Surviving a Market Correction

A market correction is a great opportunity to analyze your trading plan.

How did your portfolio react? How did you react? Can you stay the course?

CaptureI am pleased with the resilience my portfolio has shown. Yes, I am showing paper losses in my portfolio—nothing to lose sleep over. Most of this is due to the implied volatility spike (remember, I keep a high vega portfolio). The good news in this trading plan is that implied volatility is mean reverting; it will go back down. What is less predictable is whether the market will go back up.

The most important thing was that none of my positions came close to hitting my stop loss. My number one goals is to prevent my positions from having to tap out. Because I sell premium and have a rolling strategy, if I can keep a position from ever getting to a loss of 300% of the original credit received (where I close them for risk management), it will eventually win. Some positions do fail, but very few.

I did have to adjust a few positions by rolling down calls. That fact that I wasn’t defending like crazy shows that my deltas were not getting too big. The red numbers were all vega, and vega is a beast I trust.

Speaking of calls, I’d like to address the reason I sell both calls and puts, as opposed to just naked puts, since this has been a hot topic in the option selling community.

Yes, selling calls does offer a little bit of downside protection, and yes, it does give me flexibility to roll down for defense. But that’s not the real reason I like selling calls . . . .

I sell calls because it lets me stay even farther out of the money.

Now, most of the studies that look at just selling naked puts, versus strangles, will assume that you would sell a strangle at the same deltas that you would use when just selling a naked put—you simply collect more premium. But that’s not how I look at it:

correction3
SMH naked put in the Tastyworks platform

Let’s say you want to open a position to collect $100 of credit, and you’d have to sell a put at 16 deltas to do so. If you then looked at a strangle, you could sell both options at 9 deltas and still collect $100 of credit. This is why I have a target credit amount; I’m not trying to get paid more, I’m trying to stay as far away from the battle as possible and still get paid.

correction2
SMH strangle in the Tastyworks platform

Yes, I know people say you get paid more for your risk when you are closer to the money. That’s where all the premium is. But when that correction train comes barreling at you, all the statistical risk premium mumbo jumbo gets smashed and goes flying through the air in tiny pieces.

However, when you are way the hell out of the money, like under 10 delta at 150 days till expiration, the train feels more like a slow moving barge in the distance. You respect it, but you’re not afraid of it.

Happy trading!

J. Arthur

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8 comments on “Surviving a Market Correction

  1. PEDRO MIGUEL GUERRA

    Excellent blog!. Keep publish good options posts!

    Like

  2. Thanks for the time and input here, J.

    Like

  3. david holloway

    Awesome as always. 🙂

    Like

  4. Superb Arthur, thank you very much!

    My english is not super good, so here’s my question:

    If you put on the strangle, do you mean to take the credit of, let’s say $100 for the whole position?
    And because on each side you collect less the $100, you can sell the legs farther away from the market.
    Is this right?

    Again, thanks very much and please keep your blog going!

    Like

  5. Ron Williams

    Awesome explanation, thank you for sharing you insights!

    Liked by 1 person

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