Huge Options Trading Blunders: I always win eventually if I keep rolling my short puts down, right?

okay so today's video is the fifth in our series that we've entitled huge options trading blunders we decided to produce this series for traders who are really serious about trading options for a living and badly want to succeed but they keep getting sidetracked by dopey ideas with huge flaws in them instead of taking the proper steps to excel as an options trader I'm the head trader of SMB capitals options trading desk and I can tell you from many years of experience that I've seen that every one of the mistakes that we're going to be describing in these videos they're real and if you're serious about trading for a living you really need to pay close attention to these videos so that you can avoid serious problems in your trading journey so if you're committed to trading full-time as an options trader then I urge you to watch this video and the rest of the videos in this series so that you don't fall by the wayside like so many aspiring traders who don't want to spend the time to learn the actual truth about the rewards and challenges of the options trading and the skills you'll need to truly succeed we want you to take a realistic path to your trading goals which are attainable if you're serious and willing to put the work in to succeed [Music] hi I'm Seth Freiburg and I'm the head trader of SMB capitalist options trading desk SME capital is a proprietary trading firm located in midtown Manhattan and we provide capital for options and equity traders from all over the world trading both remotely and in our offices here in New York City now I'd like to suggest that you click on our subscribe button right now so that you don't miss any of our free trading videos that we produce for traders and investors all over the world they're really very valuable ok so today we're going to be looking at options trading blunder number 5 in our series on options misconceptions and huge mistakes that you can make as an option trader so blunder number 5 starts out as most of these blunders do with a true statement that unfortunately has a hidden downside that you need to think through but most people don't and that statement is this the market won't go down forever it will eventually bounce no matter how bad things get and historically that's of course true even in the depths of the Great Recession of 2008 and 2009 the market did eventually bounce in fact it did so in March of 2009 and the current bull market has pretty much remained intact ever since with a few short-lived Corrections in the mix now in order to explain how this leads to an options trading blunder I need to make sure you're familiar with the basics of how index options work if you know something about options don't worry this will be quick and then we'll jump into the core of the lesson now almost all of you are probably familiar with equity options where call buys you the right to buy 100 shares of a stock at the strike price of that option any time before the option expires and a put option entitles you to sell 100 shares at the strike price of the put before that option expires but there are also index options which works similarly to equity options except there's no such thing as 100 shares of an index like the S&P 500 you can't really buy or sell 100 shares of an index but what you can do is get paid cash $100 per point if the index expires before the strike price of an index call that you buy or alternatively you'd be paid $100 per point for point the index drops below the strike price of your index foot so for example if an index is trading at 1400 and you buy the 1410 call if the index goes to say 1415 you'd receive $500 in your account if the index closes at 1410 or lower your call expires worthless on the other side of the ledger if you buy a 1385 put and the market sells off to 1375 you'd make $1,000 but if the market just sold off to 13 85 or higher the put would expire worthless so those are the basics of index options and remember you can buy options but your broker will also allow you to sell options and your broker will allow you to put together combinations of options in other words options strategies that involve both long and short options purchased in a way that is that I've been Tages to you as a trader okay so now armed with that knowledge let's talk about this idea which some option traders have which seems so amazing on the surface yet it's so incredibly insane and dangerous once you start digging into it a little bit deeper so let's drill down a little bit deeper about the fallacy that we're highlighting in today's lesson and we can do that through a vivid example from the real world that could have taken place very easily in the past one of many examples that I could have shown you today ok so let's go back to August 17 2015 now on that day let's suppose you said to yourself hey I think I'd like to pull about 3000 dollars out of the market over the next 12 days because Valentine's Day is coming up and I need the money or for whatever reason so you figure well I know something about index options so let's see on that day the sp500 was trading it around 2100 so if I go in and sell 10 of the 2040 puts expiring in 12 days and the market closes at or above 2040 in 12 days then I walk away with 3000 $450 why because the option sells for 3 dollars and 45 cents but the option obligates you to pay $100 for each point below 2040 if the market sells also you multiply that price by 100 and since you sold 10 of them you collect a total of three thousand four hundred fifty dollars now if the market closes above twenty fourty then you have no obligation to pay anything because the deal was that you'd have to pay $100 for each option for each point below twenty forty so any closing price of SPX above that means that the option expires with no value no obligation on your part and you just walk away with three thousand four hundred fifty dollars so that was your