What follows is a stream-of-consciousness brainstorm about minding a model:

I need to shift my focus away from attempting to create a strategy, or system, or whatever you want to call it that is a slave to hard and immutable rules.

In theory, I believe in the whole idea of “if x happens do y, or if a happens then do b.” I do believe that would work for most Traders most of the time — assuming the rules were in service of a strategy that had some kind of monetizable edge.

But I think where I’ve always gotten myself in trouble with my Index Options trading is that I’ve tried to be too rigid with my rules making. I’ve tried to come up with firm rules that must.be.followed.at.all.cost.no.matter.what. And then when the market moves in a way that makes me uncomfortable, I begin to have a minor freakout moment where I trick myself into thinking my “rules” are all wrong and I’m an idiot for having thought of them in the first place.

This, of course, then leads me to abandoning my rules at the worst possible time, which then results in impulsive trading and a whole lot of “coulda, woulda, shoulda” regrets.

And then it’s back to square one. Wash. Rinse. Repeat.

I need to be putting my energy and focus on solidifying an overriding mission. A set of First Principles that inform every decision that comes after it.

So what are my First Principles when it comes to my Index Options trading?

  • I want every trading day to end cashflow-positive. Meaning: I want to end each trading day with more cash in my account than I started the day with. This doesn’t mean I earned postive PnL. I can’t control what the market gives me. But I can control my cashflow and that is the focus.
  • I will achieve the above bullet by maintaining a position comprised of out-of-the-money call and put credit spreads. And I will close these spreads when they don’t have much more to give (take profits), or when they grow to carry too much gamma risk (close losers).

I must allow myself flexibility, patience, and grace to operate in any way I see that fits the current moment, as long as it operates within the constraints of and serves these principles. If I’m taking action that does not serve these principles, then I need to take a step back and ask: why not?

What works today might not work tomorrow. The appropriate action to take today might be a completely irresponsible concept next week. As the market changes, I need to adapt to it.

There are a lot of ways to successfully achieve these First Principles — especially as it pertains to what triggers entries and exits, the timing of adjustments, and the initiation of new credit spreads. There is no perfection here. There is no right answer that will satisfy every situation. I need to forget about that “coulda, woulda, shouldas” and take comfort in knowing I executed well when my discretionary choices were in service of my First Principles.

This is the PnL graph of my SPX options position as of today’s close. The green flag shows where SPX closed (prices on the x-axis). This is a close approximation of what my position should look like at the end of most trading days while following these principles:

I guess I could these First Principles my “Trading Model” ?

If any of this index options trading stuff interests you, and you’re looking to hang with, share with, and learn from like-minded Traders, please join my discord room. It’s free and open to anyone!

What follows is a stream-of-consciousness brainstorm about minding a model:

I need to shift my focus away from attempting to create a strategy, or system, or whatever you want to call it that is a slave to hard and immutable rules.

In theory, I believe in the whole idea of “if x happens do y, or if a happens then do b.” I do believe that would work for most Traders most of the time — assuming the rules were in service of a strategy that had some kind of monetizable edge.

But I think where I’ve always gotten myself in trouble with my Index Options trading is that I’ve tried to be too rigid with my rules making. I’ve tried to come up with firm rules that must.be.followed.at.all.cost.no.matter.what. And then when the market moves in a way that makes me uncomfortable, I begin to have a minor freakout moment where I trick myself into thinking my “rules” are all wrong and I’m an idiot for having thought of them in the first place.

This, of course, then leads me to abandoning my rules at the worst possible time, which then results in impulsive trading and a whole lot of “coulda, woulda, shoulda” regrets.

And then it’s back to square one. Wash. Rinse. Repeat.

I need to be putting my energy and focus on solidifying an overriding mission. A set of First Principles that inform every decision that comes after it.

So what are my First Principles when it comes to my Index Options trading?

  • I want every trading day to end cashflow-positive. Meaning: I want to end each trading day with more cash in my account than I started the day with. This doesn’t mean I earned postive PnL. I can’t control what the market gives me. But I can control my cashflow and that is the focus.
  • I will achieve the above bullet by maintaining a position comprised of out-of-the-money call and put credit spreads. And I will close these spreads when they don’t have much more to give (take profits), or when they grow to carry too much gamma risk (close losers).

I must allow myself flexibility, patience, and grace to operate in any way I see that fits the current moment, as long as it operates within the constraints of and serves these principles. If I’m taking action that does not serve these principles, then I need to take a step back and ask: why not?

What works today might not work tomorrow. The appropriate action to take today might be a completely irresponsible concept next week. As the market changes, I need to adapt to it.

There are a lot of ways to successfully achieve these First Principles — especially as it pertains to what triggers entries and exits, the timing of adjustments, and the initiation of new credit spreads. There is no perfection here. There is no right answer that will satisfy every situation. I need to forget about that “coulda, woulda, shouldas” and take comfort in knowing I executed well when my discretionary choices were in service of my First Principles.

This is the PnL graph of my SPX options position as of today’s close. The green flag shows where SPX closed (prices on the x-axis). This is a close approximation of what my position should look like at the end of most trading days while following these principles:

I guess I could these First Principles my “Trading Model” ?

If any of this index options trading stuff interests you, and you’re looking to hang with, share with, and learn from like-minded Traders, please join my discord room. It’s free and open to anyone!

A coach’s job is to position his/her team to win.

When the team is not succeeding, the coach needs to reposition players and strategies so they can. Or the coach can swap in fresh, rested players or players who have different skill sets that are better suited for what’s needed now to take over.

What the coach cannot do is play the game for the players. All he can do is call the plays, make the adjustments, and get out of the way. Let the players play.

