A -10% move in the stock can produce a -95% move in the option.
Always assume 100% loss for long?
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A -10% move in the stock can produce a -95% move in the option.
precisely..but thats not the risk..anyone who trade based on stopping themselves down x percent or 2xATR has the very same risk that the option trader who suffers a 95% premium loss for a 10% move.Simply said,just like the "cash" trader who assumes that he can stop himself out down x%,so must the option trader trade by the same methodology.If anything,the inherent flaw is that the markets do not trade continuously and you may not be able to exit the position at the assumed price.
If I know the dollar amount I am willing to risk,and I positon size off some volatility/ATR,my only main risk is "gap risk".If long the option,one may want to assume some measure of volatility contraction and calculate vega exposure,as well as a theta(decay) factor and reduce the position size accordingly.
If you are buying ITM options, for example, an ITM call during a bullish trend, then a deep OTM put will be very cheap (small % of the call) and will cover your gap risk. This combined with a STP LMT on your ITM call will improve your chances (gap or no gap down) of retaining your initial cost. Problems is that for a simple correction or a slow rise, you may lose a good chunk of your ITM cost, far more than a simple STP on the stock.
It works for me. I used to set stop losses, but found that every time I got out the position reversed and went back my way, so now I just size the position so that my max loss does not exceed my paramters and I can just sit tight and let the trade unfold. I do use stops to protect profits though.
may i suggest adding a filter to your entry??
entry price=entry-stop%
sounds like you have discovered the perfect entry...
on your backtests,what % of your trades are stopped out?
If you remove the stop,does your % of winning trades go up?
does your max trade profit increase when removing the stop?
Quote from taowave:
may i suggest adding a filter to your entry??
entry price=entry-stop%
sounds like you have discovered the perfect entry...
on your backtests,what % of your trades are stopped out?
If you remove the stop,does your % of winning trades go up?
does your max trade profit increase when removing the stop?
I don't do backtest, can't really backtest my strategy. I'm still assessing the impact on the winning % and trade profit. The good point though is that I'm psychologically more relaxed.
curious - how did you get into the position? did you buy the puts when you bought the stock? not a bad call, capturing that decline. was this an earnings play? or entirely something you've had for a while?
a long straddle would've been great here. but I guess for less drastic price moves after earnings (most of the time), it probably pays to avoid double penalty on a straddle from the drop in volatility that comes after an earning announcement and sacrifice some gains.
furthermore, I bet that put's premium was small enough close to expiration to justify the insurance cost.