Traders know that identifying a stock market top is virtually impossible -- barring from hindsight. Countless money managers advocate adding to positions that are showing a profit. In contrast, I believe in 'Grab the Cash and Dash'. This short article will show you how to capture your options profits even if the Wall Street moves in your direction and then stubbornly retraces and takes away some or all of your profits.
I trade with a market timer that mirrors the S&P 500. The SPX is an ETF (Exchange Traded Fund) that tracks the S&P 500. Consider the chart of the SPX. The market is in a downtrend. The timer indicates a bearish signal at the start of the decline on November 11th 2008.
At the bottom of the chart,
there is a yellow histogram that displays the percentage points gained as the trade progresses. It shows the percentage gains of the SPX during a timer signal; the white horizontal lines are at the 5%, 10% and 15% gain levels.
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. This money management strategy capitalizes upon stock price excursions.
The Options Money Management Strategy Described
This in 'Grab the Cash and Dash' 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
a) When the SPX has gained 5% sell 25% of your contracts.
b) When the SPX has gained 10% sell half your remaining contracts and roll the other half to 1 strike Out of the Money.
c) When the SPX has gained 15% sell half your remaining contracts.
Table A
Gains without money management
We are going to buy 16 March contracts of 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.
Gains employing money management
Look at what happens if we employ a trade management strategy.
1. On 11/12/2008 the SPX has gained over 5%. We will sell 4 contracts at 27.30 for a gain of $2,928.00 [400 * (27.30 - 19.98)]; we still have 12 contracts.
2. On 11/19/2008 the SPX has gained over 10%. We will sell 12 contracts at 34.50 for a gain of $17,420.00 [1200 * (34.50 - 19.98)] and buy 6 March 115 contracts at 27.05; we still have 6 contracts.
3. On 11/20/2008 the SPX has gained over 15%. We will sell 3 contracts at 37.95 for a gain of $3,270.00 [300 * (37.95 - 27.05)]; we still have 3 contracts.
4. On 11/25/2008 we sell to close the remaining 3 contracts. We sell 3 contracts at 17.30 for a $2,925 loss [300 * (17.30 - 27.05)].
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 closing 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.
