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Monday, September 26, 2022


Don’t Step on The Landmine!

Options Sage submits:

“Know everything you can about what you’re doing”  Fred Trump 

The quote above reminds me of the philosophy behind Phil’s Stock World.  While I have come across myriad traders who want the simple solution, the up-or-down arrows that don’t require any thought before committing to a trade, a select few of us want to know even more, we want to know everything we can about our subject and that approach usually produces the most success. 


In years of trading I haven’t come across anybody quite as dedicated as Phil to knowing everything about his subject; from the impact of energy on other commodities to the impact of commodities on the market, the influence of the dollar fluctuations, the impact of earnings and forward looking guidance on stock prices, the effect of implied volatility on strategy selection, the integration of strategy risk with virtual portfolio risk, the ability to distill the shifts in sentiment, fundamentals or technical charts into an informed opinion and a collection of winning trades and so forth.  For those of you that wonder what it takes, here is a snippet Phil wrote in response to a question from Kustomz in the “Strategery” section on March 6 as to what kind of market research he does in a typical day:

“I read the Times (paper cover to cover, not just business), the WSJ (electronic). watch Bloomberg and CNBC pretty much all the time (always with my post-its handy to follow up), I read a ton of magazines which I only read by the computer because I’m never satisfied with just what they tell you, I read IBD (paper), Trader Mike and Barry Ritholz, Briefing.com, Forbes.com, SeekingAlpha and Zacks.com”

I haven’t asked Phil but I’d hazard a guess that one time long, long ago, some market event surprised him and cost him money.  For that matter, it probably happened to Warren Buffett too or as Phil mentioned he wouldn’t have adopted Rule #1 as “Don’t lose money!”   I’ve got my fair of "I survived the market" t-shirts as well!  The key is to learn from the landmines that we sometimes step on and try to make sure that it never happens again.

Brett Steenbarger, author of Phil's favorite trading book, has a great piece entitled "Why Traders Lose Their Discipline."  It's an extension of our article on The Three Vices of Trading and well worth reading.  Dr. Steenbarger points out that 10% of trades account for a majority of profits.  This is very in-line with Phil's general strategy of "auditioning" positions for the LTP and his often stated premise that a double only makes up for 5 misses if you stop out those misses at 20%.

Steenbarger compares holding onto a good position to having a lasting relationship – "The people who I have seen who have been very successful in dating and relationships have been willing to go on very many first dates, but not so many second and third ones. They “scratch” the unpromising dates and then focus their energies on the 10% that look worthwhile. The same is often true with respect to career and company success. A successful individual may take on ten projects over the course of a year, but focus efforts on a single initiative when it yields promise."

One of the strategies that surprised me early on in my trading career was the calendar bear call.  More often than not a calendar bear call is a place where you end up, not a place where you begin a trade.  It usually starts with a long-term call option that has been entered in expectation of strong fundamentals translating into a long-term bullish trend.  Then the landmine explodes, the stock collapses and suddenly we’re left shell shocked.  At that point, the best policy is risk mitigation, which usually takes the form of adding a shorter term short call at a lower strike price to form a calendar bear call.

This is a variation of strategy that was employed very successfully on our 2/12 SHLD play, which closed this week as we purchased the Jun $185s for $12 and sold the March $180s for $7.80, making the net investment just $4.20 on the spread.  So far, the June calls have retained $9.30 of their value and we just bought out the March caller for $1.35, a $6.45 gain so far on just that leg of the spread.  Were we to close that position today, we would pocket $15.75 on that $5.55 (the original $4.20 + $1.35 back to the caller) investment in just 28 days, not a bad annualized rate of return! 

That was a planned position, which Phil likes to call a diagonal spread.  Now that you know they work, we'll talk about adding a calendar bear call on the fly.

