If we are being honest, there is a lot of guessing when it comes to trading. As technical traders, our goal is to put the odds on our side. We know that if we do, we have a better chance of being successful. That said, there is still some luck involved pertaining to how the market moves and how the underlying position is affected. But sometimes traders can’t control themselves and are biased.

Do you force your opinion on a stock or the market believing it should do something based on your thoughts, and are you surprised when it does not act as anticipated? If you have traded at all, you will have had an opinion about a certain stock or the market and most likely both. But what I see far too often is the disappointment when a stock does not perform as the individual predicted. Well, guess what? Stocks and the market sometimes have minds of their own, no matter what you may think.

No Real Control

Like all those who trade options, we have free will (within reason and monetary constraints) to buy or sell whatever we choose. The market and stocks have free will too. You cannot force your opinion on something because the market sets the price no matter what you may think. That is why there are buyers and sellers to make the market.

Now don’t get me wrong, we have all thought a stock, ETF or index is too high or low aside from any technical analysis we may do. The market has been very volatile, and I have had several students shaking their heads in disbelief. How can the market not be surging lower when there is so much uncertainty in this world? I have heard that more than a few times over the past several months. That is fine, but when you are not willing to separate reality from your opinion, you get yourself into trouble…trust me!

Go With the Flow

As I like to say, play what is in front of you and try to put your beliefs aside when analyzing stocks and the market. Try to separate your own personal thoughts and opinions from the market, especially for short-term trades like swing trades, and focus on the technical aspects instead. Instead of asking why, ask yourself what has a better chance of happening based on technical analysis. I promise you will be better off from a financial perspective, and there will be much less head scratching going on.

I think most option traders consider this a very volatile market, and they have for several months. When to take profits can be difficult to determine, especially in an environment like this. One of the hardest hurdles I had to overcome as a retail option trader was not taking profits too soon. I was scared and I exited trades well before my plan outlined. But in a market like we have seen, taking risk off the table sometimes prematurely is not a bad thing.

Swing Traders’ Nightmare

I have continually said in MTM’s Group Coaching class over the past couple of months that this market has made it difficult for swing traders (who generally take two- to five-day trades) to make money because of the volatility and lack of implied volatility. Day trading may be an easier way to extract money from the market at present because a trader is flat at the end of the day and not subject to hoping and guessing how the market will open the next session. I have also said it might be prudent to take profits and cut losses quicker than normal under these circumstances.

Tone It Down

To me this means looking for smaller profits and limiting yourself on the loss side too. For example, if you normally look for a 50% profit, maybe consider taking a 25% or 30% profit instead. That is why I always say to remove risk and put money in your pocket for a profitable trade. The market has been gapping so much that limiting your gains actually removes risk sooner. Remember your main goal as a trader is to preserve your capital and be a risk manager. Removing risk with multiple exits is also smart.

Same for Losses

The same goes for limiting your losses. Consider smaller contract size and risking a smaller percentage on each trade. So instead of risking 25%, for example, consider 15%. Of course, how you want to do this is completely up to you. Just use this as a general guideline.

Manage That Risk

As I like to say, the market is never normal or easy. But there are times when it is more volatile than others. This has been one of them, so it may be a good time to strap on your risk manager cap just a little tighter.

We all have sayings we love to repeat to ourselves. And when we say them out loud, let’s face it, it can be irritating to others. That is actually my goal when I repeat certain sayings to my students. I want them to be annoyed with me and finally listen and adhere to what I am saying. My one-on-one and group coaching students will tell me they hear my voice in their heads. I love it!

I want them to know how important the lesson is, and I want them to hear my voice when the situation arises and think about what they need to do or consider. I am going to cover three of those sayings here. 

Odds on Your Side

The first saying I like to repeat is borrowed from a quote from Jim Rogers. When I say, “money lying in the corner,” it means I want to take a trade I deem puts the odds in my favor and feel I have to take. Let’s face it, as traders we try to put the odds on our side to extract money from the market. This can be from technical analysis, fundamental analysis, implied volatility or a combination of everything. Clearly, there is no true money lying in the corner with any trade. What I am trying to suggest is that you feel confident putting this trade on because you deem the odds to be on your side and you are taking the trade for no other reason. It is a great reminder to think about the trade before execution.

You Are a Risk Manager First

Many of you have heard the saying that the first rule in trading is to preserve your capital. And most likely you thought, no, the first rule is to increase your capital. Who could blame you as a new trader? But once you realize how trading works, it starts to make sense. Essentially when you think about removing risk first, profits are sure to follow if you are managing things properly. That is what I try to ingrain in my students’ heads, and it needs to come instinctive. If you properly manage your trades and know when to remove risk, trading can become a whole lot easier.

In almost every presentation I give, I include the saying “you are a risk manager first.” That is the whole and undeniable truth about trading. Clearly, you need to risk money to make money. But if your central focus is on being a risk manager, you are miles ahead of most traders. This all stems from you having a well thought-out and written trading plan too.

Hear Me Out

These are just a few sayings I like to use in my teaching and, let’s be honest, my everyday life. When you hear my voice in your head, you will thank me later.

The market can be very volatile, and if you have traded at all over the past several months you know that very well. As an option trader, you probably are and definitely need to be familiar with how implied volatility changes can affect option prices and the way you think about different strategies. Let’s look at something I covered in MTM’s Group Coaching class on one of those volatile days when the market was all over the place.

Vega Defined

Let’s start with defining vega. Option vega is the measurement of the option’s price sensitivity to changes in the volatility of the underlying. Keeping it simple, as I generally like to do, vega changes the premium of the option for every 1% change in implied volatility (IV). If IV rises, option prices rise and vice versa. With the market and stock rising and falling constantly as of late, you can see how option prices may be affected. Generally, when markets and stocks rise, IV drops with option prices; and when market and stocks fall, IV rises with option prices.

SPY Example

On a recent trading day, the market and the SPDR S&P 500 ETF (SPY) gapped lower to start the session. Looking at a chart, the SPY moved lower for several sessions before this gap lower and might have been a tad extended to the downside. In addition, the ETF had some potential support where it was currently trading that might provide a boost higher. For this example, the chart is not as important as understanding the general concept.

With the big move lower, IV levels were elevated along with option prices. If a move higher was expected because of being extended and/or because of potential support, IV would most likely drop to some degree as well. We considered a long call option, but a long call has positive vega and an IV drop would decrease the premium. Now don’t get me wrong, a vigorous move higher and a positive delta could certainly overcome some vega loss, but there might be another alternative.

Bull Call Spread

We also explored a bull call spread. In this case, we modeled out a 430/450 bull call spread with about two weeks to go until expiration. Without getting into too much detail other than vega, there are trade-offs between a long call and a bull call spread. Among them is that the max profit of a long call is unlimited and the spread is limited due to the short call. But in this case, we were focused on the vega position. The spread would have both positive vega (long call) and negative vega (short call) to limit vega exposure compared with the long call on its own. With an IV drop expected because of the anticipated move higher, neutralizing the vega position versus just a positive vega position seemed like a valid option. Since the discussion, the SPY has moved higher and IV levels have dropped.

Final Thoughts

Let’s once again keep it simple. If you have a positive vega position and expect an IV drop, consider a spread to offset that exposure. If you have a negative vega position and expect an IV rise, consider a spread to offset that exposure. As you can tell, a spread can limit exposure but can also limit gains. As always, everything in options is a trade-off and the most important part about the trade is still that the underlying does as forecast. Otherwise, worrying about your vega will not matter.