%-6% or more over 1-2 months and stock price of anywhere from $4 or $5 to $10 a share. Unfortunately, this only exists in stocks that are highly speculative, and usually one with debts and risks. These stocks are also the ones shorts like to target which means they can be subjected to pretty relentless shorting and inversely occasionally a huge short squeeze. I do not ride my put options till expiration so I can make 100% gain if they expire worthless. I typically close out my options once they have decayed sufficiently and don't quiver over the last 5 cent decay over 3 more weeks. This protects me against an unforeseen big shock and I can take advantage of the next volatility spike when it presents itself. In short I sell volatility. This strategy works fine until a broader market shock happens quickly and there is a stampede. In addition, if this is a biotech or pharma speculative stock and had a disappointing trial result, shorts will be feasting on the stock and decimating the stock. Similarly if someone had written a damaging article and publish it online for everyone to read, the Twitter world and everyone would be all over it and its stock price would move sharply lower swiftly. This is what the US stock markets have become, every man and woman for his or her own greed.
In my case there were only two culprits: namely XOMA and PVA. XOMA, a case of a 30 year old Bay Area pharma company not being able to successfully develop a working drug after 3 decades but somehow manage to chuck along and survive. PVA, a case of everything that can be wrong with the management of a natural gas exploration company and is wrong, a company not executing the right plans, taking on debts when the going was good for the firm. I was overweight these two stocks having made money trading and selling calls and puts on them. The option premiums I collected over the past 16 months had more than zeroed out my cost in XOMA's case so everything I made from that point was a mice steady income. This was true until the stock got decimated by shorts on bad trial data one morning I woke up to, The move was swift and there was no time to exit any options, they were upside side. My put options were exercised and I was holding worthless XOMA shares once expiration day came. In the case of PVA, I was awe struck by the speed at which the stock sank, as oil price went from $70 to 60 to 50 a barrel in a few months and natural gas price sank to fresh 52 lows each week. I was like a deer frozen by the headlight, in disbelief. You asked why didn't I use stop loss, I do not normally use stop loss as I don't want my stop loss to be hunted (now NYSE has done away with Stop losses and GTC orders). . PVA share price went from mid 6 to 5 to 3 and soon to $1 in the span of a few weeks. The mistake I made here was liquidating both positions walking away too late only when I realised that conserving trading capital is RULE ONE.
It looks like I broke my own money management rule in 2015. Lessons learned and I shall strive to be a better trader in 2016.
Here is a book I recently read and found it to be entertaining and helpful to my trading. I highly recommend anyone interested in being a better trader to read it.
Here is an excerpt from the back of the book - "Trading is a battle between you and the market. And while you might not be a financial professional, that doesn't mean you can't win this battle". Through interviews with twelve ordinary individuals who have worked hard to transform themselves into extraordinary traders, Millionaire Traders reveals how you can beat Wall Street at its own game.
