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Should We Take Profits at 300%?

About 2 weeks ago we finally broke our watch levels.

I had been bearish and not expecting that to happen and we had most of our cash on the sidelines so I decided to come up with a couple of plays that we could get involved with that were totally mindless to execute and totally liquid in the options pits so that everyone could participate.  And when I say everyone, I mean EVERYONE because it was such a simple play that I saw no reason not to make as many people rich as possible.  As I said at the time: "After all, if the Government is going to give away free money to drive up the markets, who are we to turn it down?"

It’s not often I give away free trades to non-members but our Member site is nearly full and we’ll be cutting off access to new Members soon as we head into the Summer, when we have some changes to make, so I’m giving my free readers a chance to make some quick cash and come join us before we close the doors.  Even a simple PSW Report subscription would have dropped this trade idea in your inbox at 8:30 am, hours before my posts are picked up on other web sites!  My trade idea on the morning of Tuesday, the 13th was:

As you can see from this Fallond Stock Chart of the S&P, this train has already blown through a sell signal on the 8th and the top of the channel is rising to 1,220 with 1,200 ready to become the bottom of the range if we can punch through here.  The VIX has crashed but they are still willing to give money away to the bulls on the Dow.  Here’s a simple example of how you can make a 500% return by simply betting the Dow holds 11,000 through May options expiration (21st):

  • Buy the DIA May $108 calls for $3.20
  • Sell the DIA May $110 calls for $1.85 (net $1.35)
  • Sell the DIA May $107 puts for $1.05 (net .30)

You can click on the post to get two more paragraphs of details extolling the virtues of the trade but suffice to say it’s BRILLIANT as the Dow was already at 11,000, which translates to just about $110 on the DIA so all we had to do to make a maximum $2 payout on this spread was hold 11,000 through options expiration day (May 21st).  I know it’s only 2 weeks later but I just thought I’d check in with the free crowd, who are not used to managing these high-profit trades, and discuss our progress.

As of today, the Dow is at 11,204 and the purchased DIA May $108 calls are $4.40 and the sold May $110 calls are $2.77 (net $1.63) while the sold May $107 puts are .43 (net $1.20).  So, if we were to close the trade now, after just 2 weeks, we would have a profit of .90 off our .30 net entry or 300% more than we started with.  Option contracts are for lots of 100 so we’re talking $30 on the initial contract and a profit of $90 (so far).  Of course many of our members trade hundreds of these contracts at a time – I’m sure you can do the math…  The DIA options are one of the most liquid contracts we trade and we like them because of the penny incements they trade in, which keeps our spread expenses low! 

But what do we do when we are already up 300% in two weeks on a play that is designed to make 566% in 6 weeks?  Since our average expectation was to make about 100% a week, we’re pretty much a week ahead of schedule - so we shouldn’t be all that shocked, but we need to be mindful that our risk/reward profile has now changed.  Let’s say a typical entry was 100 contracts for $3,000.  We were risking $3,000 to make a potential profit of $17,000 if all went well.  Now, however, we have $12,000 in the trade and, make no mistake – that $12,000 is at risk and ALL we can expect to make if ALL goes well for the next 30 days is another $8,000. 

In the very least, it would be prudent to take 1/2 off the table here and put a 50% stop-loss on the rest of the trade.  Locking in $6,000 now guarantees us at least a 150% return ($4,500 profit), even if we are stopped out on the remainder with a 50% loss and, if our remaining shares make their full return of $10,000 (50 100 unit contracts at $2) we will still end up with $16,000 out of a maximum possible return of $20,000 (75%) and a profit of 433% on the entire trade.  This is why Rule #2 at PSW is "When in doubt, sell half" – locking in profits is a valuable trading skill.  How many times have you been up on a trade, only to see it reverse and take back your winnings?  We teach these simple systems to keep you in control of your profits!  

Now we have clarified your thinking – Letting go of winners is a very hard thing to learn but risking $12,000 (20% of our virtual portfolio) on the Dow staying above 11,000 for a month is NOT AT ALL what we signed up for when we initiated this trade.  As I often say to my Members:  Greed Kills!  Greed is the enemy of profits and it’s very easy to get caught up in the moment with a winning trade and begin to feel invincible and, even worse – smart!  We are not smart because the trade went our way, we are LUCKY.  We WERE smart when we came up with the trade and we WERE smart when we committed a sensible amount to it and put it in play but, after that – it was mostly luck because the Dow could have gone either way, no matter how well we think we "understand" the markets

Sun Tzu (Art of War) said: "The victorious strategist only seeks battle after the victory has been won, whereas he who is destined to defeat first fights and afterwards looks for victory" and also, "If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle."  Sun Tzu would have made a very good trader because he knew that the battle is all about preparation but, as he says, you must also know yourself and we professional traders must learn to recognize when the battle is won and not allow ourselves to be drawn into a new battle which we are not prepared for.

