How to not get ruined with Options - Part 4a of 4 - Finally, the TRADES!

In parts 1 and 2, I explained the basics for options. In parts 3a and 3b I explained simple and more advanced options strategies, but all of this does not help much without concrete examples. These two last posts (4a and 4b) conclude my introduction related to options. I will show some of my key trades, explaining the why, the how, the entries and exits, and potential mitigations in case of losses. Most gave great returns, and I had a few small losses. Overall, in the past few months, I have been lucky to play along with the market, and the high volatility had a positive impact. Hopefully, nothing r/wsb worthy (although few of them might qualify :)). I wanted to explain the basics first, then show the trades last, as I did not want anyone to try to emulate these without understanding how/why they worked.

First, here are the high-level idioms that drive my investments:

• Over time, the market is going up.

• It can fall down violently, or it can jump high without obvious signs ahead of time.

• When the market goes down, it will go back up over time, and that can be very quick.

• A single stock will be more volatile than the markets and can go up or down even more violently. And unlike the market, if it goes down, there is no guarantee it will ever go back up.

• After a significant market move, the market often, but not always, reverts to the mean.

These idioms are pretty straightforward, and should not be too controversial. Overall, I am pretty market neutral, with a bullish tint. And as I explained before, I prefer selling options than buying them. My trades reflect that, and I avoid making trades that could damage my portfolio significantly if the market went up or down significantly. People who get ruined with options do not take this into account and are just gambling.

Other key things about trading in general, and options in particular:

• Always have a clear idea of your max profit and your max loss, and the probability of that to happen. Failing to understand this means that you will take more risk than anticipated, and one day you could blow up your account and get ruined.

• Keep your trades small, don’t have a “sure thing” trade that risks 10% or more of your portfolio. Don’t cripple your portfolio because of one bad trade.

• Don’t trade for the sake of trading, wait for the conditions to be right, then wait a bit more, and wait again, then when things look the best, then trade on your own terms. Do not get sucked into gambling with a poor profit/risk profile.

• Watch out for your leverage, it can be very easy to take too many risks, and use too much of your buying power. If you mix your bearish and bullish bets, you can close one side at a profit to free some buying power and reduce overall risk.

Now the moment we have been waiting for, some of my trades:

The short naked puts or covered calls:

I only do pure covered calls when the market has dropped significantly, and use the recent market conditions as a floor. March dropped quite hard, and I am not convinced that we would reach it again soon, but I still have to prepare for it. That being said, the months of March to June have been really good for covered calls as the market traded up first, then sideways, with high implied volatility. I usually target shares that are solid or did not go up too much, so the March floor is not too far lower than my strike. I usually sell naked puts after a few down days in a row and covered calls after a few up days in a row. And if the market is farther from the floor, I trade safer names when the market goes up, and target high beta when the market dropped significantly.

I am not giving you a full list, but let’s say that it was not hard, and still is, to find good names that return 1-2% per month AFTER accounting for a 15-25% share drop. Yup, you read that right, it does not work in normal markets, but it is the case right now. Even if $WM, $WMT, $INTC, $NNN, $EWW, $DLTR, $COF, $BAC, etc. dropped by around 20%, I would gladly pocket my 1-2% premium, and scoop these at a huge discount. Even if it dropped further, I can continue rolling the puts until the market bounces back. Some of the high beta names include $CCL, $REM, $DIG, $BUD, $JETS, $XOP, etc. For a high beta, I am targeting 3-5-10% or more of premium, but I usually try to offload them when they go up significantly.

But there are few other riskier trades that are worth calling out:

$DKNG - DraftKing: 11.8% in ~3 weeks.

I forgot about the IPO, and got in the game 5 days later. Although, I am not a gambler, and the stock went up already, but I had a feeling that RH fams would jump on it (gamblers beget gamblers), and that would give a floor to the stock. Volatility was high, so selling naked PUTs made sense.

May 7: SELL -1 DKNG 100 15 MAY 20 22.5 PUT @ 1.06

Per contract - Max risk: $2144 - Max profit: $106 (4.9% of max risk)

May 8: SELL -1 DKNG 100 19 JUN 20 22.5 PUT @ 2.15

Per contract - Max risk: $2035 - Max profit: $215 (10.5% of max risk)

As you know the max risk of going to $0 is possible but highly improbable, so RORAC (Return on Risk-Adjusted Capital) is much higher than these 4.9 to 10.5%.

