Since Michael was kind enough to write about my blog, I decided to take time to write about his. I will use Michael Trader because I still find the R word offensive.

I don’t post on this blog much because my trading is , frankly boring. I do the same type of trades for the most part day in and day out. Very few speculative trades. Maybe I will start posting option book reviews or something, but for now, I have something to post.

I want to say that when I first started trading options, I traded like a drunken monkey also. I started out with 5K , coincidentally, to learn how to trade. I ran that $5K up to $12K in something like 6 weeks with just a couple of trades. I was really just guessing. I did not have a defined edge, I did not have a plan. I just traded on hope. I would buy options and just hope the stock would go my way ( hope was my trading plan ). After I lost all the money I made and more in the next four weeks, I took some time off, and figured out what my edge was and I have been much more successful since that time. I think blowing out your account CAN be a good learning experience, although an expensive one.

So anyway, back to the post.

As for trading outside your size, position sizing is important. Mainly to keep you in the game. To really make a lot of money , you can swing for the fences, but you have to realize that you will strike out more. None of us can predict the market 100%. We all will have losses and drawdowns as you pointed out. The point with position sizing is so that you will be able to take a few losses in a row and still have enough money to trade. Lose 20, 30 or 40% percent of your account, makes it that much harder to come back and profit. Position sizing does not mean not trading the money in your account, but it does make you spread out your trades over different stocks. I am almost never 100% in the market, I have gotten close a few times. I usually leave some in my account so I have cash to adjust positions. I will have as many positions as my position sizing allows.

A trading plan has a lot to do with psychology. We all trade for profit of course, but a trading plan for your trades help keep you sane before and during the trade. When I enter a trade, I write down my objective & reason for the trade. Then I write the reasons to exit. What happens during a trade is you get all wound up in the emotion of trading and it makes it hard to trade with disciple. By writing down why I entered the trade and what my exit strategy is, I don’t start flip-flopping on my decisions mid way through the trade.

As for your BIDU trade , I think it was a good trade on picking the direction. BIDU is in a downtrend, and has some support at the $240 level which it looks like it has passed on the downside. IMHO, I would be first looking at at vertical spreads because of the high implied volatility and earning due this week.

( click to enlarge, 11.FEB.2008 before the open )

If you notice, the volatility falls after earnings, which affects the price of the options. Vertical spreads help you counter the effects of volatility contraction and theta. In a vertical spread such as a bear put spread, you have two options One long and one short at different strikes for the same expiration. Say the volatility of the option falls and the option you purchased falls in price. The option you sold would also fall in price, reducing the effect of volatility contraction. On the theta side, you would gain some from the option that you sold, and lose some from the option that you purchased.

I don’t trade vertical spreads that often, it is not my style, I mainly trade time spreads. I do take trades like this on a more speculative basis every blue moon. Now, if you are looking at a large quick move ( I assume south ) on BIDU, cheap OTM options would be great because of the leverage. If you expect a small move ITM options would be better. You picked an ITM options, so I assume you are expecting the stock to move lower but not plummet after earnings. The delta on your put is 53.5% ( as of Monday morning ), so a $10 move in BIDU, produces $5.35 ( roughly ) for you.

( click to enlarge, 11.FEB.2008 before the open )

The implied volatility will probably decrease after earnings ( 2/13 after the close ) so the price of the 250 BIDU option you purchased may decrease even if the stock price does not move.

Oh, and as for the 100K , that is not realistic in your case. It was just a number off the top of my head. You can get deals less than 100K of equity. Since your commissions will come down a lot when you start trading larger sizes, and no pattern day trader rule ( which stops at 25K equity ) it makes it a lot easier.

All said and done, I am 75% an income trader, and you will not get from $5K to $100K in a year income trading. So go swing for the fences, and I hope you make it.

~squid

P.S. I did play D&D in my early teens, but that was put to an end by the acquisition of a drivers license.

This entry was posted on Monday, February 11th, 2008 at 8:57 pm and is filed under Option Trading.