Valentine's Day plan now because of the risk that you're taking on with these ten puts your broker is actually going to require you to have two hundred fifty five thousand dollars in your account to make sure that if there's a really big move down in the market you could be obligated to come up with a large amount of money to pay for your obligations for those ten puts and that money needs to be in your account now in options trading there's a concept called Delta and it's defined in different ways but it roughly equates to the probability that you'll actually have to pay off on options that you sold so if an option has a delta of twenty then there's a 20% chance that the option would expire in the money which would be a bad thing because then you'd have to pay off on the option you sold as opposed to just walking away with the money that you got for selling the options you don't have to figure it out on your own incidentally every major options broker will tell you the Delta of any option for you on their platform so anyway let's say your system which would be a very common system let's say that your system is that every time the Delta of your option gets up to 20 then you'll buy back that put and roll it down to an option on that same options chain that is now a 10 Delta option which is safer and farther away from the market and because at that point you'll almost always be down money on the trade then you'll have to sell more options in order to be able to make money on the trade at the end of the day so at this point you might think well hey if the market sells off that's okay I'll just roll my options down to a lower strike and sell enough options at the new strike to still be able to make money on the trade right so I mean I really can't lose ultimately can I I just keep rolling down till I win right I mean the market will eventually bounce right always does in other words you'll get lured into options blunder number five which says I'll always win eventually if I keep rolling my short puts down right and this is a very common belief among beginner option traders now before we explain why this idea which seems so logical on the surface is actually completely and utterly insane and will never work I wanted to let you know that there really are sound techniques for trading options for income and in fact we're currently running a - our free intensive workshop where we'll be teaching you three of the strategies that real professional options traders use including a really simple but incredibly effective strategy that some of the greatest investors in the world like Warren Buffett use all the time plus an options trading strategy that has a statistical 80 percent probability of profit month in and month out plus an option strategy that you could employ with a stock that you like where you'll make your target profit whether the stock goes up goes nowhere or even goes down as a small percentage so if those strategies would be of interest to you then you should check out the free options class that we're currently running just go ahead and click the link that should be appearing now at the top right corner of your screen that will open the free registration page in the new window so don't worry you won't lose this video or you can just head on over to options class com to register for this free intensive workshop it's a rare opportunity for retail traders and investors to learn directly from Wall Street traders but that's exactly what you'll be getting through this free online workshop so click the link to sign up now and don't miss it so let's get back to our example so we sold those 10 puts at twenty forty twelve days out from the expiration and now let's move forward to August 20th now on that day the market opened up down sharply most traders will wait till about 10:30 to make moves on their options income trades and so in this case the 2040 options had actually moved up to 41 deltas which makes sense now that the markets of 2050 to the 2040 options we sold are only 12 points away with nine days to expire so shouldn't be surprising that the chances of those expiring in-the-money have now risen to 41% so with our protocol once we get into the area of 20 or higher we have to roll the options down to closer to the 10 Delta options at that time so let's take a look at what happens next it's important to understand this so our protocol dictates that we must buy back to 2040 puts well those have really increased in price because now they're so close to the market so the ones selling them is now taking on a huge amount of risk if there's a 41% chance that they'll have to pay off and so to close those short positions and buy those back is going to be very expensive and in this case it's $16.25 but remember you only sold those for 3 dollars and 45 cents so to roll your puts is gonna cost you a lot of money so now you'll see that we've rolled down but we also increased our size to 35 put options now it's crucial for you to understand why we had to increase to 35 put options so remember we originally received three thousand four hundred fifty dollars for the 2040 puts well to close them and roll them down we're gonna need to pay sixteen thousand two hundred fifty dollars now if we roll down to the ten Delta options at the 1975 strike you'll see that they're priced at three dollars and ninety five cents so even to get back up to about just one thousand dollars of cash flow you need to buy thirty-five of them because much less than that and you don't even overcome the deficit from the first roll well now the market would have to drop a lot to hit those 1975 puts but still you've taken on the risk now of thirty-five foots so now your broker is it going to require a ton more capital from you and in fact you'll need over eight hundred nineteen thousand dollars of capital to roll down and we've just gotten started so yes it's possible to sell enough puts to have positive cash flow but it requires a lot more capital than the original trade now