One of the silver linings of treacherous markets is they demand you fine-tune your management techniques and position sizing. In other words, you get multiple opportunities to learn and relearn the best practices for dealing with losing positions because so many trades end up moving into losing territory. This contrasts with easy bull markets where many trades turn profitable from the outset and never turn back.
One such position my Team Phoenix lab is wrestling with right now is an ill-timed naked put play in Marathon (MRO). You’ll recall energy stocks were red-hot this year, riding high on surging oil prices. We spotted a high base pattern when MRO was trading near $31 and sold a Jul $26 naked put for 45 cents. It was a low delta and far enough out-of-the-money to handle all but the deepest of selloffs.
Then, well, we got one of the deepest of selloffs, lol. MRO has fallen for nearly eleven days straight in a disgusting display of bearishness. It now sits at $22 placing our once $6 OTM naked put $4 ITM. Now, this leads me to the question that prompted today’s missive.
“Did you anticipate the sell-off in MRO, when we made the trade several days ago? And how do you feel about it?”Dr. W.
The short yet unhelpful answers are: “heavens no” and “mildly annoyed.”
But, as I said, those responses are hardly surprising, so let’s unpack this a little and see if I can’t shed light on how I’m handling the situation.
When entering a bullish trade I do my best to find quality patterns (bull retracements, bull breakouts, and Fade the Fear) and pull the trigger when the chart moves in the right direction. No matter how great the analysis, there’s always a chance the stock moves against me, particularly when we’re in a bear market. This year it’s actually been rare to have a trade not move against us at some point.
This is why it’s imperative we have a management plan. More on that in a second.
As for how I feel when a trade moves against me – I’m not a robot. So, yeah, there’s some displeasure and annoyance when trades sour. But I’m far less emotional than I was when I started. It comes with time and experience, proper position sizing, and understanding that the outcome of any single trade is irrelevant in the long run. When I was a wee lad, I would only do a few big trades and obsess over every one. Now I do many small trades and don’t really care about the outcome of any single trade. In fairness, I have a larger account than I did fifteen years ago so I have the luxury of being able to do lots of trades versus only a few.
As for the management plan for MRO, it’s the same as any naked put we enter with my lab. We scale in to give ourselves 3 chances of picking the low. Then, if the stock never bounces to give us the opportunity to take profits or breakeven on one or all of the tiers, I either roll out the put at expiration to extend duration while avoiding assignment, or I take assignment and sell covered calls until the stock comes back.
Occasionally we’ll exit when the stock hits the short strike but I didn’t take that route with MRO because it’s a cheaper stock and it has juicy options premiums so I think I can work it back to a profit over time.
We’re currently in two tiers of the $26 naked put. I entered the second one on Wednesday for $2.95. It’s currently worth $4.30
- Tier One: 43 cents, unrealized loss of $3.87
- Tier Two: $2.95, unrealized loss of $1.35
- Average Credit: $1.69
- Cost Basis if assigned 200 shares = $26 – $1.69 = $24.31.
- Capital requirement to carry 200 shares on Margin = $2,431
- Capital requirement to carry 200 shares in IRA = $4,862
Next steps for me:
- Consider adding tier 3 once MRO finally pivots and pushes above a prior day’s high. I will keep a tight leash on Tier 3 if I enter.
- Consider exiting Tier 2 into strength at breakeven if I want to get smaller.
- It’s too late to hedge or add bear trades unless we get a strong bounce.
Final point. There are two ways to manage naked puts. One is to use tighter stops. Your average loss will be smaller but your win rate will shrink because you’ll get whipped out a lot. The other approach is to use loose stops or none at all. Your average loss will be larger but your win rate will rise because you’ll never get whipped out and most of the trades will recover with time and good management. I use the second approach in Team Phoenix and it requires sitting through the occasional large loss. Marathon Oil is one of those. My confidence in the management techniques, patience and willingness to let the trade play out, and sizing small enough relative to my overall portfolio all contribute to eventual success.
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