The $1.06 premium was one week before expiration! I sold the MAY and JUNE PUTs at the same time. And the price was at $24 already. If the price dropped, I would continue rolling my PUTs until I am profitable. The price went up, I rolled my MAY PUTs just before earnings (and a day before expiration), to take advantage of the earning volatility, and avoiding expiration day.

May 14: SELL -1 DKNG 100 15 MAY 20/19 JUNE 20 22.5 PUT @ 2.15

Per contract - Max risk: $2035 - Max profit: $215 (10.5% of max risk)

So one week later, I bought back my MAY PUTs for $0.25 (pocketing already 3.7% of the profit) and sold the same JUNE contract as the week before with a better price and an overall premium of $2.15 (same as the week before, despite paying back the $0.25! And the stock was already up in a week. Can you believe that shit? Volatility increase definitely helped. Thanks RH gamblers!).

June 1: BUY +1 DKNG 100 19 JUNE 20 22.5 PUT @ 0.05

After a bit more than 3 weeks of holding, I decided to buy back all my contracts for $0.05 per share, for an overall 11.8% profit on risk. I pretty much reached max profit already, no need to take more risk, with 19 days to go to expiration. FWIW the stock was at $44 by expiration. It was way too much for my taste, with no premium worth the risk of any new trade.

Could I have made more profit buying shares, calls, or synthetic shares? Sure. But there was no guarantee on the direction, timing, or amplitude of the move. Here, I won almost 12% with a high probability of success, even if the stock barely budged or dropped a bit. And since 6/19 expiration, the stock dropped to $33 now. It’s hard to predict when to sell. I want many singles and doubles with few losses, instead of once in a while home runs with many losses in between.

As it dropped for 5 days to $33, I recently sold some PUTs for a $22.5 strike again:

June 29: SELL -1 DKNG 100 21 AUG 20 22.5 PUT @ 1.25

Per contract - Max risk: $2125, max profit: $125 (5.8% of max risk)

Because the PUT was deep OTM, the premium was low. The stock will have to drop by more than 35% for me to start losing money, and I can still roll my PUTs then. That seems a good trade. Wish me luck!

You can see here, that you have to look at your max risk, your max profit for every trade you are getting into, as well as the chance for them to be profitable.

$USO / $DBO / $USL: 12% in 2 months

Here is one that absolutely did not go to plan initially, but I was able to turn it around.

First, the trade that led to the disaster:

April 17: SELL -1 MAY 15 20 4 PUT @ 0.35

Per contract - Max risk: $365 - Max profit: $35 (9.5% of max risk)

Remember that USO split 1:8 on April 29, if you want to look at the numbers. On 4/17, USO was worth $4.20. Oil kept dropping and dropping for weeks and weeks, until that Friday where I decided that it was finally a good time to get into oil (like a bunch of other suckers). The lowest oil price in 40 years, etc. My trade could absorb a 14% loss in USO before I started losing money, so it did not feel too risky, and I could roll the PUTs if needed. USO rolled all their future contracts earlier that week, they were already into May Futures. Yeah, contango was a concern but seemed manageable (or so I thought).

Well, except that on Monday 4/20, oil blew up. What was bad, became an awful day. Oil tanked hard because April futures dropped, and some people paid to get rid of their contracts. Tankers started to get full, too much oil, and not enough space. USO dropped to 3.75, it was still above my break-even point of $3.65, but the volatility spiked, so the value of my short put increased a lot, that was some heavy losses. Why did I go into that trade on Friday, gosh?!?

The volatility was so high, every oil trader was running around like a headless chicken, RH gamblers were taking much heavier losses than mine (because they started buying USO long before me, oil was going to go back up, that was a sure deal! Right?). I decided to wait one more day, to see how the dust would settle. On Tuesday, USO dropped even more because now it started impacting next Month's Future (May). Tuesday was the April Future expiration, so trading was all over the place. USO dropped to $3, well below my break-even point, volatility was still high, my losses were twice as big. There was a strong possibility that May Future expiration would behave the same as April, and the rollover of May Futures to June Futures would end up in a real quagmire due to an even higher contango. USO was not the right tool, I messed up, no way moving forward, even rolling my PUTs are not going to do it, USO will drop faster than the premium I can collect. Get out, get out, get out...

April 21: BUY +1 MAY 15 20 4 PUT @ 1.42

I bought back my short PUT at more than 4 times the premium price. Gulp. That hurts.

