The Personal Fast Market

Good Morning!

This is the Jumping Cholla (CHOY-uh). The newsletter that turns options market insights into a fun, easy-to-read email that helps you reduce your chances of getting pricked while trading!

And even if you don't trade, learning how to think like a trader builds a robust framework for problem solving, taking risks, managing a plan, and just living life.

Quote of the day:

"I'm new, I don't know what to do!"

Joe Dirté (don't try to church it up on me, boy!) is experiencing a "personal fast market": he has no idea what he's doing, his actions are making things worse, and all while dealing with an easily fixable problem.

All the other roughnecks were just sitting off to the side watching Mr. Dirt fumble around like the white trash philosopher he is!

Yesterday, we compared buying vs. selling options to betting the over vs. betting the under. The idea of your house catching on fire is not good, but it is also manageable (which is why short volatility players exist and thrive).

Without a plan, you will constantly go from "there's nothing to do" to chicken little "the sky is falling". Not only is this exhausting and unsustainable, but it also adds inconsistency to your trading process and prevents you from accurately benchmarking yourself.

Today, let's talk about creating a management plan. So, when a true "fast market" occurs, you can take comfort knowing that everyone is making irrational decisions not just you!

BANG for Your Buck:

As noted yesterday, this is earnings season and some crazy earnings calls do have the potential to be a catalyst. For example, MSFT had good earnings, but their CFO's guidance cut their outlooks. Any weakness in AAPL, MSFT, or the like reverberates into the S&P 500 because it's weighted by market capitalization i.e. larger stocks have more value in the total index price. (MSFT represents ~5% of SPX price...hmmm, dispersion trading...I should put that on my topics list)

4000 level:

Dealers are net long the 4000 strike. This should act as resistance or tiny gravitation field, which helps decrease volatility near there. Pops over get sold and breaks lower get bought. Remember, this gravity is localized and not that strong, so the market has to be close enough to 4000 for it to work. From the pic below, looks like 50 handles higher and 50 handles lower is close enough. (This is the beauty of being long an option: gamma scalping. review here)

Yesterday, the market traded down to 3950, got pulled back through 4000, and settled unchanged on the day. Volatility decreased as expected.

If you are looking for a rally to the 4100s, you probably need to wait for a catalyst to reprice the market away from 4000 such as Feb 1st FOMC.

3900 level:

Dealers are net short the 3900 strike. A break below opens the door for expanded volatility and easier extension of a selloff. Recap of short option hedging from yesterday.

Creating a Management Plan

As an elementary school kid, you did fire drills, right?! I bet even some of you homeschooled weirdos did 'em too! From a young age, you had a plan for when sh*t hit the fan, so why wouldn't you while trading.

You can split a management plan into 3 parts. Stuff to do when:

• Your position is making money and you're the smartest person on the planet

• Your position is losing but "it'll turn around" (unlikely...dumb@ss)

• There's no way that happened?!

Your plan is created by answering questions before something happens!!!

• Market is in your favor:

  • How much did I expect to make here? Did I make more or less than I thought?

  • Should I exit the position, take profits and roll, or just do nothing? (you can always get back in, but you can't always get out!)

• Market is against you:

  • Is your "trade thesis" still valid? What would invalidate your trading idea?

  • If still valid, do I add more to the position? (did you plan for that, Mr. money manager?)

  • Do I have a stop-loss? (If not, how the hell are you a portfolio manager?!)

  • Do I exit, or do I take a partial loss and roll?

• The Impossible:

  • What is the most effective way to reduce or eliminate risk? Is it exiting your position? Or is it adding other positions to offset the exposure?

  • Are you going to lose more than you are willing to bear? If so...

• The #1 rule of trading "risk not thy whole wad!" because when you're wrong, you can't play anymore, and then you truly failed.

Benefits of defined management

• Gain trust in your "trading ideas" because they have pre-defined invalidation rules. This prevents overtrading and second guessing yourself.

• Build a sample size of trades with consistent risk tolerance so you can actually benchmark your "trading ideas"

• Remove emotion from trading. You're just following rules: a winning trade doesn't mean you're a genius, and a losing trade doesn't mean you suck. It's a business.

• Going out of business is up to you, not the market.

As always, pursue the process NOT the profits! See you tomorrow!