On the surface this is looks like a really smart adjustment.  The short call premium reduces the cost of holding the long call alone during the downtrend.  And it is smart, provided the stock continues lower or at the very least does not reverse higher again. It's important to note with this strategy that the theoretical risk can increase substantially, which teaches an important lesson in options trading:

“Reducing Cost Basis Does Not Always Mean Reducing Risk”

For example, holding a $100 strike LEAPS call that cost $10 but adding a short call at strike 90 for a credit of $2 as the stock dropped below $90 might seem like a trade that has lower risk but in fact only the cost basis has been reduced.  Many of our LTP plays start out like this while Phil tests them out but our goal is to hold the LEAPS at equal or lower strike prices whenever possible.

The risk of holding the above trade in the short term is the risk of the stock jumping back up to $100 in the short-term causing a short call loss and remaining there until expiration, effectively like stepping on a mine that blows up in your face.  In theory therefore,

Calendar Bear Call Risk = Difference in Strike Prices + Cost Basis

Risk = $10 + $8 = $18

Is this really our risk?  In theory yes, however, in practice we could always roll that short call up in strike price and further out in time and potentially convert the trade to a call calendar or a bull call spread trade.  The bottom line is although this is a reasonable way of mitigating risk in the original trade, it means assuming more risk than the original trade.  Once you are happy with that, it's a good trade but don't jump into it without realizing the additional risk you are assuming!

Phil does these trades more often than he recommends them for others as they can get you in a lot of trouble if mismanaged.  This educational post is a prelude to us adding this play to our trading arsenal as it may become more necessary to save some of our long positions in a choppy market.


How is last week’s Wal-Mart trade working?

Review:  Phil had decided WMT was likely to stay between $45 and $52.50 for the next 3 months:


Buying WMT Jan 09 $55s for $3.40 AND Jan 09 $45 puts $3.30 (total cost $6.70)


Update:  WMT Jan 09 $55 are  $3.10 Bid   AND Jan 09 $45 puts are $3.30 Bid ->  Total Unrealized Loss on long options $0.30


Selling WMT Apr $50s for .50 AND Apr $47.50 puts for $1.10 (total income $1.60)


Update:  WMT Apr $50s are $0.25 Ask AND Apr $47.50 puts are  $1.20 Ask -> Total Unrealized Gain on short options $0.15


Effectively the bet was biased positive that the stock would finish between $47.50 and $50 by April 20th and , although the stock has crept just below $47.50, sitting at $47.42, currently the trade is for the most part going according to plan!


Have a fantastic week!


Yours truly,


Options Sage


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Looks like we may gap up tomorrow morning and have a nice little short squeeze. . Asia seems to be trending up tonight.


Phone call, Bill Miller to Bill Gates, November 9, 2006 …

“Hey, how’s my fellow Billy doin’? Cool how us dorky guys have all the dough and get all the chicks, ay?

Anyway, I have a deal for you, brother. I’m getting absolutely killed on these homebuilder “value plays” this year. But the data mining geeks downstairs are telling me there’s tons of retail shorts to squeeze right now.

Besides, my hedge fund buddies got all the majors to pony up another round of financing for share repurchases. Can you believe it? These companies are so screwed, but they’re ponying up cash to buy their bubblicious shares!

Anyhoo, would you mind throwing a couple bil’ our way to make some easy money? You do remember all those years I bought up those Softie shares for ya’, right?

Don’t worry, we’ll get you out by the end of the year … Cool man, say hey to Melinda and the kids for me.”

Additional “free is Me” tool for Sector Analysis. Is excellent method to analyze sectors of the Market that are/did perform well/worse in selectable prior periods and “supposedly” during the trading day (although it does state prices are delayed 20 minutes). Clicking on one of the sector headings provides the individal stocks comprising that sector. Can choose sectors within a sector too, such as medical supplies within the Medical Sector. There also is a DJA sector tool available (the link is on the right side slightly up), but I was not able to get the individual stocks to pull up that comprise the sectors. Could be my cookie filter, not sure. First Market Sector tool works great though.


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