let's move forward to the next day you'll see that the SPX is now sold off again this time down to 2015 so that has pushed our 1975 puts to 27 Delta's so it's time for us to roll those down again 50 points 19:25 strikes which are a hundred fifteen points below our original strikes so now let's take a look at why we had to sell 75 of those well remember the deficit from the first roll was twelve eight but we brought back in thirteen thousand eight twenty five from selling the thirty-five puts but now to buy those back as the market has sold off so dramatically we will need to pay twelve dollars and fifteen cents and we've got 35 of them to buy back this time so it will cost us forty two thousand dollars to buy those back and roll them down and now it will take us seventy five options at the nineteen twenty five strike to make up all of that loss from the previous rolls and still be able to eke out about a thousand dollars from the trade but now that we're selling seventy five options our broker is going to require us to have in our account over 1 million six hundred sixteen thousand dollars because of the much larger risk of this trade so by now I think you may already have figured out where this is going and I won't go into as much detail on every roll but just quickly at the end of that same day August 21st we had to roll again and this time we had to roll down to the eighteen hundred strike and sell two hundred eighteen puts just the turn our cashflow positive again because at that point we were down a hundred fifty four thousand dollars on this trade and now our capital requirement has skyrocketed to over four million dollars three days later the market tubes again and now we're down three hundred fourteen thousand dollars and we're forced to roll down yet again but this time we have to sell that's right 365 puts to get to barely positive cash flow and now our capital requirements have ballooned to six and a half million dollars so let's just summarize to show you how unseen this guy we started out with ten puts and a capital requirement of two hundred fifty five thousand dollars and by the time we're done we were selling three hundred sixty five foots and our broker was requiring us to put up over six and a half million dollars in our account to cover our risk now that was the roll and at the end of the day you would have in fact made money on the trade the market did bounce at that point and the trade would have actually been very slightly profitable when the options expired but that's obviously not the point the real point should by now be fairly obvious you started out with a nice idea to buy your wife or girlfriend some jewelry on Valentine's Day and you end up before the final roll downs three hundred fourteen thousand dollars on the trade and having to put up six and a half million dollars just the more or less breakeven on the trade now why don't you close your eyes and just imagine the slow-motion train wreck of this trade even if you did have a spare six and a half million dollars lying around do you think you would have exposed it to this trade when you were down three hundred fourteen thousand dollars and had to sell three hundred sixty-five puts just to put yourself into a position to basically break even on the trade will allow me to bring you into the real world no one has no emotions and no one has an infinite amount of capital and even if you did I have never met the person who would just keep digging a deeper and deeper hole for himself even though it's an undeniable fact that if you threw enough capital this trade you'd always eventually make a little bit of money but you're human and you do have emotions and you certainly don't have unlimited capital and so one point you would cry uncle because you wouldn't be able to take the risk and the pressure of this trade if you can't intuit that from this presentation then just take my word for it you would have bailed out at some point in this process and taken a huge loss so please do yourself a favor and do not ever get trapped into the thinking of options blunder number five I'll always win eventually if I keep rolling my short puts down right the irony is that it's an absolutely true statement but it's utterly an insane and impossible to tolerate in the real world not the fantasy world of no emotions and unlimited capital professional traders would never fall into this trap and you shouldn't as well now just to remind you as I said earlier if you enjoyed this video and learn something valuable from it and would like to learn the details of three real-world often strategies that professional options traders use all the time then you should check out the free options class that we're currently running just go ahead and click the link that should be appearing now at the top right corner of your screen that will open the free registration page in a new window so you won't lose this video don't worry or you could just head on over to options class comm to register for this free intensive workshop it's really a rare opportunity for retail traders and investors to learn directly from Wall Street traders but that's exactly what you'll be getting through this free online workshop so click the link to sign up now and don't miss it and one more thing please don't forget to click on the subscribe button right now so you won't miss the next episode of huge options trading blunders and all the other free trading videos that we're posting constantly on our channel to help you to improve your game as an options trader

Channel: SMB Capital

Views: 43,012

Rating: 4.783186 out of 5

Keywords: rolling short puts, rolling shot options, short put option, short put option explained, short put option graph, short put option payoff, short put option strategy, short put option with example, put option strategy, put options, put options explained, put options trading, put options trading for beginners

Id: SmMsPFLFqc0

Length: 17min 50sec (1070 seconds)

Published: Wed Feb 12 2020