Taking a step back, this was an extreme situation and not a normal loss with a stupid long term thesis. And I lost a bit of money jumping at the wrong time. A negative future price is not a common occurrence.

USO was the wrong instrument to profit from oil, it even dropped down to $2.11. And never recovered its value from 4/17 despite oil being higher than that day. I made a mistake, but there must be better instruments that can tackle contango. Enters DBO and USL. DBO has a 6-12 month away contract, so very little impact from contango. USL has the same number of contracts from all months (next month, month after next, etc..., until the 12th month). It is mostly impacted by the contango on the front months (so for 1/12 of the value, or a bit more), but it is not as volatile as USO (USO since changed their composition too, to buy multiple months futures).

Oil blew up, volatility is extremely high, many oil traders (and RH gamblers) got ruined, but oil is bound to go up eventually. The initial trade to sell volatility through selling naked puts, and rolling as needed until oil goes back up, without being killed by the contango still seemed sound with even less risk and better rewards this time around.

April 20: SELL -1 DBO MAY 15 20 6 PUT @ 0.63

Per contract - Max risk: $537 - Max profit: $63 (11.7% of max risk)

April 20: SELL -1 USL MAY 15 20 12 PUT @ 1.05

Per contract - Max risk: $1095 - Max profit: $105 (9.5% of max risk)

April 21: SELL -1 DBO MAY 15 20 5 PUT @ 0.90

Per contract - Max risk: $410 - Max profit: $90 (21.9% of max risk)

April 21: SELL -1 USL MAY 15 20 11 PUT @ 2.25

Per contract - Max risk: $875 - Max profit: $225 (25.7% of max risk)

Notice that I sold the first batch on April 20, as I was still losing money from USO. The volatility spiked, and it was too good to pass. This is a key reason why you should never put all your money on one trade, but only a few percents at most. That way if the things are not going as planned, you don’t lose a ton, and if you can find a more advantageous position, you can double down if you have some dry powder left (but DO NOT overdo it!). It’s all about the proper sizing of trades and overall risk. I sold the 2nd batch when I closed my losing USO trade when oil dropped further and volatility increased even more! 22% to 26% potential profit on ATM puts? Just wow!

The plan for the exit is to close for $0.05 or roll to the next month for further profit. I sized my DBO and USL trades a bit more than my USO trades, so I would make up for the heavy losses. And I did roll in May and closed the June contracts for $0.05 both DBO and USL. Their prices both creeped up slowly, and the volatility dropped to something normal. DBO and USL trades were extremely profitable, and despite the heavy USO losses, the overall profit was still quite good.

Today, the price of DBO and USL is a bit high for a good profit/risk profile with naked short PUTs, however, we have some other strategies.

The verticals:

Most of my bread and butter is on selling naked puts, and/or selling covered calls, but sometimes I dabble in verticals. Here are some examples:

$UBER: 13.2% in a month

This is an example of waiting for the right time before you trade. End of May, the market went up by 36% since the bottom, it started to be over-extended. Although SPY could continue higher, it was time to think about a reversion to the mean. I needed to find a share that would continue to struggle for a long time, even as Coronavirus was lingering. I hear the news that LYFT is taking over UBER’s market and that UBER is still struggling, with potential layoffs. That seems a good candidate, and UBER has a good day at $36, let’s see what we can make of the numbers.

May 29: SELL -1 UBER JUL 17 20 42/45 CALL @ 0.40

Per contract - Max risk: $260 - Max profit: $40 (15.3% of max risk)

So I keep my $40 profit per contract as long as UBER is under $42 at the July 17 expiration. I did not pick $42 randomly, this was actually above the top that UBER reached in February. So the struggling UBER would need to go over its pre-corona numbers for me to lose money. Unlike naked puts / covered calls, where you can just be patient and roll over and over, sizing for verticals is important, the potential for full losses is a real possibility, and will happen. Sure, you could try to roll your short call and hope that the stock price will drop, but you may just end up amplifying your losses. If you really want to do that and continue with the risk, it’s easier to roll your short puts in a bull spread as the market will eventually go up.

In any case, UBER continued to go up a bit, struggled at $38 (so not even close to my vertical), then reversed. I put an order to close my position at $0.05, as there was almost a month left until expiration, and I already almost reached my max profit.

