The hard lessons I learned from losing $887 trading options in 2015

The road to success is paved with failure

I’m a firm believer you have to fail before you can really succeed. Sure you can get lucky right out of the gate and get some big success, but I think it sets you up for a harder road further down the line. 2015 was actually worse than 2014, but I think I learned more.

Today i’m going to outline those failures for you, what I learned and the rules I’m going to put in place to keep the failures from happening again. Because, honestly, at this rate if I continue to fail my account is going to cave in and I’ll be done with options trading.

So sit back and grab a drink because this is going to be a long one.

A review of my 2015 plan

Here’s was my 2015 plan:

Create small, consistent wins through trading naked puts, covered calls and collars on CLF, TRN and GE which create a 1% monthly return and capture 60% or more of the available premium.

On the surface I think this seems like a good plan. I had a well thought out process which helped me develop the plan and I rolled into 2015 executing this plan.

First, my plan is a little off. I mentioned “naked puts”, however I really meant cash secured puts. Quite a big difference when it comes to the impact on the buying power of your account and an error I should’ve caught from the outset.

Aside from this little doozy of an error, the plan makes sense and there’s nothing inherently wrong with it.

Let’s take this apart a bit and see how well I stuck to it and how good of a plan it was.

Did I stick to the plan?

In my plan I identified three stock I would trade; my nemesis CLF, the reliable TRN and the newcomer GE. So, all of my trades should’ve consisted of those three stocks. When I look back at my Trading Journal Spreadsheet trading log I see a different story.

Of my 43 trades for the year here’s the breakdown by symbol:

 

Symbol # Trades
TRN 16
CLF 15
USO 6
GE 5
CHK 1

Yeah…not quite what I had planned. Where did those seven non-CLF/TRN/GE trades come from? And why did GE have so few trades?

Let’s tackle the easy one first. I decided to stop trading GE because it was eating up too much buying power per trade and not yielding a whole lot in credit per trade. This is a lesson in volatility, but I really didn’t know it at the time.

GE, as you might guess, is not a very volatile stock. Most gigantic, blue chip type companies aren’t. This can make them great core holdings in some portfolios or those interested in dividend trading (assuming they pay a steady dividend), but they aren’t really good stocks to trade options on.

I won’t get into the details here, primarily because it requires a bunch of math and I suck at math, but options derive a lot of their value from the volatility of the underlying security. So, if you had two equally priced stocks the one with a higher volatility would fetch a higher premium.

There are many other factors which go into the pricing of an option, but I won’t discuss those. If you’re looking for a good, but pretty dense book, on the matter I’d suggest Option Volatility and Pricing by Natenberg.

I almost hit the mark of capturing 60% or more of the available premium of the trades I won. I managed, on average, to capture 56.26% of the premium in the trade after commissions.

I’d call that a win.

However, my average loss was 102.75% on the trades I lost which kept me from generating my 1% monthly return in my plan.

I’d call that a loss.

Okay, so I managed to stick with bits and pieces of the plan, so let’s dive into the plan itself and ask the question…

 

Was this a good plan?

Looking back at my plan i’m not so certain it was the best plan for options trading. I think if I was seeking to invest only in those companies it would’ve done well for me, however as an options trader I need to maintain a broader view of the market.

Restricting myself to just three stocks to trade around doesn’t leave many options (no pun intended) open for trading. This became evident when GE climbed up out of my range to sell puts against. This effectively reduced my trading options (seriously…no puns here) to just two stocks.

I adjusted to this by incorporating USO into my trading, however I think I should’ve looked even broader.

Many sites and a handful of books I’ve read suggest having a watchlist of around 20-40 securities. This allows some of your securities to sit and be boring, move the wrong direction or move out of your trading range but still allows for some to be available for trading.

The other aspect of my plan which could use some examination is my profit target of 60%. I really had no basis for selecting this as a target, it really just sounded like a good number to shoot for.

I think, however, I’ll revise this for 2016 to be just 50%. This will allow me to take profits earlier and not try to hold out for the extra 10%. And to be honest, I didn’t stick to this part of my plan 100%, but I did at least build it into every trade when I logged it in my Trading Journal Spreadsheet (TJS) log.

