Today’s piece is an object lesson in that age-old (and entirely correct) trading adage that states, “Cut your losses and let your profits run.” It could also be subtitled “How to use options to limit your dollar risk and to be able to adjust an initial position to lock in profits while still allowing profits to run.”
Clearly “Cut your losses and let your profits run” is a better choice.
In this piece I noted that the U.S. Dollar (using ETF ticker UUP as a proxy) had drawn a “line in the sand”. So I wrote about buying a cheap call option as a way to, a) make money if the line held and UUP rallied, and, b) limit risk to a very small dollar amount if the line fails to hold.
The line failed to hold. As you can see in Figure 1, on 4/29 UUP fell below our “Uncle” price of $24.19. At that point the trade could be exited with a loss if sold at the market is -$20 per contract. A good thing? No. A disastrous thing? Hardly.Figure 1 – U.S. Dollar breaks down; call option loses “a couple of bucks” (Courtesy www.OptionsAnalysis.com)
This seems like a good point to invoke:
Jay’s Trading Maxim #41: A properly managed losing trade – i.e., one that does not lose more than you can (stomach and) afford – is simply “a cost of doing business”. Nothing more, nothing less.
I don’t want to say that I “picked the bottom” in silver and rode the 2016 rally all the way up (mostly because if I ever do make statements like that something bad usually follows – Murphy’s Law being what it is and all). Still, for the record in this article dated 1/13/16, I highlighted a bullish position using options on the ETF ticker SLV (which tracks the price of silver bullion). Likewise, in this article dated 2/9/16 I wrote about an “adjustment” to the initial trade that:
a) Locked in a profit
b) Allowed for greater upside potential
c) Extended the holding period from a few months to almost 11 months
Given the recent rally in SLV things are going well at the moment. See Figures 2 and 3.
The trade presently shows an open profit of $3,234 and SLV appears to potentially be breaking out to the upside.
So here is the point of the lesson. Two trades. One a winner, one a loser. 50/50 certainly doesn’t impress anyone. But the point is:
*The losing trade lost a “couple of bucks”
*The winning trade has made a whole lot more, can make a whole lot more than that, and the worst case is a decent profit.
Here ends the lesson.