We were prepared to risk $3,000 to make $17,000, risking perhaps 5% of our virtual portfolio on the trade.  The idea was to offset some bearish bets we made that would not do well if the Dow kept going up.  In theory, the worse our bear trades did, the better our bullish spread would do.  Fortunately for us, the way we made these 200 Dow points in 2 weeks was very choppy and we were able to take nice profits on our bear trades (because we were not greedy), even while the bullish spread did it’s job and kept making money.  If $3,000 was 5% of the virtual portfolio ($60K), the $9,000 profit means our entire virtual portfolio gained 15% on just this play.  Since we don’t like to risk more than 5% on a single position, we are already treading in dangerous waters risking our $12,000 (20%) and the fact that we have removed our bearish hedges means this play is now much more exposed than we would like!

As I often say to Members: "I’m sure we’ll find something to trade tomorrow if we cash out today."  That’s another major trading mistake traders tend to make - thinking that THIS trade is the BEST trade and there won’t be another one to replace it.  This trade is 53% won in 33% of the time – we’re not going to improve on that score - it’s a mathematical impossibility.  We will go, at best, from making $9,000 in two weeks to making $17,000 in 6 weeks with our rate of return dropping from $4,500 a week to "just" $2,800 on our $3,000 play.  Why not quit while we’re ahead?  If we learn to quit when we’re up 300% in 2 weeks, then we really don’t have to play that often to have a good year.  As JRW wisely said this afternoon in Member Chat: "After Monday, Wednesday, and yesterday, I’m up six figures on the week, so I’m going to play golf."  THAT’s the way to do it - learn to take the money and run (or, in this case, drive around in a cart with beers).  

Tuesday’s play was so clever and we were so sure the market was heading higher, that we decided to press our luck on Wednesday – this time using the more aggressive SSO ETF, the ultra-long play on the S&P.  Our premise was similar, we expected the S&P to follow the Dow through our breakout levels and hold 1,200 through May 21st.  This play I made conditional to my free readers saying: "I’m not telling you you need to buy a book or do anything special – just join my Membership site AFTER you make your 566% – that’s a pretty good deal!"  We’ll find out next week whether this kind of marketing is effective… 

Our next play with my commentary was:

  • Buy SSO May $42 calls at $2.85
  • Sell SSO May $44 calls at $1.60 (net $1.25)
  • Sell SSO May $42 puts at .95 (net .30)

That’s another 566% profit in 37 days and, like yesterday’s DIA play, this spread is already 100% in the money so all the S&P has to do is NOT GO DOWN (or at least finish up here on May 19th) and we win.  Keep in mind your downside risk is that SSO, which is an ultra-long on the S&P, falls below $42 and you are forced to buy the ETF at net $42.30, no matter what the price is at the time.  As I said yesterday, $42.30 is $1.75 (4%) less than the current price so this is an ideal play for bulls who intend to buy on the dips anyway. 

SSO is now at $45.43 and the May $42 calls are $3.85 and the sold May $44 calls are $2.25 (net $1.60) while the sold May $42 puts are now .47 for net $1.13, which is up "just" .83, so not quite as good as our Dow play but mainly because we caught it a day later and missed the good entry.  Still, .83 profit on 100 contracts ($3,000) is a very nice $8,300 profit (276%) and we liked this play because it was far less margin intensive than the DIA spread.  Another $11,300 to cash here plus the $12,000 from the DIA play is $23,300 on two plays in our $60,000 virtual portfolio.  If all our other plays were neutral or we were in cash on the rest, we would now have $77,300, up 28.8% on the WHOLE virtual portfolio in 2 weeks without over-committing to any single trade.   

These are the kind of plays we look for when we have a lot of cash on the side.  Strategies must shift with the circumstances.  The Japanese have a saying that goes: "When all you have is a hammer, every problem looks like a nail."  So many traders (and even hedge funds) get into the trap of falling in love with a strategy and applying it regardless of actual market conditions.  The trick to making these kinds of returns is to have an arsenal of trades that you can put to use and to identify the kind of market conditions where they will do you the most good.  I know it seems simple but why is it no one else ever tells you these things?  This is our mission at PSW – to give you the tools you need to succeed under ANY market conditions!

Our Buy List, which I updated that Wednesday Night is a great example of the diversity of our strategies.  We closed 46 of the 66 trades we deployed Feb 8th, at the last market bottom (which was the last time we bought with real enthusiasm) and our 20 remaining plays (the ones we couldn’t bear to cash out so far), are all profitable.  As we get closer to what may be the top of a range and as the stocks we follow get nearer to full value, our strategies shift and we deploy different trade ideas for dealing with different trading problems.  The strategies we used to make money when we expected the market to go up 20% from the February lows are not the same strategies we will be using in this week’s new Buy List, nor are the stock selections going to be the same.  In our short-term chat trading, we may get a little more aggressively short as we look to protect our longer-term profits and, of course, we have our trusty "Disaster Hedges," just in case… 

I promised Members a new Buy List this weekend and, even at this moment, I’m not yet sure what the appropriate strategies will be but I do know that, whatever is required, we certainly have the tools to get the job done!

 


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