The Strength To Plow Ahead

“Tell your heart that the fear of suffering is worse than the suffering itself. And that no heart has ever suffered when it goes in search of its dreams, because every second of the search is a second’s encounter with God and with eternity.”

from, The Alchemist by Paulo Coehlo

What is the Trader’s greatest fear?

That’s easy — losing all his money.

It was Peter Lynch who said: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” On a meta level, this makes so much sense to me. Fear makes humans do irrational things. We overreact, over-correct, and over-worry when we are in a fear state.

I’ve been in the middle of a “come-to-jesus” moment with one of my pet options strategies that consumes me. This has been going on for several weeks now, and the end result was me transitioning my position to a delta-neutral “long gamma” stance which is long options premium and benefits from rises or spikes in volatility. My vehicle of choice is $SPY options. But essentially what I’m riding is the mean-reversion tendencies of volatility.

A little bit of background:

For much of the past 5-10 years, I’ve been tinkering with a strategy which at its core was designed to produced “cash flow.” 100% of my focus was on ending each trading day with more cash in my account than I started the day with. This doesn’t mean more “equity,” which is an important distinction. This positive cash flow was achieved by either selling credit spreads or naked options. And I managed risk by doing my best to keep my delta position as neutral as possible throughout the trading day.

Over the years there have been stretches of time where this strategy was pretty steadily profitable — including a 6-month stretch in 2015 where my account achieved an unbelievable 360%+ gain (!!). Of course, I’ve also uncovered a variety of issues with these strategies that make them unfeasible as a standalone concept over the long-term — chief of which is a slowly (then quickly) building amount of leverage within the position which ultimately consumes all of my available buying power and leaves my hands tied when it comes time to making adjustments to bring my position back to delta neutral and maintaining positive cash flow.

As such, at the time I most need to make moves, I’m unable to do so. And then the “paper” losses become real losses. I end up closing positions at disadvantageous prices in ways that reverse all of the “edge” capturing trades that preceded it. At best, the losses are frustrating but manageable. At worst, the losses are devastating and it’s back to square one.

I’ve come to realize that while this strategy (and it’s multiple variations) can have stretches of wonderfully consistent profits, the trick is knowing that the tide eventually recedes and I have to know when to go completely to cash and await my next moment to wade back in. Of course, I can’t predict the future nor read the tea leaves with any level of consistency that I’m willing to bet my financial life on, and therein sums up the issue with these strategies I’ve been pursuing for the better part of a decade.

The good news is: I’ve finally come to terms with this and am doing something about it.

The biggest task for me to accomplish was to eliminate the risk (no matter how slight) of any sudden adverse market movement resulting in overwhelming losses. Having this risk lurking in the shadows is no way to live my trading life. Being in constant fear about an unmanageable limit down or limit up opening where my position is caught leaning the wrong way is a recipe for bad decision making. So I needed to take that risk completely off the table. I did.

Next, I had to make sure I am always trading from a position of strength. I needed to make sure my hands are never tied when it comes time to making defensive adjustments to my position. In other words, I need to make sure there is never a margin or buying power issue that prevents me from making smart adjustments. I accomplished this by moving into long options and debit spreads instead of credit spreads and naked short options.

Then, I had to stop ignoring my P/L and account equity and instead use these inputs as valuable information to inform whether I’m in a “Risk On” mode (buying options) or a “Risk Off” mode (selling short options against long inventory) or a “Take Profits” mode (closing long options positions from existing inventory).

While trying to maintain a delta-neutral position, my rules essentially break down like this:

  • When my P/L is down on the day, this means volatility is generally declining and I want to be a buyer of new longer-dated options if/when I make any adjustments back to delta-neutral as the market moves.
  • When my P/L is up on the day (but I’m not at equity highs), this means volatility is generally rising and I look to short weekly (1-3 days to expiration) calls/puts against my existing long inventory of options (creating long debit spreads) as adjustments to get back to neutral as the market moves.
  • When my P/L is up and my account equity is at what would be a new closing high, I look to close out long calls/puts from inventory back to delta neutral to fade the spike in volatility, book profits, and reduce open risk.

(This is not an exhaustive list of all the rules)

None of these actions require margin. The only moves I would ever see any buying power restrictions on would be when I’m making an offensive move to open any new long calls or puts. And since this is “offensive”, this means these moves are always optional. I could just close positions from existing inventory to adjust my deltas if necessary. No sweat.

By no means am I at the end of my journey with these strategies. This is just where I’m at right now. I’m sure there are more improvements ahead.

As the quote that started this post reminds me, it is in this constant search for improvement that true peace is found. No matter how frustrating, time consuming, and volatile. The Search is where we find meaning and the strength to plow ahead.