This is the trading plan that has served me well.
It took me many years of learning, testing, and trading to arrive at this method, which fits my personality and has been consistently reliable. Some folks may scoff at this plan, and that’s okay. I’m not here to win approval; I just enjoy making reliable profits from option trading and have had many requests to share my full plan. So here it goes . . . .
First off, I sell strangles on ETFs and commodity futures. And I sell them with 150 days until expiration. I will talk about why I do this later on. For now the important thing to understand is that this is the heart of my trading plan.
The goal with my trades is to close them with a profit that is 50% of the credit I received when opening the position . This was something I learned from Tastytade long ago, and it has stood the test of time.
I also get out of any position if it reaches a loss of 3 times the credit received. So, if I collected $100 of credit for the trade and it is showing a loss of $300, I close it. I used to close them at a loss of 2x, but I discovered that most of those trades would have turned into winners if I had waited.
Even with that hard stop loss in mind, my primary goal is to defend a trade like mad and absolutely not let it get to that 3x stop loss . . . . if I can help it.
How do I do that? With rolling.
My rolling is much more preemptive than many other traders. Here is how it works.
First of all, I aim to sell options that have around 10 deltas. Once I am in the trade, if the delta of one of those options doubles, I roll the other side in to 3/4 of that troublesome delta. So, if the stock moves down and the put option becomes a 20 delta option, I roll the call down to the 15 delta spot.
After that first roll, my subsequent defensive formula goes like this:
If the delta of tested side = 4 x original delta: 2nd roll in of the untested side..
If the delta of tested side = 5 x original delta: 3rd roll in of the untested side.
If the delta of tested side = 6 x original delta: 4th roll in of the untested side.
You may have noticed that my rolling gets more frequent after the first two adjustments. It’s because things are getting serious at that point and I am just trying to neutralize the threat of a bigger loss. While I currently have a 93% win rate on my trades, I believe the real key to making this plan exceptional is being able to defend those positions that go bad and minimize their losses.
Here is an example of where I defended the daylights out of a trade and avoided a loser.
On June 19, I sold a strangle in GLD with 122 days until expiration (150 is not always available): A 134 Call and 112 Put, as indicated by the red dots.
The delta of each option was 10. I actually sold 2 contracts of each option, but I will refer to them as “the call” and “the put” to keep things simple.
The total credit I took in for the trade was $146.
On July 17th, GLD had moved down enough that the delta of the put option was 20. I made an adjustment where I rolled the call down to the 125 strike (bought the 134 call back and sold the 125 call).
I took in $82 for this roll. So the total credit I had now taken in for this position was $228.
On August 13th, as GLD continued to march downward, the delta of the put hit 40 and I rolled the call down to 120.
I collected an extra $62 for this roll. This increased my total credit received to $290. At this point the trade was at a loss of about -$200.
On August 15th, the delta of the put hit 50 and I rolled the call down to 117.
I collected an additional $54, bringing my total credit received to $344.
On August 16th, I rolled the call down to 115 and collected another $68, bringing the total collected to $412.
Finally, on September 4th I closed the position for a small winner, paying $401 to close the position.
All of this rolling allowed me to further reduce my downside risk as the stock moved downward. You will notice at the end I had a pretty tight strangle, and it would have taken a very long time to actually hit my profit target. But at that point, I’m not going for a profit; I consider the trade to be in quarantine and I’m just trying to get it back to scratch.
Does this tie up capital while I’m trying to do this? Yes. But it would probably take me at least 3-4 good trades to make up for this one loss, and that takes a lot more capital. I’d rather sit tight and try to get this one back to even. Plus, with this defense method I’m not hopelessly pleading with the stock to change direction and go the other way. I’m just hoping it calms down—which is much more likely.
Now if the market continues to move hard against me or bounces the other direction with a vengeance and creates a full loser, so be it. At least I gave it a darn good fight.
Be sure to check out Part 2 of The J. Arthur Trading Plan, where I describe how long I stay in trades, when I roll them forward, why I sell options so far out, and more. Feel free to send questions and I will try to address them in my next post. Stay tuned!