How to Make Money Even When We Are Wrong with Options

Every Tuesday Chuck releases a new Trader Tip video on YouTube. This week we will discuss: How many of you out there have had either a trade or a series of positions, that your trade was making money, making money, making money, and you were feeling really good about the trade and feeling really good about yourself, and then all of a sudden, BAM!, your trade turns against you, has a big one day move against you, and you see all the money that you made on the position evaporate?

You can read the episode transcript below or watch the video that follows.
If you have any questions, please reach out to us. We look forward to being a continued part of your trading education!

Welcome to episode seven of Trader Tip Tuesday, where today we’re going to talk about how you can make money even when you’re wrong.

Before we get into this, I want to step back for a second, I want to ask you just to think for a moment about some of your trades.

How many of you out there have had either a trade or a series of positions, that your trade was making money, making money, making money, and you were feeling really good about the trade and feeling really good about yourself, and then all of a sudden, BAM!, your trade turns against you, has a big one day move against you, and you see all the money that you made on the position evaporate?

How many of you have experienced this? I’ve experienced it a lot. And I’m sure like you, when I’ve gone through it,

it can be almost demoralizing because you think you’re doing really well, and then bam, the money’s gone, and it makes you really question yourself. Like, what could I have done differently? How could I have managed this trade better? It actually leads you to a series of questions that you have to be really careful about. Because if you answer these questions wrong, you actually set yourself up for further failure in the future.

But it sucks to lose all this money.

So today, we’re going to talk about how to make money, even when we’re wrong,and part of this is addressing this scenario where we make money, make money, and then when the market inevitably has these big counter trend moves, we make even more money. You probably say that’s not possible, Chuck. But it is possible, and this is why you see me talk over and over about the power of options.

When you have the right option structures on it’s like being able to share yourself against losses.

When I work with traders, the number one rule, rule number one that I tell traders, is your job is to come back tomorrow. That’s your primary job, just be able to come back tomorrow and trade tomorrow. Because if you’re able to come back tomorrow, you’re able to come back the next day and you’re able to come back the next day, eventually you’re going to figure it out, and eventually lightnings gonna strike and you will make a bunch of money. So in order to be able to come back tomorrow, we have to make sure we don’t lose all our money today. So when we can learn how to make money even when we’re wrong, when we can learn how to insure our positions from these big one day or one week draw downs, it will revolutionize your trading. Many of you lately have been long stocks, long crypto or long other risk assets. And this month sucks man, it really sucks. Because every day, every frickin day it goes down. And you’re seeing months of profits gone, this in a matter of a few days to a week.

Well, you want to listen to this.

Because this turns that around for you this is going to take that pain away and it’s going to give you confidence. It’s going to give you strength to hold through your positions and do things the right way. Now this is a topic for a whole workshop. We’re gonna get deep into that today. But let’s get in and show you some examples. Let’s work through an example of how you can make money even when you’re wrong.

We’re gonna talk about the anatomy of making money on a losing trade.

On December 20 2021, we get a buy signal in the stock Louisiana Pacific LPX at 7197. So what we do is instead of buying stock, we buy 10, Jan 72 and a half calls, which are worth 50 delta. So this is equivalent to buying 500 shares of LPX, but instead of buying shares themselves, we buy calls that will mimic being long 500 shares. So right out of the box, our LPX works. But in early January, it corrects, and it kind of comes back near our entry point. Then it starts to rally again, but this time when it starts to rally, we actually start getting divergences in the market approaches an inflection point. And at this inflection point, one of two things are going to happen, it’s either going to pop this in through this level, and it’s going to take off, and we’re going to want to still be long, or it’s going to roll over and it’s going to go back down and divergences are going to bite, and the markets gonna sell off. So we’ve been long to this point.

What we want to do, because we trade options, we have the ability to neutralize our exposure, but still benefit from the upcoming move.

So what we do is we buy 20, jan 77, and a half puts. Our original 72 and a half calls that were long 10 of have now moved in the money, and they’re now worth exposure of 900 shares. So we’re really we’re long 900 shares of LPX. By buying 20, jan 77, and a half puts each of these puts has a Delta of 45. So buying 20 of these is the equivalent of selling 900 shares. So we’re long 900 shares from our 72 and a half calls, and now we’re selling 900 shares by buying a 77 outputs, and our exposure is now zero. Now, if you don’t trade options, and you do this, you’re out. And you’re going to have to be chasing the stock higher if it does break through the inflection point. At this point, our plan is if the market rallies, because we’re long calls and long puts, it’s actually going to generate long deltas, long exposure, and if we get a confirmation signal, as we’re generating long deltas, we’re going to sell out the puts we bought and get even longer, and off we go.

