Break the Cycle

“Let me tell you about the time I doubled my money on an option trade in one day.” Wow, that’s great! “Yeah, unfortunately I gave it all back the next day and by the end of the week I was down 50% on the trade.” Sound familiar? Of course it does. It’s happened to practically every options trader at some point in their trading! Would you like to know how to break that cycle of win/lose trades? Read on and I’ll show you exactly how I do it using an example of a trade from this past week.

Look at the risk profile below. This is my current position in /ES (SPX 500 futures). The best I can do is make $2,700 on the position and the worst that I can do is make $200. So where is the area where I can lose money? There isn’t one. I know what you’re thinking, you can’t have an option position where a profit is guaranteed. No risk, no reward, right? So where is the area where I can lose money? I told you, there isn’t one. I can see you’re going to need some proof as to how this is possible. Keep reading below and I’ll walk you through the steps on how I constructed this position.

I started the position by simple buying a Put. I paid $19.00 for a single /ES Put. That Put cost $950 and that was my total risk for the new position. Most traders think that you buy an option and then hope price goes in the right direction so that you can sell it at a profit. There is so much more that you can do once you own an option than that most basic of transactions. Here’s the risk profile of buying the Put.

Less than 3 hours after initiating the position I decided to start taking the risk down. /ES dropped in price making my Put more valuable and I then bought a Ratio Spread for a credit of $3.05. That took my risk to $15.95 or $797.50. Below is the risk profile for a Ratio Spread. This trade allows for a crazy amount of risk if the price of /ES drops sharply and uses a lot of margin. That is true if I was just trading this as a standalone position. I’m not. This was being combined with the Put that I already owned.

The risk profile below shows the Long Put/Ratio Spread combined position. I’ve now reduced the Delta risk from -20 to -15. That means that the position doesn’t need as big of a move lower in the price of /ES to make a profit. That Delta reduction is the most important key to consistently profitable options trading! This trade has also increased the position’s Theta which measures profiting from the passage of time.

Next, I rolled the original 3195 Put that I owned down to the 3150 strike by selling the Put Vertical credit spread for $12.00. I’ve now reduced the position’s cost to just $3.50 or $197.50 of total risk. This transaction also reduced the Delta risk from -15 to -9. Once again I’ve increased Theta.

The last step in this process was to roll down the 3200 Put that I bot as part of the Ratio Spread to 3175 by selling the Put Vertical Credit spread for $8.00. Now I’ve taken all cost out of the position and actually locked-in a minimum $200 profit. So now we’re back to the risk profile of my current open position as was shown at the top of this post. I have a maximum potential profit of $2,700. The Delta (directional) risk of the position is just -4.97. The 3 trades that I’ve made subsequent to the original Put purchase have reduced the position’s Delta risk by 80% and increased the Theta.  

What’s so important about reducing Delta risk? It’s Delta risk that primarily causes traders to have a big profit day followed by a big loss day. It’s what drives the win/lose cycle. When you learn to flatten your Delta risk the cycle changes dramatically. The big win day is followed by a small loss day. Repeat that multiple days in a row and next thing you know you have a really good position in your portfolio. That changes the whole trading dynamic and, over time, the net profits build! Isn’t that what we’re all trying to accomplish?

BTW, here is the transaction detail from my order fills for this position showing the date and time. Oldest transaction is on the bottom, newest on top.

Vega Options is an educational service, not a trading service. However, because all of my price action analysis and option trading is done in real-time there is an opportunity for the subscribers to place similar trades from their own account. My job is to simply make available to the subscribers all of the information that I use to make trades. What they choose to do with that information is entirely up to them.

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Paul Frey is a 30+ year trader with experience in equities, options, and futures. In addition to trading he manages Vega Options providing option educational services to new and experienced traders who are looking for improved results. He teaches strategies and techniques that reduce or even eliminate the initial cost of a trade while still maintaining potential future profits.

25th Jul 2020

1 thought on “Break the Cycle”

  1. Hello Mr. Frey,

    So glad to have found your articles describing your trades with such clarity. I used to follow your posts on twitter under @optiondawg and can tell from these posts and the icon that it is you. Glad to have found these. All the best.

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