‘Houston – We have a Situation…’ (DIA)

As time wears on you, you get to noticing things that completely escaped you when you were younger.

For example, it struck us recently that there are folks who tell you that they’re “good drivers.”

That means they drive fast.

There are others who tell you that they’re “safe drivers”.

That means they drive slow.

And it struck us, too, that in the options trading game, one wants to be neither too fast nor too slow, but always at the ready to close one’s trade at le temps juste – the appropriate time.

He who’s in a rush to make vast wads of cash will inevitably be either too slow or too fast to shut down. Whereas he who is involved solely in the trade itself, and is not distracted by any larger goals he may have for himself and his family, or by the television set or by his dreams of yachting with the Windsors in Fiji, or any other considerations – he alone will succeed in that particular trade.

And we gotta play them as they’re given to us –

oneatatime

While we’re on the topic of successful trading, there’s an aspect of the business that’s generally given short shrift, but that we believe is the sine qua non of good traders everywhere and we want to spend a moment discussing it.

It’s ‘money management,’ and it’s worth a word or two.

What’s it mean?

 

In simple terms, money management refers to the amount of cash allocated to any particular trade, and, to a lesser degree, ‘trade selection,’ or ‘planning.’

Cash Allocation

When we talk about how much to devote to any particular trade, we’re essentially talking about losses and how to avoid taking a wham-doggy. Why? Because cataclysmic losses don’t just eat away at the trader’s principal. They also destroy his confidence. A trading loss of $2000 on a portfolio that’s $200,000 strong, hurts, but it can be recovered by a diligent and focused trader in good time. A $70,000 or $80,000 loss on the same portfolio leads inevitably to depression, bad choices and further losses.

bighit

The trader’s loss of principal is a tragedy in itself, but an inability to cope with that loss is far worse. And believe me, it can take a trader years to recover from a body blow of that nature. More often than not, it leads to a desire to make things back in a hurry, to be a good driver instead of a safe one, and eventually leads to a complete depletion of resources, strength, and, in the worst cases, to the street, hospitalization or jail.

Money Management is Important

 

We generally advise never to put on a trade in the options market that represents more than a percent or two of your overall portfolio’s worth. And if you’re feeling supremely confident, up to three or four – but never more. Know the risk profile of your trades, too – exactly how much you stand to lose. And where that figure is unlimited, always trade with stops and never EVER undo them.

One more item.

 

We mentioned above that money management also involves proper trade selection. And what do we mean by that?

Consider –

Ostensibly, stocks can only move up or down. That fact makes every trade essentially a 50/50 proposition. And even though reality is a lot more complicated than that, the salient truth is that either a CALL purchase or a PUT purchase should, at some point in the life of the option, be a winning proposition.

To our everlasting sorrow, however, this simplistic understanding leads a great many new traders into a gun-slinging approach to their trades. If it’s 50/50, they say, I’ll just take a stab and close her down if I’m wrong.

The problem with that strategy, is that by skipping essential questions of market momentum, a stock’s technical structure and the issue of time horizon, the rookie trader is left to the whims of the minute-by-minute seesaws of the market, and will almost inevitably be whipped out of his trade on a too-early loss, or leave a clearly losing effort on the plate for far too long and blow everything in the process.

We’ll speak more about proper trade planning in an upcoming letter, though, in truth, it’ll likely involve a larger discussion of technical analysis, and will have to be broken down into a multi-part series.

rudy

This Week’s Trade

 

We’re going to focus our trade this week on the woes in the oil patch – in a way.

In fact, to call them woes is an understatement. A 50% drop in price in half a year is an abysmal showing, a bollock-whacking that competes with pa’s woodshed hidings when we didn’t finish our mung-bean soup.

Here’s oil –

shockdrop

And what’s to blame for the cliff-edge decline? Depends who you ask.

At first, we believed it was the alleged secret deal between Saudi Arabia and the U.S. to bankrupt Russia, a country over-reliant on energy revenues. And that still might be the case. But we have to consider that the drop could also be an overreaction to a drop in demand.

That’s what corporate raider and all-round oil big-shot T. Boone Pickens says. He notes the steep fall in the rig count as an indicator of shrinking demand and a harbinger of even lower prices. And he could be right, though the 50% mark is usually a threshold bounce level.

That’s the second biggest drop, by the way, in a quarter century, and we believe it’s going to unnerve a goodly number of stock operators.

And for that reason, we’re going to set today’s trade on the SPDR Dow Jones Industrial Average ETF (NYSE:DIA), which yesterday declined 330 points, and we believe hasn’t finished crumbling.

See here –


dia1615

RSI just went sub-waterline and MACD crossed lower (in black) and our take is that the momentum will carry DIA as low as her 274 day moving average (red arrow) in the near term.

It’s for that reason that we’re going to recommend a speculative near-term PUT purchase that goes like this –

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Options Trader Elite recommends you consider the purchase of DIA February 167 PUTs, now trading for $1.96.

[/mepr-rule]

[mepr-rule id=”988″ ifallowed=”show” description=”executive_lounge_members_only”]

Options Trader Elite recommends you consider the purchase of DIA February 167 PUTs, now trading for $1.96.

And be measured, folks. No more than one or two percent of your portfolio.

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With love of the hunt,

Hugh L. O’Haynew, Senior Analyst, Normandy Research

See what people are saying...

  1. Connie Douglas

    What is the speculative near-term PUT purchase?

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