Now, the opposite side is if the market breaks, we’re going to generate short exposure because our calls have limited gains have a limited loss profile, and our long putts, will move in the money. And we’re long more putts than we are long calls. So if the market breaks, we’re going to get shorter, we’re actually going to be short on the break, and our plan is to start buying stock covering our short exposure and actually getting long. That way, by doing so, if the market does reverse higher, will not only be long, but will be getting longer as the market rallies up again. This is because when we have long options we generate what we call long gamma. So the market does indeed break on January 14 2022, and at the end of the day, we have gone from flat to now be short 560 shares on the clothes. Remember our plan is to be slightly long if we break. So we buy 700 shares in, 560 shares to flatten out the shares we were short, and an additional 140 shares to be long. Now, from this point, this is on the close to the 14th on the 18th LPX moves significantly lower. So when we went home, we were long, wanting the market to go up. This is where we would make money. But we come in LPX breaks and so even though we were long to start the day long shares but long deltas as we break on its 18th we end up making $2,656.

So if we step back for a second for most people when they’re long stock, and the stock breaks hard, like what happened last week and this week, they take large losses.

But the construction of our position allowed us to be long throughout the boot, we started long and we were long the whole time except on the 13th when we got into an inflection point we got flat. We were never short, we got flat. So then the market had the one day break. We got short, we weren’t short when we started, we were flat. But at the end of the day, we were short, we flattened all that out that went long again. So the majority of this move were long, long, long. But the positions that working. So you can see this is where we get long, we get long on the close here, we get some good follow through, but then the market corrects back, and our trade actually goes to a slight loser, then it bounces. And now this bounce is when we hatch. This is when we buy the 20 puts. And when the market comes in, we cover our short Deltas that are generated from our position and we actually get long here, then we have this big down day on the 18th. These are the individual quantities and prices of this trade. So going long 10 Jan 72 and a half calls at $3.50 on December 20. Buying 20 Jan 77 and a half puts at $1.50 January 13. The market breaking by 700 shares of LPX at 7560 on the clothes getting us long again. And then on 18th market breaking again, in which at the end of the day, the Jan 72 and a half calls are worth 43 cents. The Jan 77 and a half puts are now we’re $7.35 and we have 20 of them. And the LPX closes 7008. And we’re long 700 shares of that. So on this trade, this trade ends up making $4,422 Even though we were long the whole time. And on the day from January 14 to January 18, the big down day that we came in long. These were the closing prices on the 14th. These are the closing prices on the 18th. You can see it generates a profit of $2,656.

So why did this work?

Well, one, we didn’t buy stock, we bought calls, we bought calls instead of stock. The second reason was at the inflection point, rather than sell stock to get out. We bought puts. We bought at the money put stack to flatten out our exposure, but keep us in the game for movement. We ended up creating a position that gets longer as we rally and shorter as we break. So at that inflection point, if LPX had rallied, we get longer longer longer. Plus, you could solder putts to get longer still. Or the market could break and we go from flat to shorter, which we would cover those shorts and go long, anticipating another bounce back up. The fourth reason is we create a position that is long volatility and has limited risk. So when we get into these high volatility conditions, options don’t go to zeros quickly because the markets moving so much. And our risk is limited, because we’re long options.

Hopefully this stimulates some thought for you because you can actually cover your ass, and make sure that these big days that usually blast your account can be a thing of the past.

Think what that would be worth you. Think of the confidence you could have in making trades, knowing you knew your worst case, knowing that you’re not going to get blasted anymore. Think the conference that brings your trading it allows you to focus on when you cover your downside. You could focus on the upside, you can focus on letting your trades go. You can focus on managing them and finding new opportunities. If that works for you think about what that’s worth to you. Not just in your trading, but it’s that will make your trading more stable, more consistent, and that is going to have a positive impact in your life. It’s gonna bring you more confidence it’s going to bring you more certainty. These are things are going to affect your physical being. It’s gonna affect your health, you’re not going to deal with all the stress. It’s going to affect your relationships, your relationships are going to be stronger because you’re not stressed. You’re not losing money. Your spouse is not upset with you, and it’s going to affect your entire portfolio your entire financial picture. Because you know, your draw downs are limited. You have to avoid draw downs. The key to compounding is not not having drawdowns. So remember that.

Hopefully you found this useful. Join me next Tuesday. For our next Trader Tip Tuesday webinar where I will continue to bring you new content and new ideas.

So have a great week and God bless!
– Chuck Whitman