When the market is crashing, it’s tempting for an options seller to panic and throw a huge short position on, perhaps even buying puts. Some folks end up making money and I’m not going to knock them at all.
But I’ve been there, done that, many times, and I’m not going to do it again. I always got killed by a bounce—every time. The odds of the market continuing to crash day after day, without a relief rally, are slimmer than one would think.
So what is an options seller to do when the S&P falls 10 percent?
First, use the event as one of the most valuable learning opportunities you can find. Seriously, it’s a golden opportunity. How did your trading plan react to this move? Are there things that would have reduced risk without greatly dragging down your profits?
I will put forth that my plan is handling the situation well, though I didn’t always have a solid plan in the past. Many of the parameters that saved me from a lot of pain these past weeks are things that I am usually teased about.
First of all, I do stay way the heck out of the money. After this massive drop, only one of my 23 positions actually went “in the money.” That’s pretty impressive when I think about it.
As many of you know, I am only able to stay so far out of the money and collect a decent credit by selling options 150 days from expiration. Most people would never consider selling that far out; years ago I wouldn’t have either. But hard earned battle scars can change you.
Also, I do employ tight stop losses (2x credit received or option strike breached) so that no position remains sitting in a dangerous spot where a big drop can really demolish it without warning. While backtests tend to frown on such stop losses, I defend positions aggressively with the sole purpose of avoiding my stop loss—which is something backtesting does not simulate.
So, learning this wisdom is all good, but what can be done now?
In times like this, other traders often jest: “You wanted volatility for premium selling, well here it is.”
Yes, premium is now high which is great for selling. But those positions we had put on before; we still have to deal with them. They can still hurt. So it takes time, at least a month, for the richer premium to really penetrate the portfolio and start paying off.
In the meantime, patience is key. The existing positions are to be defended mechanically until they either come back to profitability or hit their stop loss. Either way, it’s all part of the plan.
We also stay focused on the big picture and continue to put probabilities on our side.