Options Management - Snatch the Loot and Scoot
By
Jay Leavitt, Ph.D.
I trade with a market timer that follows the S&P 500. The SPX is an Exchange Traded Fund [ETF] that tracks the S&P 500. In addition to following the SPX as a market timer, I also track every 5% price change relative to the open price whenever there is a new bull or bear signal. Gains of 5% have been frequent over the years; 10% gains occur less frequently and are often accompanied with a pull-back; gains of 15% are infrequent and usually transient. On November 11th 2008 the market is in a downtrend and the timer indicates a bearish signal at the start of the decline. Starting with Novmber 11 through November 24, here are the closing prices of the SPX along with their percent price change relative to the open on November 11: 11: 898.95, -1.98% I employ a "Snatch the Loot and Scoot" money management plan that takes advantage of the stock price excursions. The Options Trade Management Strategy Described This "Snatch the Loot and Scoot" strategy is straight forward. We are going to buy an Out of the Money call [at least $1.00 OTM] with a minimum of 45 days to expiration. If the OTM strike is $1 below the next strike and that strike is a multiple of 5 then take the higher strike. Ex. If the OTM strike would have been $44 then take the $45 strike
Gains without trade management We are going to buy 16 March contracts of the inverse ETF of the SPX, SDS, for $19.98 on 11/11/2008. This costs $31,968. If we didn't employ any money management strategy, we would have experienced a small gain of $299.20. Table of SDS and Option Values at Critical Dates
Gains employing trade management Look at what happens if we employ a trade management strategy.
Summing up the profits gained in steps 1 through 4 above, we show a total option profit of $20,697.00. This represents a gain of 64.74%. This gain was realized by selling contracts at prescribed levels to take advantage of the price move. This scenario is not unusual. Many times we find that the market goes in our direction. However, before we know that the direction has change, we give back some of our hard-earned profits. By capturing the money when it is available, we turn an OK trade into a great trade. It is critical for investors to take profits when they present themselves. The concept of adding to a trade as the trade progresses adds considerable risk. In addition, in these volatile markets, it is important to have a money management strategy that reduces risk rather than increasing risk.
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