Short poll on money management & losses.

I had asked this question in another post but mostly got people responding who didn't’t know what a covered call was and started ranting about margin requirements and naked shorts. So I’m keeping it real simple this time and just asking people to pick #1 or #2.

Actual scenario- GSF breaks above previous resistance at $77 and your strategy is to go long if it hits $78 with a tight stop at $76.50 if the breakout fails. You buy at $78, the breakout does fail and the stock drops to $76.50. Do you:
1.Sell the stock and take a loss or
2.Sell a Jan 09 call with a strike price of $50 at the bid for $28.70.

If you selected #1 you are out $150/ lot.
If you select #2 and sit on the stock, when Jan.09 comes around and the call is exercised against you, you receive $50/ share to go with the $28.70 per share you received from the call to make this a winning trade of $70/lot
This makes a difference of $220/ lot. ( minus $1 and .05 cents / share commission) .

I’m curious to see how other traders look at money management and taking losses, and whether sitting on $7650 worth of stock to save $220 and not take a loss is worth it to them.

 

You're kidding, right? Ask yourself what will happen if the price in Jan09 will be above 78/between 78 and 50/below 50. What are you risking? For what? So, isn't the answer obvious? Shouldn't you be focusing on the next winning trade instead? (Hint: never work around a losing position. Only luck can help you then...)

 

(1) Your rate of return is very low. (2) What do you do if the stock goes below 50, 40, 30, 20, 10, 5, 1, 0.01? (3) Tying up money in a losing trade keeps you from getting into something better. (4) You're exhibiting perfectionism when you have trouble taking small losses. (5) The correct choice is 1. (6) The "difference" between 1 and 2 is the bank interest you'd earn by putting the $7650 into a money market.

 

you dump it like a second wife before she figures out a way to get the house, car and boat.....i learned not to make that mistake from the first wife.

 

So, let's see what you have. You bot the stock at $78 and sold the call at $28.30. So your worst case risk is $49.30. In other words, you are risking $49.30 to make $0.70, which is 1.42%. Also, don't forget the cost of carry, which adds up to quite a bit given there's more than a year to expiry.

Overall, this sounds like an amazing use of capital.

 

"So, let's see what you have. You bot the stock at $78 and sold the call at $28.30. So your worst case risk is $49.30. In other words, you are risking $49.30 to make $0.70, which is 1.42%. Also, don't forget the cost of carry, which adds up to quite a bit given there's more than a year to expiry."

Actually, to keep it simple I left out that you could buy the Jan 09 put for $145 if you thought the stock could drop below $50.

Thanks for the intelligent answers. As you can probably guess, I would sell the call and sit on a winning trade before taking the loss. Especially when my plan would be to buy the call back at a lower price if when the stock hit the previous support level it held and started to climb again.

I'm not saying my way of trading is a good strategy. I probably have an 90% success ratio of winning trades trying to be a perfectionist, but don't make much $ and am looking at what more successful traders do.

 

<i>"I probably have an 90% success ratio of winning trades trying to be a perfectionist, but don't make much $ and am looking at what more successful traders do."</i>

Successful traders get real good at taking small losses with indifference. That clears the way to capture large wins relative to those small losses.

I guess you've heard all that before

 

"I probably have an 90% success ratio of winning trades trying to be a perfectionist, but don't make much $ and am looking at what more successful traders do."

Just an idea.

If your goal was to achieve a high success ratio then voila, you did. But as you can see "don't make much $" and I think that is often the case when we are sold on the idea that high number of winning trades are necessary for big $$.

The missing piece is the risk vs reward to make more money and in this case, you have a high success rate (low risk) and the (high)risk becomes more capital percentage to boost your earnings. Small gains,you have to invest more.

There are plenty of examples where it is not the number of winning trades but the gains from the lower number of more profitable trades that offset the larger number of immediate losses.

I remember calculating the rr on "late trade mutual fund timing scandals" Those guys were risking over FOUR DOLLARS to return a penny. The success ratio was in their favor.

 

Yea my initial training wasn't the best. I had no system for entering trades, just my gut feeling for the day. I was scalping options on the Q's and OEX. I would try to buy at the bid and sell at the ask and pocket the difference. If it went against me I would wait for the tide to turn and double up at the bottom and cash out when I broke even. Actually worked well and my only loses were when I got cold feet on large orders and took a large loss instead of doubling up.


Anyway, that was then, this is now and I am looking to get more systematic in my trading.

 

Actually, to keep it simple, long put+short call+long stock=zero, i.e. it's a flat position.