Here’s an example:

Trading Journal Spreadsheet Trading Log Showing 60% of total premium is the Target Price

Note the price in the “Target Price” column is ~60% of the total in the “Entry Price” column.

So, that’s a pretty good review  of my plan from 2015, but it’s not the only lessons I learned this year.

 

You’ve got to know when to roll them…

How you manage a trade can make or break the entire trade and knowing how and when to roll a trade can mean the difference between profit and loss.

I thought I had a good understanding of how and when to roll a trade when it moved against me. However, when I look back at my trade notes and how I felt when trying to roll a trade, I clearly didn’t have it down to the mechanical precision it needs to be.

I’m fairly certain that with better trade management I could have mitigated most, if not all, of my losses for 2015.

Looking at the analysis page in my 2015 TJS I had 13 losing trades for the year. I marked 10 of those trades as going bad due to “Bad order entry” or “Entered too soon”.

Matching the analysis with the corresponding trades, what I really could have put in is “Holy crap the stock moved immediately after I put the order in and I don’t know how to handle it”…too long? Maybe.

It all boils down to the basic fact that I didn’t know how to manage or properly roll the trades after I got into them. Earlier this year during my writing hiatus, I went on an education binge about rolling trades.

In the next few weeks I’ll put it all together for you, with the resources I pulled from, so you can understand my thought process.

It’s safe to say that rolling and managing trades requires a tad more planning than I put into it.

Though managing trades was a huge reason as to why I had a down year, it only accounted for 50% of my total losses. The other reason is completely under my control and will be remedied in late March or early April.

Treat trading like a business: manage costs

I’ve read on many sites, but most prominently at Fullyinformed.com, that you need to treat your trading like a business. I most definitely did not do this in 2015.

There are many things business owners must manage, but no matter how much a company brings in if your costs are too high then you’ll never turn a profit.

In 2015, commissions nearly equaled my losses on trades.

I paid about $424 in commissions in 2015. My losses due to trading was $463.

Wow.

You would think I’d have taken a note from Lorenzo Goncalves, the current CEO of CLF, and worked throughout the year to cut my commission costs.

With OptionsHouse, my current broker, I can trade up to five lots for $10 round trip (open and close). But when I look back at my 43 trades over the year, only six (14%) of them involve more than one lot.

My current account size doesn’t allow me to frequently place trades with multiple lots. This is just a characteristic of small accounts. However, the commission structure I’m currently under doesn’t care if you’re trading a single lot or five. You get charged the same.

Luckily, during my scouring of the Web I managed to find a reputable online broker where I can trade for just $3 round trip.

That’s a 70% reduction in my trading costs.

Now I don’t know about you, but any company that can reduce its costs by 70% in a year and still conduct the same amount of business is probably heading down the right path.

Had I used this commission structure for 2015, my total costs would’ve been $129 and my total losses for the year would’ve been $592. Still horrible, but a lot better than $887.

I’ll put together a brief article on this broker and some of the tools available here shortly, so keep an eye out for it!

Down but not out

Yeah…2015 was a rough year for me but hopefully I can put my lessons learned into action and accomplish a positive return in 2016. Like I stated in the beginning, my account needs it!

Reliving the pain of the past year is tough but required to become a better trader. Many of the folks I follow online or read about have done this for decades, but the commonality is that most of them have been in my same position themselves.

Don’t get me wrong, the current state of my trading account is poor and that’s why I’m not only making some significant changes to how I trade options, but to my trading overall. As I mentioned in the previous section I’m treating my trading more like a business which is why you’ll see dividend income reported now as well.

Business need to generate some cash flow to continue to live and mine desperately needs it. But more fundamental to my trading is perfecting the management of the trades and reducing my overall commissions. Without controlling these two aspects, I’ll never become a better trader.

I’d love to hear how your trading went (or didn’t!) in 2015. Drop a note in the comments below and tell me what was the biggest lesson you learned from trading this past year.

Happy trading,

Patrick

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