Managing a book of short options positions is no different.

The goal of selling options is to earn the premium. We want to sell premium and keep as much of it as we can. That’s how we win.

If I have some risk-defined short premium spread positions (like short vertical spreads) where theta decay is no longer working in my favor because the market has moved beyond both my short and protective long strikes, then I need to reposition. This spread is no longer serving my goal of winning. It is now having the opposite effect.

Regardless of where I think the market “might” go, or if I think the “market is wrong,” the only thing that matters is that RIGHT NOW this spread position is no longer serving my goals and it should be repositioned to new strikes and/or a later series so that I can again serve our goal of winning.

Meanwhile, the out-of-the-money spreads that are happily decaying away should be left alone. They are working. They are winning. Don’t overthink it. Let the winners keep winning.

There is a certain stoic detachment one needs when managing short options premiums. We have to deal with what IS, not what we want.

We have to stop creating “stories” about what the price action means, or what it might be threatening to do. It just IS. Nothing more. Whatever happened just happened, now here we are. What needs to be done NOW so that we’re winning NOW?

Who cares what our PnL is? Our PnL is a reflection of the past. We can’t change the past. We can only craft the future by how we act now. One, small, micro-action at a time in service of the big picture.

This is how the best coaches in any sport think. And this is how we have to think when trading a book of short options.

Traders who engage in delta-neutral premium selling strategies are unconsciously playing out the drama of life on their trading screens.

We’re simply managing our expiration to happen on our terms.

We all want to live long, healthy lives. And we want our lives to end on our terms. This is universal.

How is selling options premium any different?

As we approach options expiration for our short options, we want the premiums of these options to sail off into the sunset, expiring quietly, elegantly worthless. We don’t want any drama. We just want to enjoy the view knowing they’ve given us all the premium they can.

At the end of an options contract’s life, just like our own human lives, it’s already given all it can give in terms of premium. We want it to end completely spent. The last thing we want is to expire with the feeling we have more to give.

And therefore, as an option approaches expiration, if there is not enough premium left to offset any directional risk that is now becoming a problem as the market moves toward our strikes, we’re faced with a decision — do we hold this risk and expose ourselves to the possibility of a fiery death? Or do we roll the position out to a later expiration and try again? In most cases, the prudent move is to roll out for more time.

We humans do the same thing! If our life isn’t the way we want it… we fight with everything we’ve got to buy ourselves more time to get it right. To position ourselves to win later. More time to love. More time to experience life. More time to make that nut. More time to see the world and enjoy nature. More to time to expire on our terms.

In the end, isn’t that what it’s really all about?

Why do you rob banks?

“Because that’s where the money is.” ~ Willy Sutton

The S&P 500 Index Options — SPX — is where the biggest money managers in the world hedge their risks.

Whether you’re a hedge fund manager, a pension administrator, a large speculator, or managing an immense family office with stock market exposure — in many ways you’re paid more to not lose money, rather than swinging for the fences and chasing alpha.

And one of the best ways to insure against losses is to hedge your risk via index options.

Of course, insurance costs money. Sometimes more than it should. But the managers that are tasked with not losing money don’t care. The price of insurance — and therefore job security and piece of mind — is immaterial. They can and they must hedge. That’s what they are paid to do.

On the other side of these transactions are the speculators who provide the capital and liquidity for the risk averse to accomplish these tasks. They accomplish this by making markets for the fund managers who wish to purchase options for a premium. The fund managers are the buyers of premium, speculators are the sellers of premium.

While the large fund managers are paid to not lose money, the speculators on the other side of the trade are paid for shouldering the risk. Their job is to collect the premiums and manage their risks such that they don’t get hurt too bad when markets get dicey. Selling premium is a “high win-rate” game in which most of the time the odds are in your favor that you’ll make money. But you run the risk of the occasional bad beat. The secret sauce is in positioning yourself so that no one bad beat takes you out of the game.

I engage in this game.

I employ premium-selling tactics in SPX options that are part systematic, part discretionary. Like Willy Sutton, I want to make money. And I want to operate in the pool of the largest capital flows, swimming like a minnow grabbing a little premium here and a little premium there, while avoiding the sharks that will eat me alive.

There’s a big wide ocean of money out there. Go where the money is. Win.

I had the pleasure of rebooting our Trader Meetup Group in Boulder last night. This was our first gathering in more than a year since the pandemic started. There’s nothing quite like hanging out with like-minded traders in person and swapping war stories. 

Here’s a great anecdote that was shared with me last night by one of the smart guys in attendance. I’m paraphrasing, but here it goes:

When he was around 8 or 9 years old playing youth soccer, he was the least skilled player on the team. In addition to his lack of physical skills, he struggled to understand proper positioning and game situations.

The roster was full when the season started. But the coach expanded the roster by one for him because he was the hardest worker in practice.

In games, his coach gave him simple instructions:

“If the ball is in the offensive zone, you go to [x] spot. If the ball is in the defensive zone, you go to [y] spot.”

He dutifully followed these instructions — always heading to his assigned spot depending on where the ball was moving.

But then the coach noticed something…

While traveling to his designated spots on the field, the ball would often come right to our little hero. But he’d ignore it and continue running to his mark.

So the coach offered this advice, which now also serves him well in life and in trading:

“Young man, it’s important to have a plan and to follow it as often as possible. But when an unexpected opportunity comes your way, you have to be flexible and adaptable enough to take it.”

“When the ball comes your way — attack it!”

The art of successful trading requires us to make plans. But the true magic is found in knowing when to opportunistically deviate from the plan when the right opportunity presents itself.