June 22: BUY +1 UBER JUL 17 20 42/45 CALL @ 0.05

$SPY: Various

I also have been using SPY verticals directly as the market bounced back like crazy. I earned more than I lost, and because I am overall positive delta, even if I lose a bit of money on my edges, I am still very profitable.

For shit and giggles, one trade to show how you can take advantage of the high volatility:

June 5: SELL -1 SPY JUL 17 20 330/333 CALL @ 0.91

Per contract - Max risk: $209 - Max profit: $91 (43.5% of max risk)

June 26: BUY +1 SPY JUL 17 20 330/333 CALL @ 0.08

Profit of $83 per contract (39.7% of max risk)

June 5, SPY was $320, 45% higher than the bottom 2½ months ago, and I had hard time believing that after the market really thought that SPY would go back to pre-corona level with still phase 1 not over, no clear treatment, vaccine many months away, and potential for a 2nd wave (News flash: It’s happening before even the phase1 finished). Trees don’t grow to the sky. Again being, overall positive delta, even if this vertical had a loss, I would still profit from SPY going over my short calls. As I said earlier, I am a reversion to the mean guy, with a bullish tint. I can’t stand losing money when the market is going up (because the market could always continue going back up).

Here is another trade, not so good this time, so I don’t paint an overly rosy picture:

May 12: SELL -1 SPY JUN 19 20 305/308 CALL @ 0.79

Per contract - Max risk: $221 - Max profit: $79 (35.7% of max risk)

June 18: BUY +1 SPY JUN 19 20 305/308 CALL @ 2.48

Ouch - loss of $169 per contract (76.4% of max risk)

SPY blew way past my short and long calls. It dropped a bit before expiration, so I was able to avoid a full loss.

My verticals above are bearish spreads when I think the market will revert to the mean. But here is an example of a bullish spread:

April 6: SELL -1 SPY DEC 16 22 200/180 CALL @ 4.85

Per contract - Max risk: $1515 - Max profit: $485 (32% of max risk)

May 12: BUY +1 SPY DEC 16 22 200/180 CALL @ 3.95

Profit of $90 per contract (5.9% of max risk)

I sold the vertical a couple of weeks after the bottom, with blood in the street, even some of mine, volatility was still very high. With this trade, I would have lost money if SPY was less than $195 in more than 2 years. Heh, I could even roll the puts if the short put was still ITM in 2 years. The only reason I bought back and closed the trade was that it was using a non-negligible buying power for the next 2 years. That is a long time to earn the full $485 per contract. Have to watch out for opportunity costs too in some other trades.

The hedge:

Here is another construct that I found interesting. Again, taking advantage of the current high volatility. Back in early June, as the market bounced to $320, I wanted another bearish hedge, but this time more efficient than just selling a vertical. I wanted a good protection for my long delta, but that’s not free. And I don’t like to lose money if the hedge is not used, so what to do?

June 5: SELL -1 SPY NOV 20 20 370/380 CALL @ 0.57

Per contract - Max risk: $943 - Max profit: $57 (6% of max risk)

I picked November expiration because I expect that we will still be in the middle of the Coronavirus quagmire. $370 is almost 9% higher than the SPY top. I doubt that the economy will be back full speed by then. Again, I am positive delta, so if SPY somehow reaches $370, I may have to forgo all my overall gains between $370 and $380, but I won’t lose money overall. And then I bought this bearish vertical:

June 5: BUY +1 SPY NOV 20 20 245/250 PUT @ 0.57

Per contract - Max risk: $57 - Max profit: $443 (777% of max risk)

Here, I used the money from my short bearish CALL spread to buy a long bearish PUT spread. As long as SPY does not end above $370 by expiration, my hedge is free. If the market drops significantly my bearish PUT spread will be very profitable.

Once again, it's a long post, so that's all for today.

In the second part of this post, I will show how I used calendars to make some very profitable trades.

I will also explain a more advanced trade that I used to hedge against big losses in a normal market (setup in low volatility), so you can handle more gracefully bear markets ahead of time, and not sell in panic. You can’t use it now, but it could be helpful next time everything is great, and the market is getting overheated a bit.

And finally, remember to always size your trades properly. Do not let one trade create a big loss in your portfolio. Do not overextend! It's way too easy to be over-leveraged with options, take the full risk into consideration.

You can save up to 100% on a Tradingview subscription with my refer-a-friend link. When you get there, click on the Tradingview icon on the top-left of the page to get to the free plan if that’s what you want.