Active-Trader - Amer Weekly 3d 0h 6m left

Welcome back Active Traders and Wealth Builders.

It was a breakthrough week for my trading career with my TradeStation account rocketing out to a new all-time equity high.  Overall the year to date performance is not that impressive at 6%, but I tacked on about 3% for the week which is pretty solid.

Its ironic because in last week's post The Mind of the Trader, I was bemoaning my lack of performance in this account.  Based on that I should blog about my limitations more often!

So along those lines, I still have some heavy lifting to do regarding my trading.  Specifically, I am not position sizing properly and taking profits too soon.  And a trade this week in YELP was a perfect case in point as follows.  John Carter was back from his European vacation this week and live and in person in the Simpler Options Trading room on Wednesday for the market close.  He saw a beautiful setup in YELP with the stock close to $56 per share and he put a short term target on at about $62.5 per share which was a Fibonacci extension of the recent pullback.

His response was typical and almost automatic: 1) Sell the at the money put credit spread, and 2) Buy delta 7 calls.  I followed along and sold 2 of the Sept 21 52.5/55 PCS in my TradeStation account and bought 1 YELP Sept 21 48 calls at about $8 in each of E*Trade accounts.  At the same time, Carter bought 200 of the same contracts in his account!

Based on my account size, 1 contract was 0.0029% of my E*Trade accounts or about 2 tenths of 1%. Based on JC's account size, his trade was about 10% of his account size which is about double the normal 5-6% of his account that he risks on a solid trade setup.

What happened next is even more interesting.  YELP gapped up on Thursday  to just below the prior all-time high at $59.  I sold 2 my contracts for about $10 and make $200 each.  Carter instead held on to his 200 contracts until Friday and sold them at $14.  So based on that trade alone, I made $400 and John Carter made $120,000!  How interesting is that - 2 traders presented with the exact same stock and exact same setup and 2 completely different outcomes!

So let's examine my actions here:

1) Why did I sell the YELP contracts at $10 when the stock was clearly short of its target at $62.50?

2) Why did I buy only 1 contract when (based on the 5% position size guideline) I should have bought about 20 contracts?

The answer is the same in both cases: Fear of losing money.

In the first case, I was afraid of losing my $200 gain and since it was only a $800 investment, a $200 gain is 20% in 1 day which is pretty good, right?

In the second case, I was afraid of losing the $800 since I have the mentality that when you buy an option contract, you have to be able to accept the complete loss of the premium paid.  For me $800 seems like a lot of money, but I can deal with losing $800.  But I can't deal with losing $16,800 which would be the amount at risk had I taken a position of about 5% of the size of my E*Trade Account.

I don't want to be too hard on myself because the future is unknowable.  And I have been trading long enough to know that you always have to be prepared for the worst case scenario.  But its clear that I am trading with the mentality of someone with a $20,000 account when in reality my account is many times larger.  How ironic is it that fear of losing money prevents you from making it?

Another thing I learned this week is the power of selling weekly options.  Consider these facts:

1) 80% of Options Expire worthless and Weekly Options expire every Friday.

2) Based on the pricing patterns, it makes the most sense to wait until Tuesday, then sell weekly option spreads based on where you think the price will not go.

In my case, I sold AAPL 485/490 PCS, the AMZN 285/290 PCS and the NFLX 285/290 PCS.   I all these case, all the stock had to do is close above the short strike (higher of the 2 values) for the trades to go out at max profit.   I took max profit in AAPL, but closed out AMZN and NFLX about 50 cents short of the full credit of 1.80 - more trading based on fear.

3) Once it the trade, all you have to do is wait until Friday expiration.  The passage of time works in your favor as you can see from the graph above.  The option premium decays faster the closer you get to expiration.  Keeping a cool head in these situations is something I need to continue to work on.  In many cases, I close the trade out early in an effort to lock in gains and minimize the chance of loss.

Enjoy your weekend and good trading in the week ahead.